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. Determining the best markup percentage on cost requires the contractor consider his indirect costs, overhead, taxes, and final profit desired.
The contractor 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 .
Indirect costs average 18 to 23% 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 16 to 24% of the payroll for this part 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. This is 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 contract is for an upper scale home (custom designed and higher quality materials) located in a remote area. The contractor reviewed the site and discovered the following:
- The road to the site is a one lane road and has many potholes and very few spots to allow for passing of vehicles. It takes the contractor about 7 minutes to reach the lot from the main road.
- The site has soft or a sandy soil base.
- The site will have parking available for one vehicle at a time.
- The nearest power pole is about a quarter of a mile away
Based on this information, it is apparent several indirect costs will increase. First off, the amount of time to pay for the guys traveling into and back from the site will increase the payroll taxes and benefits. Secondly, transportation costs will increase due to the additional fuel and the wear and tear the vehicles will take to gain access to the site on a regular basis. Third, the site will require additional grates to support the weight of the vehicles due to the nature of the soil. Finally, there is no doubt that the contractor will have to supply power generators on site until the power company gets a power pole back to the lot from that distance.
All of these additional costs will add up in the indirect costs section of the formula. The contractor may substitute and add a one-time additional direct cost line item associated with these costs and continue to use the standard indirect formula to evaluate the correct markup.
Next the contractor should consider the issue of the higher quality materials. To ensure proper installation and minimum material losses, the project manager will spend more time on the project to inspect and monitor this aspect of the project. Therefore, his compensation package should be covered by having a higher indirect cost percentage. This will increase the markup even more.
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 using 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.