Q. Can you explain what costs should be included when estimating a project and what percent I should be using for markup? And should I mark up smaller jobs more than large jobs?
--Paul Kocharhook, Pathway Design & Construction, Seattle, Wash.

Hi Paul,

The answers to these two questions depend on many variables (most of which are specific to your company's unique situation), but here are some general concepts that I hope will be helpful.

Q1. Can you explain what costs should be included when estimating a project and what percent I should be using for markup?

The basic elements to include when estimating the cost of a particular job include:

  • 1. Materials that will be required.
  • 2. Subcontractor costs.
  • 3. Other costs of getting the job completed (e.g., permits, dumpsters, temporary sanitary facilities, utility connections, rentals, travel reimbursements, etc.)
  • 4. Labor costs.

The first three costs (materials, subcontractor costs, and other costs of getting the job done) are fairly straightforward and can be nailed down by obtaining quotes from materials suppliers and subcontractors.

Tip: Create a "Miscellaneous Materials Costs" checklist for all of the small extra materials costs that tend to surface throughout the life of any job (e.g., saw blades, small specialty tools, miscellaneous hardware items that may have been overlooked in the original orders, materials spoiled during construction that need to be replaced, and so forth).

The fourth cost, labor, is typically the biggest risk factor as it is more difficult to estimate. Why? Because it requires a high degree of accuracy in two distinct areas:

  • The number of hours that will be required to complete the job, and
  • Your employees' true cost per work hour.

Reliably predicting how long it will take you and your employees to perform various job tasks will be key to profitability as (assuming that you are working on a fixed-price basis) the cost of labor over-runs will directly reduce your potential profitability. So you'll need to dedicate some in-depth thought to computing how many hours this job will require (and be sure to allow some cushion for slippage!).

You then need to know the true hourly cost of your direct labor employees (and don't forget yourself if you'll be working on the job!). You'll need to determine "fully-burdened labor" costs including hourly rate, payroll taxes, benefits, time off, vehicle/tools/equipment usage, bonuses, training, and other costs. Click on the following link (labor burden) to learn more about how to determine your employees' real cost per production hour.

Materials$10,000
Subcontractors$8,000
Other Job Costs$750
Employee & Owner Labor$12,500
Total$31,250

Multiply the hours required by each employee X their burdened rate, add in your materials, subcontractor, and other job costs, and you'll know how much the job will potentially cost you to perform. Here's an example:

Now, to compute markup on the entire job:

You should have a gross profit goal in mind for your company. How to go about determining this goal for your company is a topic for another Q&A, but the percentage often used by consultants for remodelers is 30% to 35% (typically enough to cover company overhead and provide a profit).

Assuming that your company goal is 30%, does this mean that you should add 30% ($9,375) to your cost of $31,250 to arrive at your price for the job? Let's see what that would yield in terms of gross profit:

Cost$31,250
Plus 30% of cost$9,375
Total price$40,625
Price$40,625
(Less) Cost $31,250$31,250
Gross profit = 23.1%$9,375

So the answer is NO! Absolutely not!

I am stressing this point because it's a common error made by construction companies. As you can see by the example above, a markup of 30% only yields a gross profit of 23.1%! To achieve your desired gross profit of 30%, you would need to mark your costs up by 42.9% (i.e., $31,250 x 1.429 = $44,650):

Price$44,650
(Less) Cost (marked up 42.9%)$31,250
Gross profit = 30%$13,400
Gross Profit vs. Markup
Mark up represents profit and is computed and expressed as a percentage of cost.
Gross profit represents profit but is computed and expressed as a percentage of gross income.

As you can see by the preceding example, it's extremely important to first determine what gross profit you need to achieve for your company (i.e., what do you need to make before your general company overhead costs such as marketing, administration, etc.). Then you can determine your gross profit goals for each job, and mark up your costs sufficiently to meet your gross profit goals.

Q. 2 Should I mark up smaller jobs more than larger jobs?

The general rule of thumb answer is "Yes" but there are a variety of factors to consider:

It can depend on how you view your smaller jobs.

  • If you use them as a stepping stone to larger jobs, then you might want keep them at your standard markup in order to encourage an increase in smaller jobs.
  • If you want to discourage smaller jobs due to risk-factors or personal preference, then you may want to mark them up enough to either minimize the number of small-job clients, or so that you feel good about taking them on due to the higher profitability.

The answer can also depend on your "mix" of jobs, …If you have 1 large job per year, and 50 small ones the answer would be different than if you had 10 large jobs per year and 5 small jobs.

From a straight numbers standpoint, every job is going to have some background cost elements that are very similar, regardless of job size. For instance, whether the job sells for $5,000 or $105,000, you will need to meet with the customer to discuss needs, obtain permits, order materials, etc.
  • If you're doing a great job of detailed estimating, you'll build these extra job costs into the estimate, and theoretically you wouldn't need a higher markup.
  • But if you aren't currently estimating for all of these background costs, then you would want to build in a higher percentage for smaller jobs.

There are other administrative costs that reside in your company overhead area (e.g., sales time and design (if not included in direct job costs), estimating, contract preparation, timesheet and payroll administration, answering phones, preparing and entering purchase orders, entering and paying bills, invoicing, problem-resolution, etc.) that tend to not fluctuate in direct relationship to the size of the job. E.g., You may determine that background administrative costs on the $5,000 job are $120 (2.4%), and on the $105,000 job are $1050 (1%). Results such as these would support adding a higher percentage to small jobs and reducing your required percentage on larger jobs just a bit.

So as you can see, this becomes a balancing act between pricing your larger jobs and smaller ones.

Technique

You might want to consider adding a flat rate to small jobs to pick up the difference in admin costs. Using the example shown above, you could determine the difference as a percent of income (in this case, 2.4% - 1% = 1.4%) then add this to the price of the job (1.4% x $5.000 = $70).

Whether you choose to subtract the 1.4% off of larger jobs (in this example the reduction in price on the larger job would be $1,470) is up to you,...

You would likely want to do some "what if" projections based on your current level of large jobs vs. small jobs before making any major changes to your pricing model.


--Diane Gilson (dcg@infoplusacct.com), created the accounting firm of Info Plus(+) Accounting® in 1994 with the intent of providing current and future-oriented management accounting services to small and medium-sized businesses. Since the firm’s inception, Diane has worked exclusively in QuickBooks® – a powerful, flexible, multi-functional software accounting system currently used by 70-85% of small to medium-sized businesses in the United States. She is a Certified QuickBooks® Advanced Professional Advisor and Certified QuickBooks Enterprise ProAdvisor (through Intuit), and a Certified QuickBooks® consultant (through the Sleeter Group Consultants Network).

Read Diane's other contributions or ask her a question.