Avoid Financial Pitfalls
Most pitfalls in this business are related to budgeting, planning, and understanding cash flow needs.
Understanding The Relationship Between Overhead and Volume
There is an old saying that flits around the construction industry. It goes something like this, “As your volume goes up, your overhead expense comes down.” Most people who have been around for a while have heard at least one contractor say, “Well, that job was quite a bit larger than the jobs I normally do. So I was able to cut my markup since my overhead was lower.” But it simply isn’t true.
The fact is: As the dollar volume of jobs sold and built goes up, your overhead expenses go up as well. They do not go down. As you build your jobs, you spend more dollars on overhead. The percentage of your overall overhead budget does come down, but only in proportion to the total volume of work being done. This is a perfect example of how the old saying has created problems over the years. There is some truth to it, but only when you are dealing in percentages of your total volume built.
Can You Cut Your Markup on Larger Jobs?
It depends. If you are using a sliding scale and have the discipline to raise your markup for smaller jobs, than yes. If a job is large enough to increase your projected sales volume for the year, you should take the time to recalculate your markup factor. There is a good chance you will see that with the higher sales volume, a lower markup factor is justified. But if you cut your markup on larger jobs and leave it the same on smaller jobs, you won’t have what you need to pay your overhead expenses and make your projected profit.
Don’t Compare Apples To Oranges
Contractors doing remodeling or specialty work are in a cost-based, service-oriented business that is labor-intensive. As they do more and their sales volume goes up, they acquire more overhead expenses, both fixed and variable. Contractors doing either new home or commercial building construction are in a more commodity-driven business. They have lower overhead expenses, to begin with, but their business is also labor-intensive.
If you have doubts about the relationship between volume and overhead, check your own company books for any two-year period when the volume of the second year was more than the preceding year. If your books are in order, you will see that your true variable overhead expenses went up, but your percentage of total overhead compared to your total annual volume of sales went down.