What is overhead and profit in construction?

Knowing how much you spend is key to understanding your profit. First, let’s review what general contractor overhead and profit margins mean.

Understanding contractor overhead

Every business has regular expenses. This is your business overhead. It’s the costs associated with keeping your business open.

Expenses are typically broken down into direct costs and indirect costs.

• Direct costs. These are costs that can be connected to specific projects or departments. Costs can include labor costs (subcontractors like carpentry and electricians), machinery and equipment.
• Indirect costs. These are your other general and administrative costs that you need to complete projects but aren’t tied to specific tasks. For example, office expenses, office equipment, bookkeeping and accounting, taxes, legal costs, business insurance, and more.

You need to factor in the cost of goods and the cost of the job itself to determine your full overhead. All of these overhead expenses need to be considered when working out how much to charge as a general contractor.

Understanding profit margin for contractors

Your profits are what’s leftover from what you were paid, after you’ve subtracted your overhead and the “hard costs” of the job. The hard costs include labor, material, supplies and more.

To make it easier to understand, we’ve included an example of this below. You need to clearly understand the job costs and your overhead to know how to price jobs as a contractor.

When preparing a bid, you need to take these costs into account and adjust your profit margin accordingly. One way to improve your bottom line is to increase your markup, or raise your prices.

So how much should a general contractor charge? Use overhead and profit margin as your main considerations.

General contractor profit margin formula

To figure out how to make money as a general contractor, you need to understand how to calculate your. You also need to understand how to write up your bid (the amount the homeowner will pay for the job) so that you’ll make a profit after you’ve paid your overhead and your job costs.

Keep in mind: Your profits do not automatically include your salary as the business owner. Ideally, your salary should be included as part of your overhead expenses. Profit is money that belongs to the company and should get reinvested for business growth.

Example of how to calculate profit margins

Your minimum profits objective should be around 8%. 10% is average, and 15% is ideal.

For our example, let’s work with a 10% theoretical profit. Let’s say that your revenue for a job will be $500,000. That’s the amount you bid, and the customer agreed to pay.

If your overhead costs are $100,000, and the job hard costs you $350,000 to complete, you’ll be right on track to hit a 10% profit.

Here’s the formula:

Revenue – overhead = job costs and profit

$500,000 (your revenue) – $100,000 (your overhead) = $400,000 (your job costs and profit)

Next, subtract your job costs to get your profit:

$400,000 (your job cost and profit) – $350,000 (job cost) = $50,000 (your profit)

See, $50,000 is 10% of your original revenue.

$50,000 (profit) ÷ $500,000 (revenue) = .10 or 10% (profit margin)

Calculating profit is all a bit complicated. You’ll want to go over your numbers more than once to understand your overhead and profit margin and ensure that you’re on track to make the money you want.

Average gross profit margins in the construction industry

So, how much should contractors charge? First, we need to figure out what the average profit margin for a general contractor is. It’s important to be aware of industry standards before you work out your pricing. It’s also just as important to understand your own overhead to factor that into your pricing.

In the construction business, gross margin has averaged 17.08-23.53% over 2020. However, suggested margins can be as high as 42% for remodeling, 34% for specialty work, and 25% for new home construction.

In terms of average wage per hour, this depends on your profession, with carpenters earning an average of $26/hour, electricians earning an average of $29/hour and other professionals’ earnings varying widely.

While it helps to know these nationwide benchmarks, the more important consideration is your overheads and profits when it comes to setting prices.

How and when to raise your prices

It’s a better business practice to quote per construction project than per hour. Doing so allows you to work out your overhead and profit margin, as well as the right markup, to ensure your business profitability.

Also, it’s always a good idea to raise your prices before you are desperate. For example, if you wait until after you’ve hired an employee to raise your prices, your business will be under a lot of financial pressure while your clients adjust to the new payment schedule.

Instead, try to plan and give your customers a warning about your growth plans. By planning ahead, you can raise your rates in a measured and incremental way.

Some customers will not be able to afford the new fees or may look for a bargain elsewhere, and that’s okay. Explain the benefits of your growing business to your customers. Work on strengthening your relationships with your current customers at the same time as you increase your rates so they will value your business enough to stay.

Follow small business bookkeeping tips to stay on top of your expenses so you can create a clear strategy for pricing jobs. This will help your business remain profitable.

Reduce overhead by only paying for the insurance you need

Having high overheads can quickly become a drain on your revenue. While having business insurance is essential for protecting your business, you need to ensure that you have the right amount of coverage for the projects you’re working on. (And not paying more than you need to.)

NEXT Insurance specializes in creating customized insurance packages for general contractors. Whether you’re a one-person shop or have a team of employees and subcontractors working for you, we have coverage designed to fit your business’s unique needs.

You can mix and match insurance policies to meet your needs, so you’re never over or underinsured. And you can easily update and make changes to your coverage online. Our online application process makes it easy to get a free quote, see your policy options and choose the coverage you need in less than 10 minutes.

Our U.S.-based, licensed insurance advisors are ready to help if you have any questions during the application process.

Get your free instant quote today.