For contractors and small construction businesses, calculating profit isn’t always straightforward. Unlike product retailers, these companies provide a service using labor, materials and equipment to clients to earn their income. There are a significant number of other direct and indirect costs to consider too, making profit calculations quite a challenge.
Working with an accountant is a common practice in the sector. However, the utilization of reliable and efficient construction management software that integrates all cost and income-generating activities can monitor your company’s transactions very efficiently—helping you calculate profit margins more accurately.
Before using the software, it helps if you have a solid grasp of what profit margin means as a construction business owner. Consider the tips below to ensure that you are calculating yours accurately and operating to the level that is acceptable to you.
1. Understand The Basics
Income generally means any amount of cash gained from a business transaction, while profit or margin means the amount of money left following specific expense deductions divided by revenue. Without proper knowledge of what constitutes profit and expense, it’s hard for any business, including construction companies, to develop a realistic view of its financial performance.
As such, construction companies must learn to identify and compute overhead expenses and markups effectively. These two are the main factors that impact a construction company’s profitability.
Overhead expenses refer to the costs of doing business which means they cause income reductions. On the other hand, markups refer to the additional costs contractors must charge to cover their costs and earn profit from the materials and services provided. Learn more about these concepts and understand how accounting for profit margin works in a construction company.
2. Learn To Calculate Different Types Of Profit
After learning the basics, entrepreneurs must know the different types of profit and how to arrive at correct figures even without the help of an accountant.
- Gross profit/margin- refers to the total amount earned minus the costs of goods sold or COGS divided by revenue. The term applies to manufacturing costs, raw materials, and labor fees in the construction sector.
Gross profit calculation: Total income – Cost of goods or services sold
Gross profit margin percentage: Gross profit / total revenue x 100
- Overhead/Operating profit- represents the revenue left after the cost of doing business or overhead costs have been deducted from the gross profit. Recurring expenses such as rent, insurance, and employees’ payroll are included in the overhead costs.
Operating profit calculation: Revenue – Overhead Costs – Cost of Goods Sold (COGS) – Other Day-to-Day Expenses
- Net profit- Also called net income or bottom line, it refers to what’s left after cash inflows and outflows have been considered.
Net profit computation: Gross Revenue – Business Overhead and Taxes
Net profit margin: Gross Profit – Business Overhead and Taxes / Total Revenue x 100
Your company’s net profit is an indicator of your business’ financial health. As such, owners must have concrete figures for gross revenues and overhead expenses to calculate a realistic amount.
3. Know Your Actual Overhead Figures
Ideally, every company should project its operating expenses to know how much it needs to keep the business afloat. Along the way, organizations must ensure not to spend past their monthly or yearly operating budget.
For contractors, labor, material, and subcontractor fees are considered direct costs as they’re directly tied to the project. Rent, taxes, and insurance are indirect costs, including administrative spending to complete particular tasks.
Overheads can also be considered a business investment that one has to spend to yield returns. For instance, some construction companies set a goal of earning anywhere from 20% to 50% of their pre-tax net profit return. If a business expects to spend USD$300,000 yearly, it can set its net profit amount from USD$60,000 to USD$150,000.
4. Review Your Cash Flow
In identifying operational costs, it’s necessary to look at your cash flow to spot any other expenses impacting your profit margin. Account receivables or transactions that have been done but aren’t paid yet are considered sales revenue and should be added to the net profit. Inversely, excluding your account payables, such as debts, taxes, and other financial obligations can render inaccurate net profit margin figures.
5. Automate Your Accounting System
There are several financial considerations involved in running a construction business. For instance, contractors don’t just provide materials and pay for the labor costs of installers and technicians. In most cases, they’ll have to rent equipment and pay for electricity and fuel for this. Similarly, labor costs don’t only cover an employee’s hourly or monthly salaries. These include health and worker’s compensation, insurance, and other benefits. The cost of logistics such as fuel, vehicle maintenance, and repairs need to be included in the calculation too.
With the said things in mind, it helps to have software that integrates all activities and expenses to better monitor your business cash flow. Ultimately, materials, labor, and equipment costs are easier to calculate with available figures from the software.
Generating income is essential to any business. And high-profit margins ensure the sustainability of a construction company.
Understanding these key business components is crucial in calculating profit margins with better precision. Most importantly, the figures enable you to identify the profitable cost of every construction project. Without these, contractors will find it challenging to arrive at reasonable bids and projected earnings, increasing the risk of undercharging and business failure.