Have you ever wondered why most businesses fail in the first 10 years? It’s not high taxation, recessions, or other more obvious reasons. When a contractor goes out of the business, it’s almost always because of cash flow problems. When a business runs out of money, the business ends. Here is the most probable reason why a contractor might have a cash flow issue:
Lack of profitable sales.
Not charging enough for your work has to do with one thing: not knowing your real company markup or gross margin numbers. Every company should establish its own markup based on their company’s overhead and desired profit margin. Using someone else’s numbers for your company can be disastrous.
There’s a popular myth that there is a certain percentage (overhead and profits) that a contractor should use, 25% or 30%, and that by simply adding this on top of the job cost, you’ve figured out your sale price. Even worse, some so-called “industry experts”, like those you’ll find lurking in insurance companies, will tell you that contractors should use a 10% overhead and 10% profit margin. But, where do they get these numbers? How do they come up with this formula?
Well, there’s a reason why this approach won’t work: you don’t know for sure that those “industry standards” will support your company’s overhead costs and the net profit you intended to make when you started your business (if you even planned that far ahead). Your company should have a unique markup factor or a margin percentage based on your company’s financial situation. Here’s why:
#1 Your company will not have the same overhead as your competitor.
Let’s say you have a business with a big office, a warehouse, a bunch of equipment, service trucks, a full team of production managers, job supervisors, sales reps, a marketing department, and a couple of owners, each with their own salary expectations. The overhead costs list can go on and on.
On the other hand, your competitor may be a one-man operation, running his company from home with no equipment, service trucks, or office rent. He’s managing all the sales, running the jobs, and maybe even doing all the work. His company might not even make a profit, but he makes a good enough salary, so he doesn’t care.
It’s obvious that these two companies will have two very different margins or markups. Your office, team, and equipment help you deliver more value to your clients than the one-man show, but if that value is not reflected in what you charge, you won’t be doing it for very long.
#2 Every company will have different expectations of how much net profit is made off each sale.
Some of the big construction companies have profit-sharing programs for their top-performing employees and/or management teams. Smaller companies probably aren’t in that position (yet). Depending on the size and financial situation of your company, profit sharing can be an excellent way to retain talent and keep company morale high. But it’s something you need to decide in good time. This serves as another reason that you need to develop your own markup or profit margin formula based on your revenue, real overhead costs, and desired profit.
Here’s the wrong way to calculate a job’s sale price:
Job cost + Overhead + profit = sale price ❌
And this is the correct way:
Job cost x markup = sale price ✅
A deep understanding of how to establish and use the right markup, gross margin, and breakeven points for your company should be your #1 priority as a business owner.
If you don’t think you’re working with the right formula to mark up your jobs and you’re serious about your company’s financial success, I encourage you to watch this video where one of my best mentors explains “Calculating Your Markup”:
Finding your ideal crews and building trust with them takes time and effort, but once you find high-quality crews, the relationship can go on for many years. If you would like to learn more about how we train and manage our crews, contact us at office@prochoiceroofing.com.