Profit – that elusive and mysterious thing. As small business owners, we know we’re supposed to strive for it. Yet, for a variety of reasons most of us don’t achieve it.  And let’s face it… the construction industry is a low profit margin, high risk business. 

We’re not selling widgets. What we’re selling is our time, skills, knowledge and expertise. So, the question is how to get better margins?

What’s It All About?

As a young carpenter, it took me a long time to even begin to figure out what profit was, what it meant to me, and how to work through my own personal emotional baggage around the concept of profit that prevented me from earning one for a number of years. 

And what about all those different kinds of profit – Gross Profit, Net Profit Before Tax, and Net Profit After Tax? What the heck were all those about? I certainly didn’t understand them nor did I know how to command an appropriate profit. 

I came of age in the late ‘60s and early ‘70s, a disruptive time, somewhat similar to today’s environment. Profit? That was for those “big, greedy, corporations.”  

I didn’t like school. I liked working with my hands building stuff. I was a long haired hippie carpenter who traveled around the country, seeking out cool projects to work on. I was a working man and proud of it. 

I knew my employers were billing me out at a rate twice of what they were paying me. So it seemed like they were doing pretty well off of my labor. Little did I know.

Of course, that kind of thinking helped me to decide to work for myself. Then I found out that it wasn’t so easy. Turns out there’s a lot more to running a business profitably than meets the eye. 

So, after a few rough years, in which my first contracting business basically went broke, I started to see the necessity of earning a profit. Mostly because my wife and I were living hand-to-mouth. 

I’m not a natural born businessman. Nor was I a natural born carpenter. In fact, I’ve never been a natural at any skill. The only way I’ve gotten good at something is through persistence and practice, over and over again, studying what worked, and more importantly, scrutinizing what didn’t work and what I needed to do to change that. 

I’m stubborn and I have a high tolerance for pain. Both of those traits are keys to success, especially in the construction industry.  Yet, by being hungry, overly optimistic and severely underestimating labor on jobs, I learned pretty quickly that I had to get smarter. 

I asked around and found out what other contractors were charging. I assumed that if they were able to make a living that way, then I should be able too. I had a lot to learn.

I still didn’t know the meaning of the various kinds of profit. It seemed like if you had a good Gross Margin Profit but a low Net Profit Before Tax, that was good because that meant you didn’t owe the government much in taxes. Which was good because I didn’t have anything left over to pay taxes. 

However, that wasn’t much fun. So, then we learned that we needed to get our Net Profit Before Taxes (PBT) up too.  So, we pushed that PBT up a bit, but not quite enough, because now we owed taxes on that PBT. And funny enough, it seemed to be that whatever we had left in our bank account was exactly the amount we owed the government. 

So, over time we learned how to grow our PBT a few more percentage points, which meant that now we got to split what we had in the bank with the government. That left us with Net Profit After Tax. Some of which became Retained Earnings and some went into other investments besides our business in order to diversify our assets. Which is another good survival tip for contractors and business owners.

More specifically, here’s what we did to move the needle on our profit margins.
•    We job costed every job.
•    We learned which jobs were more profitable than others.
•    We built our reputation of doing quality work.
•    We managed costs by instituting firm accounting controls.
•    We made a point of sharing what we learned from every cost overrun.
•    We stood our ground on our fee, even in down times.

That’s when things began to make some sense. It only took us about 15 years to get there. Like I said, I’m not a natural at anything. I have a feeling that you’ll probably get there much faster.

Earned Profit

Profit is not a birthright. It’s definitely not an entitlement. Profit is earned. And not just on a financial level. 

Profit is the reward for a job well done, priced fairly, executed promptly and efficiently. Profit is the incentive motive for humans to want to do a better job for others. 

Then there’s the worst kind of profit, short term profit. You see it where contractors short their trades, vendors and, worst of all, their clients. Sure it’s a quick buck, but it’s a short sighted gain. 

To really earn consistent profits means that you’re consistently providing value. Enough value that’s recognizable in your market so that your customers will willingly pay your fee. To do that means you’ve established a reputation, you’ve handled a variety of tough situations well, your work is recognized for being top quality, and you deliver results and pleased your clients. You know your numbers, how to keep score, and how to make adjustments in a constantly changing world and you can defend your fee.

Even if you’re the greatest builder in your market, you still have to deal with market pressures. You may be able to command a higher fee because of your proven record, but it’s not going to be dramatically higher. You’ll also run into clients who are tough, smooth and savvy negotiators who will try to get you to reduce your fee. Your ability to sell the job, defend and retain the right fee is an acquired skill.

Earned Profits also means that you’ve got Retained Earnings in hand, which means you’ve stockpiled some cash from the past to get you through tough times. Retained Earnings allow you to be choosy about who you work for, especially in tough times, because that’s when the sharks come out. 

By sharks, I mean those clients who set out to get a bargain, and then some. They are profit destroyers. They also take the fun out of the business.

So, Retained Earnings means when times are good, don’t take it for granted. Nothing lasts forever, neither good times nor bad. So sock some cash away.

It sucks having to take a job to ensure some cash flow for survival. Been there, done that. Those jobs are almost always losers and more trouble than they’re worth. Yet, at the time, they seem so necessary to take when you’re running low on Retained Earnings.

The Net Result

Once you subtract all your Direct Costs (labor, material, subcontractors) and your Indirect Costs (workers comp, unemployment insurance, project overhead), you’re left with your Gross Profit. 

Now subtract your G&A which consists of your salary, your fixed overhead costs, your admin, and everything else that’s associated with the cost of running your business, and you’re left with your Net Profit Before Tax (PBT). 

After you split off your shares to your silent partners… Uncle Sam and your local governments, then you’re left with your Net Profit After Tax. My advice is that you split your NPT between Retained Earnings and other investments outside of your business.  

Markup vs. Margin

Then there’s the mysterious difference between Markup and Margin. Jobs are sold with a Markup. Results are always measured in Margins. 

The markup is typically your fee. Markup is added to the cost of a job. Margin is derived from taking the cost of the job divided by the total of combined costs and fee. It will always be less than markup.

A 15% markup will yield a 13.1% margin. A 50% markup will yield a 33% margin. Here’s what I mean:

Markup: $100 cost of job x 15% markup = $115  
Margin: $100 cost of job / $115 total = 86.9% cost of goods = 13.1% Margin

Markup: $100 x 50% = $150
Margin: $100 cost of job / $150 total = 66.7% cost of goods = 33.3% Margin

Year Over Year Profits (YOY) and the Scoreboard

One of the hardest things to do is maintain profitability year over year. Markets change. Recessions rear their ugly heads. Competition increases for scarce work. Then some competitors bid jobs at cost or even below to win work for cash flow.  How you position your company, the work you’ve done, the reputation you’ve built, your understanding of the numbers… all those things and more affect your ability to maintain profitability year over year.

If you’re a fan of any sport, you understand metrics, keeping track and why the score matters. If you’re in business, you keep score with a Scoreboard based on your Financials and Key Performance Indicators (KPIs). 

If you’re like me, you don’t have an MBA or an accounting degree. Therefore, to understand your Scoreboard of Financials and KPIs, you’ve got to study them, ask questions of people who know more about Financials than you do, and work to make sense of them.  

The Scoreboard is like learning a language. Like any language, it’s an acquired skill.  You’re looking for trends. You’re looking for causations. You’re looking to see how each job that you do impacts your financials. 

For instance, what kind of job is the most profitable? What kind of client? How do you get more of those? What steps do you need to take to find more of that kind of work and less of the other? 

Every number on your Financials can be affected by specific actions. Just like a football player gets measured on every yard they gain or lose, so can your actions be measured and results modified by applying your observations to your practices, then measuring again. That’s how financial improvements are made and profits earned. Cause and effect.

Trade Contractor Profits

When I was a fledgling general contractor, my uncle Mel, a steel fabrication contractor, gave me some wise advice about developing successful relationships with my sub-trade contractors. 

“Bruce,” he said, “when your trade sub-contractor shows up on your job site, make sure that you’re ready for them.”

“If you’re not ready, and his crew has to leave your site, they’ve just lost an hour out of their day. That just cost their boss his profit for the day on that crew.”

“If for some reason, they lose two hours out of that day, then that cost their boss not only his profit, but also his overhead as well. Now the remaining 6 hours just covers their wages and their burden. So that’s time they’ll never get back, yet a full day that he’ll have to pay for.” 

“So, if you can make sure your job is ready for your trades when you say it is, you’ll not only help your trade contractor to make money, you’ll also build Goodwill. And Goodwill is extremely valuable.”

That was great advice. And leads to the discussion what is the appropriate billing rate for trade contractors. Of course, there’s the market which somewhat dictates what people will pay for the services of trades. 

Then there’s your labor costs and burden which establishes a floor. A common rule of thumb for many design and engineering professionals who don’t charge a markup on top of their billing rate is:

2.2X hourly labor cost. For example, someone making $35 / hr. will be billed out at $77 / hr. This would cover burden, overhead, and profit.

While General Contractors may generate an average Gross Profit Margin of 15% and survive, trade contractors typically need to generate a higher Gross Profit Margin than that. That’s because they’re dealing in one specialty, with lower volume, and a higher percentage of overhead.  

Taking my Uncle Mel’s point of view, that means a markup of 33% on top of your guy’s labor costs and burden. That will give you a yield of 25% Gross Margin. Assuming that your crews work efficiently, and you know how to bid your work, that might be enough. Although even then, that may not still be enough for long term business survivability. 

So Why Profit?

Well, as self-employed people, profits provides a means for survival in downtimes. It’s also our retirement fund. It’s the reward for a job well done. It’s the benefit of having provided value to someone else. It’s the incentive to do a good job so that we can do it again. 

With profit, we attract good people to work with us. By being profitable, we can provide benefits, health insurance, paid time off, and 401Ks. Without profit, none of that is possible. 

And guess what, once you start attracting great people to your company, your work becomes more recognized for providing value. Then your enterprise really starts to build on itself. Now you’ve got a flywheel. That’s the fun part. 

The Bottom Line? 
Profit: Learn the Scoreboard. Study it. Understand it. Plan for it. Earn it.

Comments? Questions? Feel free to reach out.
 

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Photo by Damir Spanic on Unsplash