Gross profit Margin, an estimator’s best KPI

We’ve been discussing margins and markups on direct costs when it comes to pricing your projects and services. One of the most popular methods for doing so is the Multiple Overhead Recovery Systems (MORS).

Traditionally you would mark up material costs in bids 10% to allocate general and administrative (G&A) overhead cost. Subcontractors are usually marked up 5%, truck and equipment costs 25% and anywhere from 35% to 95% for field labor and burden costs. A net profit margin is then applied to the total of all of these. The problem with the MORS system (and any percentage-based system that multiplies your direct costs by a multiplier) is that the markups are totally pulled out of thin air.

What to do

Remember Harry from my June article? He had purchased and implemented an estimating software program utilizing the MORS pricing method. He wanted me to review his bids in the new software to see if they were accurately recovering his G&A overhead costs. As it turned out, they were not. His margins were too low for the bids that he was producing, and he didn’t know what to do.

I told him not to worry because there was a simple solution to his dilemma. I call it “calibrating” an estimating or bidding system. To do so, first you have to understand how to define gross profit margin (GPM). GPM is the total of your G&A overhead in a bid added to your net profit margin (NPM). Calculated another way, it is the price for a bid minus the total direct costs (TDC) to include materials, field labor with burden, trucks and equipment costs, and subcontractor costs.

GPM = G&A overhead + net profit margin

Or

GPM = Price - Total direct costs

Second, you have to realize that the market (customer) doesn’t give a rip about how much of the GPM in a bid is G&A overhead or net profit margin. Finally, you need to know the clues that the market gives us as to how much GPM you should put on the bids that you are producing for your projects and services.

Benchmark GPM KPIs

As a result of more than 35 years of spreadsheet analysis of bids, budgets, financial statements and job cost reports, I’ve developed the following benchmark GPM KPIs (key performance indicators). Three caveats: first, these apply to projects and services priced in a normal (today’s) market; second, owned field truck and equipment costs are not included in G&A overhead costs as they are bid separately in direct costs; and third, calculate your GPM on your projects and services without including any subcontractor costs in them. Price subcontractor work separately.

As noted, these benchmark GPM KPIs apply to a normal market. They drop 10% to 15% in a recession. Often contractors panic and reduce their prices to their break-even point (BEP) in a knee-jerk reaction to an economic downturn. BEP is calculated by adding your G&A overhead costs to your TDC.

BEP = TDC + G&A overhead costs

If you include your owned field trucks and equipment in your G&A overhead costs (which I do not recommend), add roughly 10% to the above KPIs to compensate for doing so.

Conclusion

Harry simply had to monitor the GPM in them and compare it to the chart above. He could increase or decrease the GPM on bids by increasing or decreasing the NPM. It’s that simple. Most estimating software programs will show you the GPM on bids.

Use my benchmark GPM KPIs as a starting point and begin to monitor it in your bids and in your job cost reports. Your KPIs may be higher or lower than mine. The important thing is to adapt them to your pricing and your market. They will not only help you be more consistent in your pricing, but they will also increase your confidence level as you price your work.

Travels with Jim follows Jim Huston around the country as he visits with landscapers and helps them understand their numbers to make smarter decisions. He can be reached at: jhuston@giemedia.com.