The critical formula at the heart of any remodeling business is a clear understanding of gross profit, overhead and net profit. Gross profit is the profit a company makes after deducting all the costs associated with making and selling its products.
The formula is straightforward: GP – (OH+ COGS) = NP.
Starting out a new year, a remodeler must have gross-revenue goals in place. Your goal for net profit should be a constant 10 percent or better. Your goal for gross profit and gross revenue should be based on your most scientific estimation as to the amount of work you and your team can complete and bill for in the coming year.
The final piece is your overhead (OH). Overhead is all your costs that cannot be billed to a specific job. Overhead includes rent, office supplies, salaries that are not billable to a job, and portions of salaries that can’t be billed to a job—such as when employees are in company meetings or are sick, on vacation or holidays, and benefits such as 401k matches and many other miscellaneous costs. This is often called a labor burden.
Once all your overhead costs are added up, they can be expressed as a percentage of your gross revenue. For very small, lean remodeling firms, overhead percentage can be as low as 10 percent. For larger firms overhead can be 30 percent to 40 percent of revenue. Knowing your overhead percentage enables you to add it as a multiplier to your COGS for each job on top of your desired net-profit percentage.
The Relationship of Overhead to Gross Revenue
Your overhead can be budgeted and should be relatively fixed for the year. As your year progresses and you see that your revenue projections are exceeding your plan, then your overhead will drop as a percentage of gross revenue. This is the “Goldilocks” zone, where your net profit can exceed your planned 10 percent net profit.
Of course, if your revenue intake slips below your projected goal, your overhead increases as a percentage of gross revenue, and your net profit slips below 10 percent. Job-cost slippage and mistakes in construction and estimating also can eat at gross and, thus, net profit.
Adjusting Overhead from Year to Year
Each year, your overhead will change due to raises and new hires. These occur as you grow new positions that can and cannot be job-costed, such as marketing and human resources. For an average remodeling firm, the recommended spend on marketing is 2 percent to 3 percent of gross.
As your overhead goes up, so does the multiplier that must be applied to COGS in your estimates. In 2022, inflation contributed to slippage as well as an increase in overhead stemming from the “great resignation” and increases in salaries.
Some firms vary their markup depending on the size of the job, with large jobs receiving the least markup. With this model, it is harder to control and plan for a consistent net profit. A lot will depend on the size and mix of jobs won. Your overhead will vary greatly depending on your business model.
The more self-performed work that you do on each job, the more your overhead will go up. The more subcontractors you have with only a project manager as an employee, the more your overhead will go down.
Multiplier Table to Get the Markup You Need
Unless there is something incredibly unique about your business—and there usually isn’t—these are the recommended markup ranges for different types of contractors: remodeling contractors = 1.50 to 1.70; specialty contractors = 1.35 to 1.50+; new homebuilders = 1.26 to 1.30+.
Below is a table showing net profit (in green) for a given markup and overhead. If you are not making the net profit you desire, this table will tell you the adjustments that are required. The overhead percentage is shown across the top. The markup percentage is show vertically at left.
One of the tricky things for new owners to grasp is the relationship between markup and profit. If you add $5 of markup to $10 of goods and services, you don’t have a 50 percent gross profit. You have a 33 percent profit. That’s because the $5 of profit isn’t on $10 but on a total of $15 of goods and services.
You should be able to get all the numbers you need to calculate your markup from your own profit-and-loss statements (P&Ls). If the last line on your P&L isn’t a 10 percent net profit, change it to 10 percent for this exercise. If you haven’t been achieving a 10 percent net profit, your price (markup) is too low. QR
Christopher K. Landis is founder and chairman of Landis Architects and Remodelers based in Washington, D.C. He is an architect with 30 years experience operating a remodeling company with his brother and co-founder Ethan Landis.