How much profit should I make on a project?

Clients often ask how much profit they should make on building projects. My flippant answer is “profit is like horsepower; you can never have too much”. Your level of profit should reflect the value that you add to a project in comparison to your competitors. When customers feel good about what you provide, and they value it, they’re willing to pay more for it.

Our industry tends to think that price equates to cost plus profit – but it shouldn’t be that way. YourQS works with over 200 builders, and we see mark-ups ranging from 8% to 53%. We even see wide variances within the same markets, which shows that the margin you can make is not necessarily related to your costs.

There are lots of examples where the price that clients are willing to pay has little to do with cost. I’d bet that the cost to make a Louis Vuitton case is not that different to a Samsonite one. The difference in perceived value, however, means that the price people are willing to pay is very different. The skill is creating greater value than your competition.

So, what’s the best way to calculate a profitable mark-up?

When I come across builders who are using a 10% mark-up, I remind them that they’re running a business, not just doing a job. Being in business means you need to be making a profit over and above what you earn for the work you do. You need to cover overheads, make a return on the capital invested in the business, and get something for the risks of being in business. Otherwise, you’re better off working for someone on a wage. Most businesses have overheads of 8% to 14% of turnover; so, a 10% mark-up might be okay if the job is charge-up (i.e., low risk) and you have low overheads. If you have an office and any sort of admin staff, then you probably aren’t making any profit. If you are fixing prices, and therefore taking on more risk, then you want at least a 20% mark-up. A 25% mark-up would more likely be needed to give you a return better than just investing your cash in the bank.

What’s the difference between mark-up and margin – aren’t they the same thing?

Mark-up and margin are just different ways of looking at profit.

When you know your cost and you set your sell price by applying a mark-up to it, that achieves your target profit. Margin is when you know your sell price and you want to know how much of it is your profit.

Let me explain by using an example.

Our cost is $100. If we add a 25% mark-up, the profit is $25 and the final price is $125. If I want to know how much of the sale price is profit (the margin) then I calculate the profit of $25 divided by the sale price of $125. I get a 20% margin. We’re using the same input numbers, just with a different perspective: cost up or sell price backwards.

The margin view is important as you tend to look at operating costs in relation to turnover, which is the same perspective. This helps you understand what portion of your sell price is available to cover your operating expenses. If your operating expenses are 20% of your turnover, then you need at least 20% margin to cover them. So you then need to apply a 25% mark-up to ensure you have enough margin.

Here’s another analogy.

Imagine we’re making some concrete using 4 bags of builders mix and 1 of cement. The resulting 5 bags of concrete is made up of 20% cement (1 bag divided by a total of 5 bags), but we added 25% of cement (1 bag) to the 4 bags of builders mix we had.

Understanding what makes up your build costs – and how to control them

The pie-chart (right) shows the breakdown and analysis of the 2,331 projects that we have done estimates for since the start of 2019. I looked at renovations and new builds, general builders vs group housing, and the breakdown was similar across them all. Ideally, you should be getting quotes from your subbies; the allowances are controlled by your client choices and changes should be passed on. Materials are what you would typically get from a merchant, so the prices are hard to fix down. But even if you are out by 10%, that is only 1.4% of the total job, so not worth spending too much time worrying about. Site expenses must be managed, but typically you have limited ability to affect their price.

The big controllable is the labour. This has two aspects – the labour rate and the estimated labour times.

How to calculate your labour costs

When we estimate labour costs, we work out the hours of work involved with the project and allow for it as Labour Carpenter. We then work with our customers to set an hourly cost rate for their typical team. That way, it doesn’t matter who is doing the work – the cost for the time going into the job is being covered.

When determining your hourly cost rate, the main driver is obviously the amount the person is paid. But there are many other employment costs and factors to consider:

Hourly rate The employees’ hourly wage rates

Hours per week The number of hours per week that employees work

Workdays The days per week that employees normally work

Allowances Non-taxable allowances paid per week (e.g., tool allowances, travel) Sick leave days Number of sick leave days per year for each employee

Annual leave Number of annual leave days for each employee

Discretionary days Allowance for days that employees don’t work but are still paid (e.g. training days) KiwiSaver Allowance for company contributions to employees’ KiwiSaver accounts Productivity factor You may factor in/compensate for a less productive worker

ACC rate Your ACC percentage

Liability insurance A recovery for your Public Liability costs An easy way to calculate how these factors affect labour costs

At YourQS we have developed a spreadsheet tool to help you accurately calculate labour costs. It allows you to enter details for each team member (whether they’re an employee or contractor), and it works out your average hourly cost rate and helps you determine your charge-out rate from this. If you would like free access to this labour calculator, email me at nick@yourqs.co.nz.

“Prediction is very difficult, especially if it’s about the future!” This is a great quote from Nobel Prize laureate and physicist Niels Bohr. Predicting the future is exactly what cost estimation is – and labour is more so.

There are three key methods that builders use to estimate labour:

1. Schedule of rates

A schedule of rates is built up for the different elements of the job.

2. Square metres (or linear metres, etc.)

A cost or hours per m2 of floor area or similar.

3. Rule of thumb

An experienced builder looks over each aspect of the project and estimates how many people and how many days each will take (e.g. 3 guys x 5 days). At YourQS, we aim to be as accurate as possible on every job. We use the power of computing, many years of research and development, and a lot of builder feedback to do a first principles labour calculation on every element in the building project.

For more information, visit www.yourqs.co.nz or email nick@yourqs.co.nz.

Nick Clements, YourQS, and Member NZ Institute of Quantity Surveyors. Nick joined the construction sector in 1993 and couldn’t understand why the architect’s computer didn’t talk to estimating systems. Thinking “there must be a better way” he started a software business to find it. This morphed into a team of 16 at YourQS providing residential estimates using the resulting software. YourQS are NZCB National Partners.