Making a decent profit starts with bidding. There are a couple of bidding pitfalls that, if you’re not alert to them, will negatively impact your bottom line, and will render your powerless to protect your profits once in production.
1 ) Not using the most up-to-date figures for the cost of employees (everyone is paying more for employees these days).
2) Not using the correct overhead markup percentage (many people get this wrong). See my post of May 17, 2018, for more on this.
3) And, if you don’t understand the difference between markup and margin, your profits will start to bleed before a project even begins.
In this post, I want to focus on #3 – Markup vs. Margin.
Markup vs. Margin
A surprising percentage of contractors and business owners will confuse markup and margin. Each figure helps you set prices and measure productivity but, a margin vs. markup chart shows that the two terms reflect profit very differently. It’s important to know the difference between margin and markups in your pricing because when you don’t you can mistakenly price yourself too low.
- Markup is the percentage you must add to the direct cost to cover both overhead expenses (including owner salary) and profit.
- Profit Margin is a profitability ratio calculated as net income (revenue less costs) divided by revenue. Essentially, your rate of return.
For those who do not know the difference, a large markup can seem like price gouging, even if the profit margin is reasonable.
How it works in dollars and cents…
While explaining these terms may seem basic and obvious to some, knowing the difference is vital to both the short- and long-term success of your business. It’s also important to be able to explain to those who “just don’t get it” that you are not indulging in “unethical” business practices.
With that in mind, let’s examine a markup and compare it to margin.
- If you buy a product from a supplier for $100 and sell it for $200, you’re working on a 100% markup. However, this does not account for overhead and can be misleading.
- In this scenario, your profit margin is 50%, gross profit (selling price less direct costs) divided by the selling price. When overhead costs (office salaries, rent, utilities, etc.) are deducted, your net profit margin will drop even more.
When bidding you want to have a gross profit margin goal that is sufficient to cover costs with a net profit left over. In other words, if you have a hefty overhead of say 50%, your 100% markup will not allow room for profit – you’ve just broken even.
Like my client Constantine Contracting (not their real name), when they first came to me, their revenues had been growing steadily for the past four years, but their profits had declined dramatically. They went from making $200,000 net profit on $5,000,000 in revenue to losing $250,000 with $15,000,000 in revenue.
What they had not taken into consideration was the large increase in overhead when they were pricing projects. They hoped that doing more volume would make up for the shortfall. That mistaken thinking can destroy a business.
But, if you work on a higher gross profit margin, you can cover your overhead costs, and still make a decent profit. Applying the right markup and having a gross profit margin goal are two key ways for you to protect your profits.
Constantine did this and within six months they started producing a consistent profit on their bottom line.
I appreciate this is a deep subject so, if you’re wanting a bit more depth and understanding on how you can start marking up enough to get your desired margin, check out my article, Markup and Margin Explained where I go into more detail on this subject.
As always, if you have any questions or comments to add to the topic – please drop a comment below or feel free to reach out to me on Facebook or LinkedIn. I’m happy to help and very interested to hear how others get on with implementing these tools into their business.
Warmest,
P.S. If you’ve enjoyed what you’ve read here (and hopefully learned something), you’re probably going to enjoy my upcoming book too, “The Profit Bleed: How managing margin can save your contracting business” – it takes a deeper dive into what I’ve talked about above (and more).
If this is something you might be interested in, please join the tribe of other like-minded folks who want to grow their bottom lines too! When you join you’ll get my recording on “How to Always Make a Profit” that’s full of ideas on how to improve your bottom line.
Vicki Suiter helps people see their businesses differently, then gives them the tools to do things differently. Since beginning her business in 1990, Vicki has helped hundreds of companies achieve the kind of success they never dreamed possible. Today, in addition to consulting, Vicki is an in-demand speaker at industry conferences nationally and internationally. Vicki’s articles and opinions have been widely shared in print and across the web. She is also the author of forthcoming book “The Profit Bleed” How managing margin can save your contracting business.