As Profit First professionals, one of the things we’re most passionate about is sitting down with business owners, looking at their financials, and helping them discover effective strategies for realizing real profits. One thing we’ve noticed is that a number of our clients have questions about one specific area of profitability—that is, pricing.
It all boils down to a fairly simple question: Are you charging the right amount for your services? You obviously don’t want to charge so much that you lose all your business to more-affordable competitors, but neither do you want to charge so little that you’re missing out on high profit margins.
Markup and Profit
And all too often, the calculations involved here are oversimplified. Here’s an example. You decide that you want to make $25 on a particular service offering. It costs you $100 to provide the service, so you charge your customers $125 for it—easy enough, right?
Actually, it’s too easy. That $25 represents a cost- plus approach—but cost-plus is not the same thing as applying markup to achieve the profit you deserve. Cost-plus minimally will cover your cost of goods but will not cover your overhead and profit—so while charging $125 may allow you to tread water, it’s not necessarily going to add to your savings account.
Confusion between applying markup and cost-plus causes many contractors to charge less than what they really should. Remember: Cost-plus simply refers to what you charge beyond the direct cost of an item. It doesn’t address things like marketing costs, job supervision, sales commissions, office expenses, insurance, licensing fees, taxes, employee benefits—you get the idea.
Returning to our example of the $25 cost-plus, then, that contractor may not even break even, much less turn a profit. The question, then, is how do you calculate your markup?
Calculating Markup, Ensuring Profit
First, understand that, in calculating your markup, you must include both overhead and profit. If you don’t account for overhead, you’ll lose money. And if you don’t make profit, you won’t be in business for long. Companies need to generate profits to survive, plain and simple.
Calculating your overhead means adding all those “soft” expenses—basically any costs or spending your company does over the course of a year—to find your break-even point. Those costs should be factored into the markup for each job you do.
Something else you’ll need to know is the cost of goods—basically, the direct cost of each job, before any markup. This includes materials and supplies but also the hourly rate of your employees who work the job.
When you add your cost of goods, overhead, and whatever kind of profit margin you want to make, you may find that you need to come close to doubling the direct cost; so, returning to our previous example, rather than charging $125 for a $100 job, charging $200 is probably much more realistic.
There are online calculators and apps you can use to help you with the specific numbers; we recommend the Marcus Margin Calculator, which you can download from the app store of your choice. It offers the ability to input your costs and the desired margin who want on the costs to get to your selling price.
The key to this is understanding your overhead and profit needs. Typically, a successful HVAC and Plumbing business needs 25 percent to 30 percent in overhead costs and achieves minimally a 10 percent Net Profit. Therefore, you need to have a markup to achieve a 40 percent Gross Profit Margin. The markup for this is 1.66 multiplied times your direct costs. A 50 percent Gross Profit Margin is 2.00 times the direct costs.
Of course, we also recommend giving Contractor in Charge a call. We offer free consultations, and we’d love to sit down with you, look through your books, and help you determine what you should be charging for your services. Ultimately, we want to show you how to make your company truly profitable. Start that conversation with us today; reach out to Contractor in Charge now!