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Many construction contractors equate "mark-up" with "gross profit". Why not? They come out to the same number in the end, right? Not quite.

Consider the contractor that estimates the costs for a contract at $100,000. He then adds 20% to the job, "to cover overhead and profit." The contractor then wins the contract with a bid of $120,000. At the end of the contract the contractor has earned $120,000 and incurred $100,000 of cost, leaving $20,000 of gross profit. However, that gross profit is only 17% of the contract revenue ($20,000 / $120,000 = 17%). This example doesn't even take into account the cost of unapproved change orders, weather, delays or any other general conditions that eat into gross profit. That 3% difference between mark-up and gross profit is a big deal, especially in an industry where 3% may be the difference between having a net income for the year or a net loss.

The other important point to consider is that most business thinking is done in terms of gross profit such as break-even analysis, planning, budgeting, and benchmarking. If the gap between mark-up and gross profit is not clearly understood, it is possible that you are setting yourself up to fail before you even win the bid. They are not interchangeable terms!

Many contractors respond to this by saying, "That's nice, BUT, I am limited in what I can bid by what my competition is bidding." That is where the entrepreneurial spirit comes in. Do you have, or can you develop, a more efficient method of providing your trade compared to your competition? Are you able to specialize within your trade, or should you diversify more? Should you self-perform more or subcontract more? What other options are there?

If you are interested in discussing this topic further, the Certified Construction Industry Financial Professionals (CCIFP) at Rea & Associates are ready for you. We are CPAs who have earned the highest financial designation in the construction industry. Collectively, we have over 60 years of experience in the construction industry.

- by Dan Allman, CPA, CCIFP (Dublin Office)


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