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What should the gross profit margin be for building and construction?
Builders and tradies: How to assess and improve your gross profit margin
The building and construction industry has definitely had its ups and downs over the last couple of years. Skyrocketing material and labour costs – with building a new home increasing by as much as 26.6% in the last 12 months – has led many building and construction groups to increase pricing. However with buyers and property investors facing increased living and operating costs of their own, many builders and tradies are reducing their margins to win projects.
But what’s the average gross profit margin for the building and construction industry, and what should you be aiming for?
In this article our business advisory team explores these gross profit margin questions as well as share strategies and tips to help increase the profitability of your building and construction business.
Gross profit margins and mark-up: What’s the difference?
Before we start going further into gross profit margins, it’s important to note the difference between margins and mark-ups.
For many builders and tradies we speak to, marking-up a final estimate is often considered the profit margin added. And this misconception isn’t exclusive to building and construction, with many business owners using them interchangeable. While both consider the costs of goods, these two measures are actually very different and help you assess different aspects of your pricing.
Mark-ups
A mark-up is simply how much you should be increasing your prices before you sell them. This can be applied to services, materials and products, and relates specifically to your final sell price.
This is worked out by:
(Sell price – Buy price) / Buy price = Mark-up price
To work out your mark-up percentage, this is then multiplied by 100.
Your mark-up price should always be bigger than your margin.
Margins
Your gross profit margin tells you what percentage of income is gross profit, that is your profit after your cost of goods are subtracted from your revenue. Essentially, your gross profit margin is your cost of goods sold (COGs) and should take into account any associated costs associated with your building or construction project.
Your gross profit margin is calculated by:
(Gross profit / Revenue) x 100 = Gross profit (GP) margin
Your gross profit margin is key to understanding the health and profitability of your building and construction business.
Other than understanding your profits, what can gross profit (GP) help you measure?
Understanding and measuring your gross profits can lead to more than simply making sure you have enough sales coming in to cover operating and project costs. It can also help you measure business efficiency, identify potential business income risks, and give you insights into profitability.
In the building and construction industry, understanding your GP can help you understand how efficiently you use your materials and labour as well as how well you’re managing your project costs and if your services are priced correctly.
What gross profit margin should builders and tradies be aiming for?
There are many factors that can impact your gross profit margin, including:
- Your type of contract and project
- Project overheads
- Your business and administration structure
- Number of sales and volume of projects
- Number of staff employed and trades contacted
- Material costs and supply and demand
Economic and industry factors can also impact your gross profit margin. This is why it’s essential to keep your work in progress up to date, allowing you to catch these impacts before they become a profit-taking issue.
For cost-plus contracts, it’s common practice to have a gross profit margin up to 15 – 20%. Fixed-price contracts –gross profit margins can be greater than 25%.
Unfortunately for these larger building and construction groups, a lot of these profits are absorbed by the increased costs associated with operation, such as the advertising, trades and infrastructure required to operate at volume. Gross profit margins also change depending on the building project, with higher gross profit margins often found in the residential sector and commercial builders operating dangerously lean with single digits.
Here at Mead Partners, we recommend builders and tradies aim for a 25% gross profit margin. This reduces income risks associated with the volatility of the current market and puts you in a better financial position for growth.
Not happy with your current gross profit margin or nowhere near the recommendations above? Our business advisors can help you identify areas of improvement and strategies to increase your gross profit margin. Working with builders and tradies across Victoria and Australia, we know exactly what to look for and what strategies work best for your industry.
How your work in progress can impact your gross profit margin
Your work in process (WIP) can do more than simply track your project costs and remaining budget. It can help you meet project timelines as well as understand the financial status of each project underway.
Without your WIP being tracked and reported correctly, you could unknowingly be absorbing project profits. The higher your WIP value, the more capital is required or tied up to complete your project – reducing your gross profit margins in the process.
Our business advisors often use WIPs to help compare the profitability of projects, helping you make informed decisions on what project and contract types might work best and what to focus on in the future. It also helps you decide pricing strategies and gross profit margins you should be applying depending on the project type you’re quoting for.
Not using WIP reporting in this way or feel your WIP recording isn’t accurate? It might be time to book time with our business advisory team to leverage the insights your WIP can provide to improve your profit margin.
WIP management is also a key part of our virtual CFO service, helping you get a better handle on your WIP recording.
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