Gross Profit in Construction
Gross profit is calculated by subtracting your job costs from your revenue or sales price. It is what you use to pay your overhead expenses and your profit. It is a dollar amount, and gross margin is simply gross profit, expressed as a percent. If your business has $1,000 in sales and $600 in job costs, your gross profit is $400, and your gross margin is 40 percent.
Now at association meetings or hanging out at the supply yard, you might hear contractors talking about their gross margin: “I won’t take a job with less than a 60% margin,” or “Anyone asking for a gross margin over 30 percent in a crook.” Everyone and their brother has an opinion on what the appropriate gross margin is for a construction business. Let me give you my opinion.
It doesn’t matter. Not one little bit. Net profit matters – that is what is left after all the bills have been paid. A gross margin is an arbitrary number, and it can be increased or decreased just by changing your accounting. Do you want a higher gross margin? Decide to move some of your job costs to overhead. Do you want a lower gross margin? Move some of those overhead expenses up to job costs. Does the IRS care? No. Taxes are paid on net profit, and as long as all income is reported as income, and all your expenses are legitimate, your net profit is correct and they will get their share.
What matters are your numbers, and your accounts have to be set up in a manner that is easy for you to understand and to work with. Once they are set up, you need to make sure your markup is calculated off your numbers. What you call job costs must be included in every estimate, and what you call overhead expenses must be included in your markup calculation. And that is how you price jobs correctly.
Leave the gross margin comparisons to the other guys. They are simply repeating what they heard from their accountant, who made an arbitrary decision on how to set up their books. Do what is best for your company and ignore everyone else.