We’re going to quickly address a few questions we recently received.
Is your definition of net profit pre-tax or after tax?
When we talk about net profit, we always talk pre-tax; it’s the profit you make before you pay state or federal income taxes. If you’re incorporated, your business pays taxes from net profit. If you’re a sole proprietor or an S-Corp, your family pays the income tax on the net profit from your business.
As a side note, while we’re talking about taxes, if you’re required to collect tax from your client on the price of their job, make sure when you quote the job that you clearly state it’s “this price, plus tax.” You can word it a number of ways, but be sure they understand that the sales tax (or whatever you’re required to collect) is not included in the sales price. Also make it clear on your contract. You don’t want to hear “we didn’t understand” when it comes to collecting payment.
I’d also collect that tax on every payment made. Don’t wait until the end of the job to collect taxes from your client that you need to send to the state. If they decide not to make their final payment, you’ll be paying those taxes yourself. Collect taxes as you go along.
How do you calculate markup if you’re new in business, or don’t have any historical numbers?
We cover this in the book Markup & Profit Revisited. Calculate your personal financial needs, ie, the money you need to earn to pay all your personal bills, then divide that figure by an appropriate percentage based on how long you’ve been in business.
Example: If you’ve been in business fewer than five years, divide your income needs by eight percent. That will tell you how much business your company must sell, build and collect so it can afford to pay that salary. Don’t forget to include a percent for saving and giving, and a percent for income tax. Let’s say you need to take home $60,000 a year before taxes. Divide $60,000 by .08; your company needs to produce $750,000 to pay that salary.
As time goes on, you can bump the percent that you can pay yourself as salary but I’d limit it to ten percent. You don’t want to create cash flow problems for your business by paying yourself more in salary than the company can afford.
Will Markup & Profit work for a one man home improvement business as well? I’ve been crunching the numbers and I have to produce A LOT for being a one man show to hit what I came up with. Just curious if this formula works for smaller construction entities?
Yes, the formula works for every business because math is math. You have to charge a price that will pay all the job costs, all your overhead expenses, and make a reasonable profit.
But remember, if you’re a smaller company or a one-man show, you won’t spend all your time running your business. You’ll likely be working on the jobs part of the time. The wages you pay yourself to work on the job needs to be included in every estimate. You’ll probably also handle all sales, and you should be paid a sales commission. Assuming you need $60,000, subtract the wages you expect to earn while working on jobs and your sales commission from $60,000. What’s left is what you need to earn as the owner; divide that amount by eight percent. That’s more realistic.
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.