We’re halfway through the year. It’s a good time to look at how your business is doing by checking your year-to-date figures against your goals. There’s still time to make adjustments as necessary.
With that in mind, I’d like to address two quick issues. The first is your Profit and Loss (P&L) statement. Construction is different than other businesses, and your books need to be set up differently. Your P&L should have 5 sections: Income, Cost of Goods Sold (COGS), Gross Profit, Overhead or Expenses, and Net Profit.
The most common problem I see with a P&L is categorizing things improperly. Items that can be charged to only one job belong in COGS. Items that can be charged to two or more jobs are overhead.
When you have items in COGS that are used on numerous jobs, like tools and small equipment, or when you have items in Overhead that are job-specific, like permits and rental equipment, you aren’t getting good information. If your CPA or bookkeeper doesn’t understand construction and doesn’t set up the chart of accounts correctly, you’re going to calculate your markup wrong and won’t be charging the correct price for your work.
The items in COGS should be identical to the items you consider when you estimate a project. You don’t include the cost of your tools in your estimate, so tools shouldn’t be in COGS. You do include rental equipment in your estimate, so rental equipment should be in COGS.
Labor is always an issue; the important thing is to be consistent. If you pay your employees $20 per hour and have an additional $15 per hour in payroll taxes and other direct benefits, your fully-burdened labor rate would be $35 per hour. The most common approach is to use that $35 per hour labor rate when estimating your jobs. Include payroll taxes and direct benefits in Cost of Goods Sold.
It’s also acceptable to estimate jobs using the $20 per hour labor rate, as long as the payroll taxes and other direct benefits are included in overhead when you calculate your markup. As long as you’re consistent, you’ll account for all labor-related costs in either your estimate or your markup, and you’ll be covered.
When your books are set up properly, it’s easy to calculate your markup, and it’s also easy to compare your actual results to your estimates. The information you need is available and can be analyzed quickly.
The second issue to address is the quality of the data used to calculate markup. If at all possible, use data that has some substance and longevity. You want to look at your job costs and overhead expenses for a period of at least a year or more.
A year’s worth of data is a much better reflection of your business than just a month or the last quarter. It represents the type of projects you’ve built and is a far better picture of actual overhead expenses. Adjust as needed, of course; you need to consider potential or known increases in insurance, rent, or salaries for office staff.
If you don’t know how to calculate your markup, we cover it in detail in our book, Markup & Profit Revisited. If you’re new in business, we also discuss how to estimate your annual volume and overhead needs in the book.
Take the time to collect the data you need and get your numbers right. Better data means you’ll have a better chance of charging the price you need to be able to pay your bills and take care of your family.
One more thing on markup: I often read articles discussing markup, gross margins, net margins, and how much profit is too much. At the end of the day, one number matters. You’ll find it on your P&L, last page, bottom line, right-hand column. That’s your net profit, and that’s what counts. Your goal is at least eight percent; if it’s below that, figure out why and get it fixed. If you’re not sure how, give us a call. We’re here to help.
The knowledge and experience Michael Stone gained in his 60+ years in construction has helped thousands of contractors improve their businesses and their lives. He is the author of the books Markup & Profit Revisited, Profitable Sales, and Estimating Construction Profitably, and is available for one-on-one consultations.
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