Construction profits can be difficult to predict, especially as circumstances in the market continue to change. In order to get on top of your profit margins and business growth, you’ll need to get acquainted with the various costs in your business and how these can serve you to improve your business’s efficiency and overall profit.
This article will cover costs, challenges and how you can calculate your construction profit margin.
But let's get started by answering the most basic question of all!
What is a Construction Profit Margin?
In short, a profit margin is how much money your business has made.
In long, a construction profit margin is the percentage of your profit as it relates to revenue: it’s the percentage of revenue left over after all the costs have been deducted and is one of the most important metrics your business needs to keep track of.
There’s a lot more to it, of course, and we’ll cover what goes into calculating one and what it involves below.
Cost of Goods/Services vs Overhead Costs
Before we start calculating construction profit margins, we need to understand the variables in the equation. Revenues, profit, cost of goods/services (COGS) and overhead costs are all involved in calculating construction profit margins and your business’s overall profit.
If you’re planning for a job, you may need to use cost estimates to produce an estimated gross and net profit to calculate the value to your business and if a job is viable. If you want to start keeping track of your cost estimates, we have the ultimate cost estimate template ready!
It can be tricky to differentiate the COGS (cost of goods sold) and the Overhead costs, so we’ll go more in-depth about each and what falls under them.
These are the costs associated directly with the job/service your construction business provides. COGS are also known as direct costs required for the job to get underway and be completed.
Direct Labour Costs
These are the costs of labour for a job: the hours and salaries for employees. Your business can calculate rough costs in an estimate and reflect on the total cost after completion.
Equipment required for the job. This covers hiring or purchasing costs depending on the needed equipment.
All the supplies and materials you use also include the transportation costs of moving the materials to a job site.
It can be tricky to keep track of all the supplies needed for each job, liaising with suppliers and trying to get reasonable prices for costly materials.
To stay competitive and flexible, your business might need specialised tools. AroFlo’s purchase order management software is one of many tools AroFlo offers, streamlining the process of acquiring inventory and connecting with suppliers. The added efficiency of such tools leads to the following major class of costs that cut into construction profits: Overhead Costs.
These costs don’t fall under the costs of goods/services and are not directly linked to any one job, but they are the costs that keep everything running. Regarding construction profit margins, these things can cut into your take-home.
Don't worry; as you gain more experience and understanding, you’ll be able to streamline these costs and use more efficient practices.
Let’s get into these costs!
In construction, your equipment will likely get a thrashing on a worksite, and it’s essential to keep maintenance up-to-date. This may seem like a significant cost, but the last thing you want is crucial equipment failing on the job and running you over budget and over time.
Training and Development
Depending on the job, your employees may require safety training or skills development.
Worksites might require targeted safety modules to ensure workplace safety requirements such as first aid certification or correct PPE usage. Skills development includes new workplace software, documentation and detailed reporting.
Compare plans and offerings from different companies, but this is a necessary expense to cover yourself and your business. Liability, equipment, vehicle, and employee insurance are vital to have.
Licensing and Permit Fees
The kinds of licenses and permits required for each job will change. This is a case-by-case evaluation of what you’ll need to account for and if it will be included when calculating an invoice.
Indirect labour covers work such as admin, customer outreach, safety reports and accounting. Bookkeeping can take a lot of your time, which becomes an opportunity cost or the cost of hiring an accountant to take care of the books.
Improving efficiency in administration can streamline time-intensive processes and save you extra costs.
This can be disproportionately large for your budget at first. As a business is getting off the ground or expanding into new areas, you’ll want to advertise this to customers and adjust your marketing to reach a wider audience.
As you continue to grow and build a client base, a smaller proportion of your budget will be needed for marketing. In construction, getting an initial foothold will be when the advertising bites most, but it will be worth reviewing what marketing your business needs as time goes on.
One of the inevitable things in life. These include taxes on your income and employee wages.
How to Calculate Profit Margins
Now that you have an overview of the potential overhead costs to consider, we’ll cover the different profit margins and how they are calculated.
It’s important to take both into account as Gross vs Net Profit can provide valuable insights into what is affecting your business profit and where to start to improve your margins.
This will involve a lot of numbers to keep track of, and with a smaller/growing business, you, as the owner, will likely be the one doing this. If you’re managing the numbers, our bookkeeping guide for tradies is a great place to start. Looking into software to help? We have 5 tips for choosing the right accounting software for your business.
Now, for the calculations, find out your construction profit margins!
Gross Profit Margin
Your construction business’s gross profit is your total revenue minus the expenses of providing a service. This includes materials, supplies and equipment used.
To calculate Gross Profit (GP,) take your total Revenues (R) and subtract the direct costs of the goods/services (COGS) rendered, as outlined above.
R - COGS = GP
For example: R is $200,000 and COGS is $60,000
$200,000 - $60,000 = $140,000
So GP = 140,000
To calculate the Gross Profit Margin, we need to figure out its percentage of the Revenue. To do this, you need to take the GP and divide it by the R, then times this Result (Re) by 100.
GP / R = Re
Re x 100 = GPM
Using our example numbers:
140,000 / 200,000 = 0.7
0.7 x 100 = 70
So using these numbers, the Gross Profit Margin is 70%
Net Profit Margin
Net profit differs from gross profit in that it takes into account all overhead costs, not simply the direct deductions from the services/job. It’s a more realistic reflection of your construction profit margin and business performance and can highlight what expenses could be eating into overall profits.
To calculate your Net Profit (NP,) take your Gross Profit (GP) result and subtract total expenses (TE), including all the overhead costs covered above.
GP - TE = NP
We’ll use the example above to calculate this one. GP is $140,000, TE is $90,000
$140,000 - $90,000 = $50,000
So NP = $50,000
Now we do the same as we did above to calculate the Net Profit Margin.
NP / R = Re
Re x 100 = NPM
Using our example numbers:
50,000 / 200,000 = .25
.25 x 100 = 25%
Therefore, in this example, the net profit margin after all costs are considered is 25%.
Both of these examples use simpler numbers, and the percentages may not be reflective of the results your business gets. You can use estimations and job projections to come up with the rough numbers your business might expect from any job. AroFlo’s job estimation software is part of our offered tools to help streamline this process. The more accurately you can estimate and the better your construction profit margins, the more confident you can become in business cash flow and plans for growth.
Comparing Gross and Net Profit
Suppose you’re noticing a significant percentage difference in your gross and net construction profit margins. In that case, it might be time to look into your overheads and see if any areas need adjusting or can be streamlined. There will always be a difference as your business will incur various overhead costs, but it doesn’t hurt to review and change flexibility is essential for your business!
Of course, there are many external reasons why your construction profit margin might fluctuate or near a net loss.
Challenges to Construction Profit Margins
There is no doubt that the market is incredibly competitive. With the amount of money flowing into the construction sector, many businesses are trying to be the ones to snap up a share.
Labour shortages, material delivery delays, and high equipment demand can incur additional costs and eat into your construction profit margin. On top of that, these delays and obstacles can cause project overruns, unhappy clients, and opportunity costs for you and your business.
It’s a lot of challenges to your business and your construction profit margin.
Your Construction Profit Margin and Staying Competitive with AroFlo
It can be challenging to keep ahead of all these moving parts, maintain construction profit margins, and keep up with the competition. Still, with the right tools, your business can remain efficient, competitive, and flexible to weather whatever the market throws your way.
AroFlo’s construction management software is an all-in-one package that consolidates all the paperwork and admin and gives you access to your business’s needs any place, any time. This kind of flexibility and access can give your business streamlined and timely responses to any challenge.
There’s a lot of competition, but by working hard and smart, you can gain market share and look to the future for business growth. Try AroFlo today!