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 last 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 the amount of money expected as profit on completion of a job, it must necessarily start with a reliable estimate which guarantees a lucrative contract.
Any negligence or omission in the estimate may diminish or nullify the expected benefit and cause financial problems.
Markup – Formula
Markup is the amount by which the cost of a budget is increased in order to obtain the selling price.
We apply the markup to the quotation as follows:
1 – As a percentage of the final cost of the estimate – Cost markup.
Final price (no taxes) = cost + cost * (% cost markup)
If the cost is 1 and the markup 20% the price is 1.20.
2 – As a percentage of its selling price – Mark-up on price
In this case we will obtain the final price as follows.
We denote the unknown final price as Pf.
Pf = cost + Pf *(% markup)
From the formula, we clear the final price (Pf) and we have:
Pf = cost / (1 – (% markup)
If the cost is 1 and the markup is 20%, the final price is 1.25.
Profit Margin – Formula
The profit margin on a work is the cash remaining after all expenses to perform it have been paid.
The first case has a margin of: [1.20 – 1/ 1.20] *100 = 16.66 %.
The second case has a margin of: [1.25 – 1/1.25] *100 = 20.00 %.
The margin 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 work.
-The risk that the bidder considers reasonable to assume, etc.
How to Calculate Profit Margin – Typical Contractor Profit
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.
How to Calculate Profit Margin – Calculate Man Hours.