### Calculating the correct Gross Margin for your company

To continue our pursuit of making good profits this year, let’s look at calculating the sales price for your work using gross margins. As I said last month, thoroughly understanding the numbers is how the smart people in this business make money.

Using gross margins to calculate the sales price for your work is a more complicated process than using a markup times your job costs. That is why I always recommend the use of markup instead of gross margins. However, some folks started using gross margins and are comfortable with that, so let’s review that process.

We will use the same numbers as we did last month to allow you to compare the results.

Again, you must make 8% net profit on every job you do. This gives you a cushion against mistakes and the inevitable stuff that seems crawl out of the woodwork during jobs that leach our profits and can put our company in the red.

A specialty business that builds fences, decks or other outside work will normally have a gross margin 26% to 34%. If you set and use good estimating habits and tightly control your overhead spending, you will derive a lower gross margin to work with.

OK, same numbers as last month. Our sales goal is $875,000. We know we want an 8% net profit of $70,000, and our overhead expenses are (for this example) $210,000 (or 24% of sales). That means our job costs will be $595,000.

Job costs ($595,000) plus Overhead ($210,000) plus Net Profit ($70,000) = $875,000

Your basic formula to establish your sales price using gross margins is your job costs ÷ the reciprocal of your gross margin = sales price

The question then is…how do we get to our gross margin?

Gross profit is the total of our overhead and profit. In this case it is $210,000 (overhead) plus our net profit of $70,000 = $280,000.

Then, gross margin is our gross profit divided by our total sales:

$280,000 ÷ $875,000 = 32%

Now to use our gross margin to calculate the sales price, we have to jump through a couple of math hoops.

Our job costs for the Kopetski job are calculated by adding up your labor, materials, any subcontractor quotes and any other costs such as rental equipment, plans, permits, etc. on your estimate sheet. Job costs for the Kopetski’s is $5,690.

Now we must divide the $5,690 by the reciprocal number of our gross margin of 32%. That number is 1 - .32 = .68

Then: $5,690 ÷ .68 = $8,367.65 or $8,368 sales price.

One of the things I must caution you about is the arbitrary use of some number, which you divide into your job costs to get to the sales price. In most cases, when I talk to various contractors, they are using some number that someone else gave them. This number will be wrong for your company in over 90% of all cases. Why? Because another companies overhead expenses and their profit expectations almost certainly will be different than yours. No two companies will have the same overhead expenses. Therefore, they rarely will have the same gross margin.

Next time we will talk about why you cannot cut your markup or your margin on larger jobs. This is one of the old myths in this business that gets so many contractors into financial trouble. We will also discuss a couple of other math formulas that are guaranteed to help you make good money for your jobs.

You can learn more and get far more detail about your markup in our book, Markup and Profit; A Contractor’s Guide. You can find this book on our web site at: http://www.markupandprofit.com/books_mark.html

To learn to sell your services at a good profit, take a look at our new book, Profitable Sales; A Contractors Guide that you can find at: http://www.markupandprofit.com/books_sales.html

Using gross margins to calculate the sales price for your work is a more complicated process than using a markup times your job costs. That is why I always recommend the use of markup instead of gross margins. However, some folks started using gross margins and are comfortable with that, so let’s review that process.

We will use the same numbers as we did last month to allow you to compare the results.

Again, you must make 8% net profit on every job you do. This gives you a cushion against mistakes and the inevitable stuff that seems crawl out of the woodwork during jobs that leach our profits and can put our company in the red.

A specialty business that builds fences, decks or other outside work will normally have a gross margin 26% to 34%. If you set and use good estimating habits and tightly control your overhead spending, you will derive a lower gross margin to work with.

OK, same numbers as last month. Our sales goal is $875,000. We know we want an 8% net profit of $70,000, and our overhead expenses are (for this example) $210,000 (or 24% of sales). That means our job costs will be $595,000.

Job costs ($595,000) plus Overhead ($210,000) plus Net Profit ($70,000) = $875,000

Your basic formula to establish your sales price using gross margins is your job costs ÷ the reciprocal of your gross margin = sales price

The question then is…how do we get to our gross margin?

Gross profit is the total of our overhead and profit. In this case it is $210,000 (overhead) plus our net profit of $70,000 = $280,000.

Then, gross margin is our gross profit divided by our total sales:

$280,000 ÷ $875,000 = 32%

Now to use our gross margin to calculate the sales price, we have to jump through a couple of math hoops.

Our job costs for the Kopetski job are calculated by adding up your labor, materials, any subcontractor quotes and any other costs such as rental equipment, plans, permits, etc. on your estimate sheet. Job costs for the Kopetski’s is $5,690.

Now we must divide the $5,690 by the reciprocal number of our gross margin of 32%. That number is 1 - .32 = .68

Then: $5,690 ÷ .68 = $8,367.65 or $8,368 sales price.

One of the things I must caution you about is the arbitrary use of some number, which you divide into your job costs to get to the sales price. In most cases, when I talk to various contractors, they are using some number that someone else gave them. This number will be wrong for your company in over 90% of all cases. Why? Because another companies overhead expenses and their profit expectations almost certainly will be different than yours. No two companies will have the same overhead expenses. Therefore, they rarely will have the same gross margin.

Next time we will talk about why you cannot cut your markup or your margin on larger jobs. This is one of the old myths in this business that gets so many contractors into financial trouble. We will also discuss a couple of other math formulas that are guaranteed to help you make good money for your jobs.

You can learn more and get far more detail about your markup in our book, Markup and Profit; A Contractor’s Guide. You can find this book on our web site at: http://www.markupandprofit.com/books_mark.html

To learn to sell your services at a good profit, take a look at our new book, Profitable Sales; A Contractors Guide that you can find at: http://www.markupandprofit.com/books_sales.html