Understanding your profit

Recently, a landscape installation client called to ask, “How much profit should I put on my jobs?” I knew this contractor, his business and his market. However, before I could answer his question, first we had to clarify what he meant by profit.

There are three types of profit margins: gross profit margin (GPM), net profit margin (NPM) before taxes and net profit margin after taxes. My job as a consultant is to help clients make as much money as possible (before taxes). Your CPA’s job is to make it look like you’re going broke and to keep you out of jail. Let’s define our terms using an installation job as an example (below):

The GPM for this job is calculated by subtracting the total direct costs (TDC) from the price ($4,000/40%). The NPM (before tax) is calculated by subtracting the general and administrative (G&A) overhead cost from the GPM ($1,500/15%). The break-even point (BEP) is the TDC plus the G&A overhead cost ($8,500/85%). You, your CPA and the IRS calculate your after tax NPM.

Industry benchmarks.

Now that we’ve defined our terms, we can apply industry benchmarks to our analysis for this job. You’ll notice that I’ve kept any subcontractor costs and margins added to them out of this analysis. This will distort the percentages due to the low margins applied to them. For a normal economy, the benchmarks are as follows (at right):

How it works at the bid table.

When bidding and pricing your various market segments, calculate both the GPM and the before tax NPM for each job. I’d recommend doing this for jobs that you’ve previously priced and installed. Look for trends regarding these two categories.

If your margins exceed the industry benchmarks, great! If they are below industry standards, you might want to increase your NPM on your projects, if you can.

Conclusion.

Once we defined our terms, I told my client that he should apply a 20 percent net profit margin to his break-even point. He should also review the GPM on his projects. It should range between 35 to 40 percent. This will provide him with an objective reference point for pricing his work. I told him if he could price his work with higher margins, by all means, do so.

When analyzing your pricing, first you must define your terms clearly. Then calculate your GPM, BEP and before tax NPM on future projects and work that you’ve previously completed. Look for trends and compare them to my industry benchmarks as a staring point. Then, calculate the benchmarks for your company using your data to make your pricing more scientific and more consistent. And who couldn’t use a little more of both in today’s business environment.

Jim Huston runs J.R. Huston Consulting, a green industry consulting firm.