His face went white as he dropped his head into his hands.
“Now I understand why we’ve been working so hard and yet I still can’t see any more cash in our bank account!” groaned Sam.
Sadly, it’s all too common. Trade business owners like Sam who work extremely hard turning out great quality products, installing to tight schedules, rectifying defects at their own cost to make sure they win the next job and yet, when it all comes out in the wash, they’re still getting paid less than many of their employees.
The good news is, with some very simple measures put into place, you can change this situation and actually start generating the return you deserve from your trade business.
What our friend Sam had just discovered was that he’d effectively been working for free on a large chunk of his projects.
As a shopfitter he was responsible for coordinating many other trades, keeping them to schedule, monitoring their progress and quality, all to ensure the project was completed on time, to quality standards and within the budget allowed.
It’s this last point that had really gotten the better of Sam and unfortunately he neither had the awareness of, nor the solution to, the problem.
What Sam had been doing is pricing the peripheral trades into his quotes at his cost plus a percentage.
In his mind, Sam was ‘making’ the amount he’d been adding on to the prices he’d been provided by electrical, flooring, paint etc.
The reality of the situation though is that Sam had only been ‘making’ an amount much less than this to the point where it wasn’t enough to cover his time and project management on these components.
This meant he was only making profit on the joinery and install. Not a complete disaster but certainly not ideal either.
The mistake Sam had made was not distinguishing between markup and margin.
To his credit, our friend had done some great work in calculating his target margin and then aiming to measure and manage that on his projects.
Problem is, if your target margin is 20% and you add that to the cost of your materials, sub contractors and so on, you actually don’t make this much margin when all is said and done.
Don’t worry, many business owners struggle to differentiate and it literally robs them of thousands of dollars profit in their pocket each year.
Let’s take a look in more detail.
Suppose you’ve worked out that, to run your business effectively and leave enough net profit (after fixed overheads) to pay your desired personal earnings, you need to generate 60% gross margin on projects, on average.
How do you calculate your markup on input costs such as materials, sub contract components and labour so that you have your 60% gross margin left when you’re quoting?
The first thing to note is it’s not as simple as increasing your costs by 60%.
Here’s an example.
It’s easy to look back on a completed project to work it out. For instance, if you quote a project at $100,000 and the cost of your materials and sub contractor components is $40,000 then you’re making $60,000 gross profit and hitting your 60% target.
But how do you get this right when quoting a project in future?
Let’s say you calculate your costs for a project at $14,000.
Should you simply increase this by 60% to get your margin?
No and this is the mistake Sam was making.
He was charging out the $14,000 at $22,400 by increasing the figure by 60% (14,000*1.6).
His true margin on that scenario is this:
Total sell price $22,400 minus costs of $14,000 equals gross margin of $8,400.
Gross margin percentage equals dollar margin of $8,400 divided by total sell of $22,400 times 100. Answer?
That’s a long way short of our 60% target!
The correct way to mark up your costs is to do this little calculation:
Cost price/(1-target margin % as a decimal)
In this example we’d see:
14,000/(1-0.6) = 35,000
This means you should be quoting the $14,000 of materials and subcontract supply at $35,000 leaving you with $21,000 gross profit and a 60% gross margin as desired.
Clearly you can’t always pass on your costs at target levels when you take into account market pricing and competition. /
It does give you a starting point to work from so you don’t end up working for free or for very much less than you should be if you’re going to get paid what you’re worth. Sam was able to review some of his quotes and also put pressure back on his suppliers to bring numbers closer to his target margin.
Like Sam, it also gives you the opportunity to say no to projects that might be too lean on the margin front, so you don’t spend all your time working like crazy for clients who aren’t paying you nearly enough.
Better to find projects that fit your niche with clients that see the value in dealing with you…but that’s a whole other discussion!