By John Kenney, Cotney Consulting Group.
With the new year just around the corner, you should be thinking about your year-end numbers. While there’s not much time to drastically change your company's overall finishing financial outcome, there is still time to drill down and review your company's economic patterns to prepare for the coming year. Set your business up for success by understanding what your company is doing well now and what you could be doing better. Set attainable goals for a more lucrative 2021.
Meet with your accounting professional and review what systems you have in place and make sure they work for you. The primary objective of your accounting system is to help you track your company's income and spending. A comparison of the two will give you a snapshot of the company's profits or losses, although other factors often determine whether your company is successful. Some of the ways it can pay for itself help you control operations and utilize your working capital to the greatest possible advantage.
You must review your internal processes and make sure you are covering all your costs in your estimates. Most contractors feel they cover their direct costs of job site labor, materials and equipment costs, but you have to know your actual indirect costs of overhead to recover all your costs of doing business.
Indirect Costs- Include all your cost that is not directly associated with jobs (supervision, office administration, insurances, etc.) To simplify, all costs you pay to operate your business, whether you have a project to work on.
There are several ways to mark up your overhead costs on your estimates. One standard method for roofing contractors to recover their overhead is by allocating these costs against labor, materials, or a combination of both. Recovering against both labor and materials is known as the "Dual Overhead Recovery Method.” Your accounting professional can assist you with the best method for your type and size of business.
Now that you have your true costs covered, you are at the break-even point of your estimates. You have to add your profit to your estimate so that you make money. Profit should not be a dirty word in your company; without it, you will not survive.
The most common mistake when calculating gross profit is using a markup versus margin. Is there a difference? Absolutely. More and more in today's business environment, these two terms are being used interchangeably to mean gross margin, but that misunderstanding may be the menace of the bottom line. Markup and profit are not the same. An unclear understanding and application of the two within your estimate can have a drastic impact on the bottom line.
Many mistakenly believe that if your estimate is marked up, say 25%, the result will be a 25% gross margin on the income statement. However, a 25% markup rate produces a gross margin percentage of only 20%. If you knew this, great. If you did not see the difference, don't worry; you’re not alone; studies show that nearly 85% of contractors are miscalculating their profit margin.
Using the markup method to calculate your profit, the below example will demonstrate how much money you are leaving out of your bid and off your bottom line.
Break-even cost of estimate with a 10% markup is $100,000.00 multiplied by 10% = sales price of $110,000.00
Break-even cost of estimate with a 10% margin is $100,000.00 divided by 90% = sales price of $111,111.00
Preparing your estimates correctly with all the direct costs, indirect costs, correct profit margin calculations upfront is a non-negotiable step in your process for keeping your business financially healthy. It will allow you to separate yourself from your competitors in the endless cycle of increasing top-line revenue and cutting expenses to generate more profit.
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Original article source: Cotney Consulting Group