5 Tips to Determine Sales Price as a Contractor
One of the most common questions we get here at Esticom from new contractors is: how much they should charge for their work? What they’re really asking is how much can they charge for their work, and is there a standard profit margin percentage that other contractors are using that would be considered “acceptable”?
As a general rule, businesses that manufacture and produce a finished goods product such as contractors should aim to reach a minimum 30 percent gross profit margin as a low bar. What we mean by gross profit margin is the profit (sales minus cost) divided by the sales price that is required to produce the finished product. Gross Profit Margin is the sniff test your CPA will use to gauge if you have a healthy business or not.
Now as a contractor, you might not use a profit margin percentages to price your jobs, because many contractors use the overhead and profit method to sell their jobs which is fine, but when the dust settles you’ll want to land around 30 percent GPM to ensure you can keep the lights on long term.
- Material – $1,000
- Labor – $1,500
- Equipment – $500
Total Costs – $3,000
Job Costs $3,000 x 45% (30% markup + 15% overhead) = $1,350 profit for a sales price of $4,350 or 31% gross profit margin
How did we determine the gross profit margin? Divide the profit by the sales price, so in this example: $1,350 / $4,350 = 0.31 x 100 = 31%
Ultimately you’ll be able to charge what the market will bear, but you have to make enough profit margin on the work you’re doing to stay in business and make it worth the risk you’re taking on. So how do you handle a market that will not pay a fair price for your services? You’ll have to decrease the cost of your services, or sell the value that you’re offering to get a higher sales price. I hear all the time contractors complaining that they cannot sell jobs at a decent price, but they refuse to use lower quality materials, tradesmen, etc. This is a mistake, while I love the idea of providing a high quality product and “Grade A” craftsmanship, but someone has to pay for this high quality product and it shouldn’t be you as the contractor. If you do not make this adjustment you’ll be in financial trouble before you know it.
One suggestion would be to offer A/B quotes for your customers where you give them a higher grade product at one price with a secondary option that uses a lower grade product at a lower cost and a lower warranty period. This will give them perspective to make a choice and it removes the burden from you.
All markets are different when it comes to competition, some have more work than contractors to do the work and can increase price to accommodate the demand, while others have so much competition prices are driven down and profit margins shrink as everyone races to the bottom to win projects.
So how do you determine your sales price?
- Know your Costs – Knowing the cost to complete a project requires that you perform a detailed estimate outlining all the direct costs (labor, material, equipment rentals, etc.) and indirect costs (estimating, sales, marketing, office lease) to run your business
- Use a Known Good Bid as your Baseline – Bid an old project using the detailed estimating method described above to figure out the delta between the project cost and your sales price. Did you make out well on the project? Subtract the cost from your sales price to get your profit in dollars, now divide the profit by the sales cost and multiply by 100 to get your profit margin percentage that you can use moving forward and adjust over time as demand increases.
- Ask for Feedback – Submit a few bids and ask for feedback from the General Contractor and keep a log. Are you high or low and make adjustments from here, so if you’re losing because you’re too high, ask how much higher and lower your next round of bids slightly. Be careful that you’re not going too low, aside from the obvious of losing money, you can actually turn General Contractors away when you’re too low and there’s a good chance you’ll win the project but leave money on the table.
- Refine your Numbers Over Time – Review your bids and refine your process until you’re winning a comfortable enough amount of work, but with enough profit that it is worth your effort. Once you’ve got a backlog of work you should start increasing your price slightly until you find a sweet spot.
- Hire a Construction Accountant (Consultant) – Hire an accounting firm that specializes in construction sooner rather than later. This will do a few things for you, first it’ll remove some of the guesswork as they more than likely can tell you standard profit margins in your area and secondly they’ll give you feedback on where you’re landing after you’ve completed a few projects.
Remember, profit is the reason you’re in business. As demand for your services increases, it’s good business to increase your margins starting with the 30% profit margin baseline we mentioned above, and do so without apology. On the flip side, when demand is down, it’s not wise to take on low margin projects just to keep your staff busy — as this is a recipe for disaster. For example, at times you’ll have to make corrections in the size of your staff, but when things slow down you need to make corrections early to ensure you avoid cash flow issues. In short, selling to just stay busy, and taking on bad (read: not profitable) work is not the answer. It does come back to knowing your sales price, but you start with knowing your profit margin.
Estimating Profit Starts with Knowing Costs
My biggest word of advice is this: No matter how much profit you aim to attain, make sure you’re being honest with yourself about project costs. Knowing your costs will allow you to predict, with a reasonable degree of accuracy, what your actual profit will be at the conclusion of the work.
When comparing your actuals to projected costs, there shouldn’t be too heavy of a swing one way or the other. Going over allocated budget is a clear “don’t” but do you know why you should also care about being way under the budget?
If you’re awarded a project and the anticipated cost was $30,000 and you finish the project at $15,000, then that means you’re not estimating the work accurately. First of all, this is bad because it probably means you’re losing other projects by estimating too high and you’re not being competitive enough.
Secondly, it also means that you’re inflating your cost and staying competitive by reducing your profit margin and overhead at the estimating stage. Best practice is to have your actual costs close to projected costs so you can make informed decisions.
Finally, consider this – what if your next project is more competitive and you’re asked to offer your best and final price? You will be guessing at best because you will not know that you have fat to trim since you’ve inflated your costs. You’ll have a slim chance of being competitive now.
At the end of the day, it pays to know your costs! A detailed estimating method is the only way to know the true cost of taking on a project.
In closing, you need to understand your risk, costs, competitive landscape, and cash flow obstacles in order to determine your reasonable profit margin. Only then can you intelligently determine your sales price and bid for confidently.