Understanding Profit, Job Cost & Mark-Up

funnel_with_headerJob costing for builders and contractors is the important first step in running a profitable business.  Contractors make a profit when the job costs, estimates and mark-ups are accurately calculated. Yet, many have trouble doing the math that delivers the target profit.

One of the recurring lessons I teach in the CASHFLO Academy is that you should focus on cash flow instead of profit.  That does not mean profits are not important.  In fact, if you look at the 7 Key Numbers that Drive Your Business (learn more here), you see they work together to result in profit. One problem is that many small business owners don’t understand profits.  That might be because there are so many similar sounding terms people use to measure different elements of “profit.”

In today’s business world, it’s vital to understand the relationship between gross profit, job cost percentage, and mark-up.  The most important thing to remember is that if you know your gross profit or you job cost percentage, you can easily figure out how much of a mark-up you need for your products.

Let me provide you with three simple steps to master your understanding of these terms and offer you some examples to help you feel more comfortable using them. To begin to figure out how much of a mark-up you need for your products, you must first decide on the company’s gross profit goal. Keep in mind that your gross profit should NOT include your overhead costs or your ideal net profit.  Once you’ve determined your ideal gross profit, you are ready to calculate your optimal product mark-up.

The relationship between gross profit and mark-up.
Mark-up and gross profit are all related, both mathematically and using common sense.  In fact, they form a sort of interdependent triangle, just like revenue, expenses and profit do.  Let’s first look at them using common business sense.If you want higher gross profits, then you will need to mark up your prices high enough to generate sufficient revenue to supply these higher profits.   So higher mark-ups lead to higher gross profits, all else equal.  In essence, the difference between mark-up and profit is your cost to perform the job or sell the product.

For example, if you sell a job that costs you $50 to complete and you want to receive an extra $25 gross profit to cover your overhead and net profit, it’s easy to figure out you need to sell the job for $75.  So, you mark up your costs of $50 by $25 to arrive at the price of $75 for your customers.   In this example, your mark-up is 50% ($25 of the $50).  This is the same whether you are talking about a service (job) or product. By the way, a lot of people get tripped up on this part.  Do you divide your gross margin by the costs or final price to get your mark-up percentage?  The answer is costs.  And, here is how to remember that.  It’s called mark-up. This means you start from the bottom (costs) and add on top of that.

In this example, you are marking up the price by another 50% of the $50 cost.  This tells you how to price other jobs as well.  If a job were to cost you $60 instead of $50, you would still mark it up by 50% to arrive at a new sales price of $90 ($60 x 150%). The other calculation, dividing your gross margin ($25 in the original example) by the final price ($75), is important as well.  That is called the gross profit percentage.  In this example, the gross profit percentage is one-third or 33%.  This tells you that for every job you sell, you keep one-third for profit.

Remember:  Gross profit is based on SALE PRICE and mark-up is based on COSTS. So, that is the relationship between gross profit and mark-up.

In the next post we’ll explain job cost percentage and how to accurately calculate that important number.

Additional resources:
CASHFLO Academy
7 Key Numbers Overview

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