How to Calculate profit margin for a Construction Project.
We define the profit or benefit as the income remaining after we pay all expenses…
These expenses include engineering costs, direct and indirect labor, supplies, consumables, equipment costs, overhead, interest, taxes, etc.
In the following figure we highlight the Item Profit margin, which is analyzed in this post.
Profit Margin – Markup for a Construction Project
The profits earned belong to the owners of the company.
The shareholders or owners of the firm can keep the money or reinvest it in the business.
In short, we calculate profits as total income minus total expenses.
The markup determination stage is just as important, if not more so, than the stages discussed above.
The determination of the industrial profit or net profit margin that the contractor seeks to get as compensation for his work is the final step in any budget estimate.
In the execution of a project, each contractor puts into play his prestige, capacity, experience, capital, equipment, and other relevant factors.
For a contractor to get at the end of a project the amount of money expected as profit, the starting point must be a reliable estimate that ensures a lucrative contract.
Any negligence or omission in the estimate may diminish or nullify the expected benefit and cause financial problems
Markup – Formula
We add the amount of profit to the budget as follows:
1 – As a percentage of the net final cost of the estimate (surcharge on cost)
Final price (without taxes) = cost + (cost *% profit)
If the cost is 1 and the profit margin 20% the price is 1.20.
2 – As a percentage of the sales price. (Margin on price)
Here the final price Pf (unknown) = cost + Pf *% margin is maintained; clearing Pf, which is what we want to know:
Pf = cost / (1 -% margin)
If the cost is 1 and the margin 20% the price is 1.25.
The markup that companies set, naturally, depends on:
-From the previous experience that each company has in the execution of similar works.
-The characteristics of the work.
-The size of the project.
-The payment terms.
-The time stipulated for the execution of the work.
-The firms against which they will compete in the market.
-The interest or need of the proponent to execute that particular work.
-The risk that the bidder considers reasonable to assume, etc.
How to Calculate Profit Margin – Typical Markup Percentages
In practice, the percentage of profits usually varies between 5 and 30%.
Commonly, high percentages are common in small and/or risky jobs.
The usual is:
-For small and/or difficult jobs, the margin to be charged is between 20 and 30%.
-On medium-sized jobs and with less risk, margins of 15 to 20% are common.
-From large and low-risk works, the margin is 10 to 15%.
-In very large and low-risk works, the margin is 5 to 10%.
Each company defines its percentage of profits or earnings according to:
-The stability of the currency in which we quote it.
-The profitability which is the percentage of return on investment measured over time.
-Occupation of its operational capacity.
-The size and risk of the work.
-The intention to achieve continuity of work with that client, etc.
In the next post Tax for Construction Contractors, we summarize the type of taxes that will apply to tenders in the construction sector.