Total Job Cost+Overhead+Profit=Price
Once all of the factors involved in the equation required to determine the Selling Price have been determined, contractors can understand the term Mark-up and its use in the Estimating process. When contractors have identified their individual Overhead, and know the amount of Profit they would like to achieve in their business, it is common to use a ‘unit cost’ estimating system to establish Job Cost and then simply add a percentage to arrive at the Price. The following examples assume an overhead of 30%, that is to say they are based on a scenario in which a contractor has identified all of the costs of doing business (those which can not be identified by a job address) and calculated these to be 30% of his total sales volume.
Job Cost
1)Labor
2)Material
3)Subcontractor
4)Plans & Permits
5)Clean-up
= Total Job Cost
+ Mark-up
= $elling Price
The percentage factor added to Total Job Cost is called Mark-up. Mark-up is simply a mathematical short-cut used to speed the estimating process. Mark-up is used to increase Job Cost enough to accommodate those factors we have identified as Overhead and Profit. Exploring the following examples helps to understand how this works:
Example 1:
A) Job Cost 6000
B) Mark-up 50% or 1/2 + 3000
C) Selling Price 9000
Here the Job Cost is increased, or marked-up by a factor of 50% or 1/2 to arrive at the Selling Price. Depending on the amount of Overhead and Profit the contractor needs to allocate to each project, this may be an adequate Mark-up. In order to determine if this is an adequate mark-up, contractors must understand the term Gross Profit and it’s relationship to the above example:
Gross Profit = B/C = 3000/9000 = 33%
By dividing the mark-up by the Selling Price (B/C in the example above) a percentage which is Gross Profit is determined. This percentage represents the Profit generated by the project before accounting for Overhead.
Gross Profit – Overhead = Net Profit
33% – 30% = 3%
If the Overhead has been determined to be 30% and the Job Cost is increased or marked-up by an amount sufficient to produce a 33% Gross Profit, the difference between Gross Profit and Overhead is 3%, which would be Net Profit.
Example 2:
A) Job Cost 6000
B) Mark-up 67% or 2/3 4000
C) Selling Price 10000
Here the Job Cost is increased, or marked-up by a factor of 67% or 2/3 to arrive at the Selling Price. As with the above example, Gross Profit is determined:
Gross Profit = B/C = 4000/10000 = 40%
If the Overhead has been determined to be 30% and the Job Cost is increased or marked-up by an amount sufficient to produce a 40% Gross Profit the difference is 10%, which would be Net Profit (40% Gross Profit less 30% Overhead = 10% Net Profit).
Gross Profit – Overhead = Net Profit
40% – 30% = 10%
The following analysis looks at the above Examples 1 and 2 from a slightly different perspective, comparing the same project with the $6000.00 Job Cost, but with two different Selling Prices of $9000.00 and $10,000.
Analysis of Examples 1 and 2 Above:
9000 Selling Price 10000
6000 -Job Cost 6000
3000 Gross profit 4000
2700 – 30% overhead 3000
300 (3%) Net Profit*(10%)1000
*before taxes
Notice the large differences in Net Profit accomplished by changes in Mark-up, a 50% mark-up produces a 33% Gross Profit in the left column and a 67% mark-up produces a 40% Gross Profit in the right column.