Every construction project has costs beyond the direct costs and the contractor wants to earn a profit. To cover these costs he must have an appropriate markup. The contractor must give consideration to many variables and circumstances to calculate the best markup for a construction project. To determine the best markup percentage on costs, the contractor should consider his indirect costs, overhead, taxes, and final profit desired.
To assist the contractor he should give consideration to the variables that impact indirect and overhead costs to determine the final markup percentage. See What is a Reasonable Profit in Construction? for more information about these types of costs. Another article that is beneficial and covers more details about indirect costs is Best Format of the Construction Profit and Loss Statement .
It is important to understand the indirect costs of 17 to 21% plus overhead costs of 7% for the company have a profound impact on the markup formula. Indirect costs include the following:
- Management fees – the compensation package for the project manager
- Transportation – covers the costs of project manager’s vehicle, the contractor’s vehicle and the field crew vehicle. These costs include fuel, repairs and maintenance, insurance, servicing the debt on the vehicles, taxes and licenses. In general, it costs about $8,000 to $11,000 per year to operate a vehicle.
- Payroll taxes and benefits – the tax rate at a minimum is 7.65%, for most small business operations it runs around 9.7% of the payroll (direct cost). Add in such items as retirement matching, health and other insurance policies and the typical small business is paying around 18 to 22% of the payroll for this section of indirect costs.
- Communications – a typical cell phone runs no less than $80 per month for a small business owner. Add in the cell phones for the project manager(s) and include internet access and you have another indirect cost to include in the markup.
- Insurance – most projects have insurance included in the direct costs, the contractor has to buy both a bond and some type of risk policy to cover site issues. Many contractors use a policy that covers several ongoing projects. This type of insurance plus the general liability insurance and workman’s compensation adds to the overall indirect costs.
- Equipment, Tooling, & Supplies – most contractor use generators, power tools, come-a-longs, yard tools, and hand tools to build a project. Add in the cost to operate some type of small backhoe, trailer(s), and/or site development equipment and you can have a pretty expensive cost here. Supplies include materials transferred from one project to the next, examples include environmental barriers, rigging systems, temporary power poles and energy transfer lines, markers, signs, and temporary road systems. Another example of a significant cost adding to the overall indirect costs.
As a contractor you need to take into consideration the above to evaluate the utilization of these items in the project. If the project dictates a higher utility rate for any of the above items, then add more markup to cover that type of cost. The following is an example of this:
The contractor should sit down and evaluate the project as it relates to these indirect costs. Remember, this section of costs is the highest for the contractor after direct costs of construction and has the greatest impact on calculating the markup for the project. Notice issues such as geography, quality of the project, local codes and even community compliance to regulations have a bearing on the final cost to build the project. The contractor has to take these into consideration to determine what is a fair percentage of margin to cover the indirect costs to build and complete the project.
Now that you have a more accurate indirect cost percentage and using the formula in Best Format of the Construction Profit and Loss Statement the contractor can then determine the best markup to use on this particular project. No two projects are alike and so by using the thought process as illustrated above, the contractor will eliminate losses associated with a low markup. If another contractor comes in uses some archaic formula to markup his projects and his projected contract is significantly lower than yours, let him build the project. It’s better to let him spend his money than for you to get a project just to spend your money. Remember, you have to make a profit for several reasons. Primarily you have risk, both economic and industry. Secondly, you want to be around in five years to service the same customer when they want some repairs or upgrades. More importantly, let the customer know that if the competing contractor is not around next year, it will be difficult to deal with the warranty work. Act on Knowledge.
If you have any comments or questions, e-mail me at dave (insert the usual ‘at’ symbol) businessecon.org. I would love to hear from you.