As a contractor, your ability to calculate your overhead and profit margin are what can make or break your construction business. It’s not easy to know how much to charge as a contractor, but understanding typical contractor overhead and profit can help clarify how you should price your jobs.
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), material costs, machinery and equipment.
Indirect costs. These are your other general, administrative and operational 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 or subcontractor.
General contractor and coordinator at the non-profit California Homebuilding Foundation (CHF) Michael McSweeney learned the hard way when he was starting out as a young painter getting hired by local contractors: “I didn’t understand what my costs were. I didn’t understand what my overhead was. I was getting 90% of the jobs I bid, and I thought I was just the world’s greatest businessman. The reality was I was undercharging for really good quality work.”
Don’t forget: your construction costs go beyond materials and wages.
“If you’re paying a guy $30 an hour, then there’s taxes, overhead, workers’ comp — all those things add up along the way,” McSweeney says. “So what does it actually cost you per hour to have [a subcontractor] in the job? The $30 an hour you’re paying him could be more like $50.”
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 a particular 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 project 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 net profit margin accordingly. One way to improve your bottom line is to increase your construction markup, or raise your prices.
So how much should a contractor charge? Use overhead and profit margin as your main considerations.
Contractor profit margin formula
To figure out how to make money as a contractor, you need to understand how to calculate your net profits (Remember, gross profits are what you make initially; net profits are what you ultimately make after factoring in your costs.) You also need to understand how to write up your bid (the amount the client 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 the amount of money that belongs to the company and should get reinvested for business growth.
Example of how to calculate profit margins
Your minimum net 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 construction 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.
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? Well, it depends on a lot of factors including what your services are, whether you work in commercial or residential building and more. There’s no one size fits all answer.
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.
For instance, according to the National Association of Homebuilders’ (NAHB) most recent study, the average gross profit margin in 2021 for remodelers was 24.9%, with a net margin before taxes of 4.7%. Which is not much higher than historic average profit margins for general contractors at 1.4-2.4%, according to the Construction Financial Management Association. (Subcontractors reported between 2.2-3.5%.)
In terms of average wage per hour, this depends on your profession, with carpenters earning an average of $23.20/hour, electricians earning an average of $28.87/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
Raising prices can be a sensitive topic since business owners worry about striking a balance between a company’s profitability and losing clients. However, we have a few tips for going about it strategically:
Ask around
Are you undervaluing your work? Less experienced contractors might price more competitively to gain clients and experience at first, but it’s not the most sustainable way of doing business.
If you’re not sure what to charge for your work, ask others in your field. Maybe you’re part of a trade association group or have a mentor you’re working with. Both of these parties can help you with pricing.
Early in his career, McSweeney recalls going to a cocktail party and meeting a local industry veteran who told him he should be charging more. “I raised my prices after going to that trade show by 10%, and I didn’t have a single client blink,” he says.
Estimate on a project basis
Typically, 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 contractor markup, to ensure your business profitability.
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.
Plan for the raise
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.
Be transparent with clients if asked
There’s no need to explain yourself or your reasons for raising your prices, but it is good to have some reasoning in your back pocket instead of “just because,” especially with longstanding clients. For example, with inflation, labor shortages and supply chain problems consistently in the news, many people already understand what you’re going through.
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.
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 specializes in creating customized insurance packages for contractors. Whether you’re a one-person operation or have a team of employees, 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.
