Construction Profit Margins: How to Track and Increase it

A big fat profit margin is what every business owner wants to see. And why not? Having a high profit margin means generating more income by spending the least.

But do you know how to calculate it accurately for your construction business?

Don’t worry if your answer is no. Here, we will teach you how to do that and its other fundamentals, so you can precisely track it. Let’s start by understanding what exactly is a construction profit margin.

What is a Construction Profit Margin

It is the percentage of profit your construction company makes on a project as compared to the total revenue earned. In other words, you can say it is your net income for each dollar you earn. 

For example, if your profit margin is 40% on a $100 sale, that means you earned a profit of $40 in that transaction.

This is important to understand and track because it helps you: 

• Make data-driven decisions
• Identify areas for reducing expenses
• Negotiate better pricing with suppliers
• Ensure that your company remains profitable

Next, we will look into the factors that affect construction profit margins.

6 Factors That Affect Construction Profit Margins

By identifying the key factors that affect your margin, you can take the right step to increase it. So here are 6 factors you need to look at:

1. Labor costs

The cost of labor can be a major expense in construction projects and can have a significant impact on profit margins. 

And, apart from that, it is recurring. That means you will have to bear it for each project you do. Thus, keeping labor costs under control is essential for maximizing profits.

2. Material costs

The cost of materials varies a lot depending on the type of construction project and the materials used. And just like labor, this is also recurring. This is why you will need to use your materials efficiently to prevent any leaks.

3. Equipment costs

To calculate your equipment costs, you have to choose between purchasing and renting them.

The good thing about purchasing is you have to pay only a single time to use the equipment. But you will need to maintain it well to stay away from recurring costs.

Renting equipment is also not a bad option, especially for new construction business owners. However, you will need to pay for it recurringly. 

4. Overhead costs

Overhead costs are usually ignored or miscalculated but can be a significant part of the overall expenditure. It includes expenses such as office rent, utilities, and insurance.

To help you better, here is a guide for reducing construction overhead costs. 

5. Market conditions

In the construction industry, the market also has a say in how much profit you make. For example, remember the real estate market crash of 2008?

But this is something outside your control. At best, you can stay aware of what’s going on and adjust accordingly.

6. Competition

Competition in the construction industry can be fierce. Thus, finding ways to differentiate from competitors and offer high value is essential for maintaining healthy profit margins.

Keep these 6 factors in mind when it comes to determining your profits. However, it would help if you knew how much your competitors are making in each project.

Average Construction Profit Margins

To give you an idea, builders reported a gross profit margin of 18.2% and a net profit margin of 7% on average, as per the data of NAHB.

But average profit margin in the construction industry can vary widely, depending on the type of project and how you manage your finances while executing it.

For example, residential construction companies typically enjoy lower profit margins than commercial construction companies due to lower pricing and higher competition. 

To get a better picture, compare profit margins with your competitors to understand where you stand and what to improve. 

How to Calculate Construction Profit Margins

Let us show you how to calculate the profit margin of your business. For this, here is the formula you will need to use:

Profit Margin = (Revenue – Cost) / Revenue x 100%

To calculate profit margin: 

• Know your project revenue and accurately calculate the project cost.

• Subtract the total costs of a project from the revenue generated by that project. 

• Divide that number by the total revenue 

• Multiply it by 100% to get the profit margin percentage

For example, if a construction company generates $500,000 in revenue from a project with total costs of $400,000, the company’s profit margin would be:

($500,000 – $400,000) / $500,000 x 100% = 20% 

By calculating it, you can make informed decisions about pricing and resource allocation to improve profitability over time. But first, beware of these common mistakes.

Recommended: How to Make Money in Construction

4 Common Mistakes to Avoid When Calculating Profit Margins

1. Misunderstanding the difference between gross profit and net profit

Gross profit means your total revenue minus the direct costs of the project, such as labor and materials. 

Your net profit, on the other hand, is the gross profit minus all indirect costs, including overhead expenses. 

It is important to understand this difference to accurately calculate your profit margin.

2. Failing to factor in overhead expenses

Your overhead expenses are the indirect costs of running your business, such as rent, utilities, and administrative salaries. 

Failing to include these expenses in your calculations can lead to inaccurate profit margins and hurt your business.

3. Not accounting for all costs involved in a project

When calculating your profit margins, it is important to factor in all costs associated with a project. 

This includes not only direct costs, such as materials and labor, but also indirect costs, such as equipment rentals or maintenance.

4. Not adjusting profit margins for market conditions

Market conditions like supply and demand can greatly impact your profit margins. 

Thus, you must monitor it and adjust your pricing accordingly to ensure you are competitive while maintaining profitability. 

This can also include diversifying your services or targeting new markets to increase your opportunities for earning higher.

Were you making any of these calculation mistakes till now? If yes, then from now onwards, your numbers will be different and more accurate.

But what if you want to get a higher profit margin? That’s what we will discuss next.

5 Strategies for Increasing Construction Profit Margins

Here are some actionable strategies that you can start implementing now to increase your contractor profit margin:

1. Streamline operations and improve efficiency

One of the easiest ways to improve your profit margins is to eliminate inefficiencies in your operations.

Are you and your team doing their tasks efficiently? Otherwise, to save time and resources, try:

• Reorganizing your team
• Optimizing your supply chain
• Automating certain processes

2. Negotiate better prices with suppliers

Striking a better price from your suppliers for the materials you buy reduces your job cost. But how to do it? You can do this by:

• Building long-term relationships with your suppliers
• Shopping around for better deals
• Leveraging your purchasing power to negotiate lower prices.

3. Reduce labor costs

Labor is often the biggest expense for construction companies. Thus, finding ways to reduce your labor costs can significantly impact your bottom line. 

Start with optimizing your staffing levels, increasing employee productivity, and finding ways to outsource certain tasks.

Pro tip: Provide key performance indicators to your staff to help them serve you better.

4. Diversify services

Diversifying your services enables you to tap into new markets and increase your revenue streams. 

For example, you can offer additional services like renovating or expanding into new areas such as green building or sustainable construction.

5. Invest in technology

This improves your efficiency and reduces your operating costs. For example, using bulldozers and excavators completes the task faster than laboriously. 

You can also use construction management software to manage your projects more effectively.

This is how you get your desired profit margin. But to get an added boost, brand your business as a professional to win more jobs.

Conclusion

Many construction companies fail to set the profit margin right. But not yours, as you now know how to calculate profit margins and give it a boost. So, start calculating it for your latest project to identify what you need to do next.