Mark Up and Margin are confusing terms in the construction contracting industry. It seems as though there is a slight bit of difference but the concepts produce widely different results. If you care about profits then, you should be interested in knowing more about each concept.
Let’s look at the how they can affect a contractor’s profit and thus, wealth building.
Mark-up is a profit percentage as a factor of cost. As most of us know, if we have a $100 cost and want to make a 10% profit then, we multiply .10 by $100 and add the result – $10 – to our cost of $100. Our price to the client is $110.00. Simple enough.
Alternatively, margin is the use of a profit percentage that is a factor of revenue.
To calculate this,
1) Take 1 and subtract the percentage desired (1-.10)
2) Divide the remainder into the cost (100/.9)
So in application, our $100 cost is divided by .9 is $111.11. The 11.11 of profit is exactly 10% of 111.11.
Another compelling reason to use margin is that all other costs are budgeted as a percentage of revenue. It follows that so should profit. So as we plan for the coming year, our employees and we will be accurate in marking up work. Good, consistent financial results over years are a result of discipline. Using this and other insights only push profits higher.
If you plan on making 10% on revenue, your people cannot achieve that using 10% on cost. As an aside, most suppliers use margin to calculate their price and thus profit. Their’s is a challenging business but, that process allows them to be paid more for their trouble.
Still another reason to use margin is that some clients restrict your profit % on change orders to a certain percentage. Margin would be the better way to go. Condition your bid to accomplish this.
Now, there is an old saying about “sell on margin and buy on markup”. What does that mean? The first part is explained previously. The second part is a little odd.
Buying on markup – cost plus a percentage on that cost – makes that product or service cheaper to buy and thus, allows for more margin. If you do the math, it is a gain of over 15% as compared to buying on margin and selling on markup.
There are no windfalls left in construction or as a high government official once said, “No unknown unknowns”. The business is about taking small insights and leveraging them such as using margin instead of mark-up in both buying and selling.
For more information on this critical subject, purchase a copy of my McGraw-Hill book, Managing a Construction Firm on Just 24 Hours a Day. We offer a bundle with Excel templates that are featured in the book and 5 on-line courses to help teach construction business concepts.
Our workbook companion with 10 case studies for Managing a Construction Firm on Just 24 Hours a Day is now available. This text is focused as an assist for Colleges, Associations and Contractor Training Programs that teach the business of construction.
My next book, The New Business Model of Construction Contracting is planned for December 2007. It focus concerns the changing construction environment and what processes address those changes.
Matt Stevens is President of Stevens Construction Institute, Inc. A management consulting firm which works only with construction contractors. Learn more at www.stevensci.com