Markup and Margin Explained for Remodeling Contractors
As a business owner, you need to be on top of your financial picture to ensure work is being priced correctly and that you’re profitable on every job. Otherwise, you could just stay home and go broke.
Both mark-up and margin play a role in making your business profitable, so it’s important to understand the key differences between these two terms.
Because if you aren’t charging the right mark-up, you won’t achieve the correct margin, which means you could be choking your company’s cash flow, and selling your work at a loss.
What is the Difference Between Mark-up and Margin?
To understand how to use each of these in your remodeling business, it’s important to first define them.
When pricing your work, you have three things to consider:
Cost of Goods Sold (Labor, Material, Trades)
Contribution to overhead
Contribution to profit
Those contributions to overhead + profit come from the mark-up you charge and the margin you yield.
Mark-up is the percentage that you multiply your Cost of Goods (COGs) by to come up with the total price you will charge your client.
Margin (also known as Gross Margin or Gross Profit Margin) is an expression of the gross profit received from the mark-up compared to the total price you charge your client. In other words, it’s the space between your COGs and the Total Price you charge.
The higher the mark-up percentage you charge on your cost of goods the larger margin you’ll earn.
Why Are Mark-up and Margin Important?
Simply put, margin and mark-up are important because using them is the only way to generate revenue to pay for your overhead and provide your company with a net profit.
Not charging the right mark-up percentage on your selling price will leave you with cash flow issues, and keep you caught in a vicious cycle of having to choose who to pay, and when to pay them. This is particularly common if you’re using bank balance accounting to measure your profitability.
Margin and mark-up are also important because a “poverty line” exists in any business, and if you're beneath this you won't be in business for much longer. Using a mark-up percentage below a certain level (typically in the low teens), means you’re selling your work at a loss. This chokes your company’s cash flow because you aren’t bringing in enough revenue on each job to cover the cost of goods, overhead, and profit.
The Relationship Between Mark-up and Margin
In my coaching business, I talk a lot about how to calculate mark-up and margin, particularly when I’m working with clients to review and tweak their pricing models.
(Learn how to figure out your ideal mark-up percentage and build your pricing model by booking a call with me.)
Here’s a quick example to illustrate the difference between mark-up and margin percentages on a remodeling project, and how you use mark-up to calculate your margin.
Let’s say you have a project with cost of goods (COGs) totaling $100,000.
In this example, we're going to assume you are using a 25% mark-up. This means that we are going to multiply your Cost of Goods by 1.25 to come up with the total price we charge your client.
Cost of Goods: $100,000
Mark-up: 25%
Formula: $100,000 x 1.25 = $125,000
Gross Profit: $125,000 - $100,000 = $25,000
So if we had a $25,000 Gross Profit on this project, what is the margin? (Remember, margin is the space between your Cost of Goods and the Total Selling Price you charge your client.)
We express this by taking the Gross Profit ($25,000) and dividing it by the Total Selling Price ($125,000).
$25,000 / $125,000 = 20%
This means that your Gross Profit Margin on this project is 20% when you charge a 25% mark-up.
Take a look at some of your projects right now and calculate your Gross Margin to ensure you see the relationship between mark-up and margin.
The Pitfalls to Avoid When Setting Your Mark-up and Margin
You need to learn how to calculate your own unique mark-up based on your company’s revenue, cost of goods, and overhead expenses. The amount of mark-up you need to charge does change over time and should be reviewed frequently (monthly or quarterly at least.)
The key to running a successful remodeling business is understanding your complete financial picture and developing a pricing strategy that works for you while avoiding these common pricing pitfalls:
Pitfall #1- Copying Someone Else’s Mark-up
The mark-up percentage charged and profit margin that makes one remodeling business successful might be a complete disaster for another one based on that company’s overhead costs and desired net profit.
The remodeler down the road may be operating with a 22% profit margin because that aligns with their personal and professional needs. But let’s say you have plans to expand your business, add new equipment or hire additional administrative team members next year. In that case, you might need a higher gross profit margin, which means you’ll need to charge your clients a higher mark-up on your cost of goods and bring in more total revenue to make that happen.
So using their formula wouldn’t work for your business.
The other thing to keep in mind is that you have no idea if the business owners you’re comparing your company to actually understand their numbers well enough to be profitable. You don’t know if their mark-up or margin percentages truly work for them, or if they’re losing money on every project.
Your mark-up and margin are based on your overhead and desired net profit, so don’t look over the fence at what someone else is doing and think you can apply that to your business.
Pitfall #2 - Breaking Your Price
It’s in a client’s nature to always look at the price you quote them and ask you to do it cheaper or to lower your mark-up. And saying no to that prospective client can be a difficult task.
But if you do lower your final selling price to meet a client’s demand, you’re only reducing your gross profit margin, because materials and labor cost what they cost, meaning you can't reduce your cost of goods. In fact, in many cases, your COGs end up being higher than estimated.
So, by breaking your price, you are short-changing yourself on cash flow and not bringing in what your business needs to cover overhead and provide a net profit.
Pitfall #3 - Being Unorganized With Your Finances
You can’t make informed decisions about your business if you don’t have a clear picture of your company’s financials. That includes determining what the correct gross profit margin is that you should be charging. If you miscalculate it, you’ll end up in that vicious cash-flow cycle we talked about earlier, where you’re always juggling who to pay and when to pay them.
So you need to use a proper accounting system (like QuickBooks) to track and understand your company’s full financial picture - and use that information to make your financial decisions.
If you’re not accurately tracking the 5 KPIs in your remodeling business, you can’t determine what mark-up percentage you need to charge to have the right gross profit margin. Even worse, you’re leaving money on the table - or paying to work for your clients.
If you want to learn the 5 KPIs and how to calculate your exact mark-up then book a call with me.
Understand the Big Picture
Determining what mark-up to charge in order to achieve a healthy profit margin depends on your understanding of your company’s full financial picture.
That means having financial systems in place to track your revenue and costs accurately, understanding what your run rate is (the overhead costs of running your business), and determining what you need to charge in order to be profitable.
Are you looking for software tailored to the residential construction industry that can truly show you your project costs?
I created BUILDWISE to help remodelers and custom home builders keep their project finances organized, know their margins in real-time, and make the process of communicating costs to clients easy so you can profit like you deserve.
Click below to book a demo.
