Let’s face it, we understand that a significant number of our website visitors are generally looking for information to help them understand the costs related to a quote they received from a contractor. They want to know what is reasonable. How much should a contractor charge?
One of the biggest misconceptions contractors have to deal with is the confusion between Markup and Profit. We hope this post will help set the record straight: Markup isn’t profit.
Markup is a cost accounting term used in all business models globally. It is best understood as the combination of overhead and profit that is required to keep a business, well….. in business. All businesses use markup as a way to ensure they have a future and meet the operational obligations above direct job costs.
Contractor Markup Breakdown
If your contractor has a 50% markup (which is reasonable for a remodeling contractor), that means that if the estimated cost for a job is $10,000, they’ll multiply the $10,000 x 1.50 and arrive at a $15,000 sales price.
If you’re not an entrepreneur or even a seasoned business owner you might be thinking right now, “Oh, look at that crook. He is making $5,000 profit on my job.” Nope, not true.
So let’s talk about this $5,000 for a minute. Where does that money go? A contracting company will use this margin to pay their overhead expenses. What is left from that is what we consider reasonable profit. “Reasonable Profit” is really the only subjective term I will use in this blog. Reasonable Profit is not about getting rich it’s about offsetting the risk of doing business.
Now for those of you thinking, “Wait a minute, contracting companies don’t have much overhead.” Guess again. They have overhead. Advertising, sales commission, job supervision (which isn’t usually a job cost as it’s diversified over multiple projects simultaneously), office expenses (even if they work out of their home), insurance, training and education, accounting and legal fees, licenses, taxes, employee expenses, and their own salary are just a few of their overhead expenses. The typical remodeling contractor in Ontario will have overhead expenses ranging from 25% to 54% of their revenue – that means every $15,000 job could have overhead expenses of $3,750 to $8,100.
Somewhere along the line, people started believing that a 10% overhead and 10% profit is the industry standard for construction jobs. Or that a 20% markup is all a contractor needs. Armed with that knowledge, owners try to get their contractor to reduce the price of the job they want done.
Here at My Next Home Reno, we know you’re not made of money and like us what money you have – you’ve worked hard for. But expecting a contractor to reduce their markup to this arbitrary 20% could be a dangerously careless imposition. And good contracting companies simply won’t take on that work. Good contracting companies know the risk of doing business, and the obligations they have to allocate profit for their future without sacrificing quality or ensuing unnecessary risk. But you know who will take that work? That’s right, the contractor who isn’t thinking about his financial future… or yours.
If you think it through, it’s not a smart move. Would you ask your surgeon to reduce his price before doing open heart surgery? Would you ask your auto repair shop to reduce their price before rebuilding the engine on your car? Do you really want them to go cheap? For most homeowners, your home is your largest single investment. Why do you want to use a cut rate contractor to improve or repair your major investment?
Profit Isn’t Bad
Every business, regardless of their vertical; must make a profit or it will cease to survive. It must price the work or services to include the cost of its goods or services as well as cover its overhead expenses and make a reasonable profit. It needs a reasonable profit to build and maintain the business, keeping it viable during the down times. Profit is what insures a business’s longevity – if it doesn’t make a profit, it might not be in business in six months. If it can’t cover overhead expenses and make a reasonable profit, it might not even be in business long enough to finish your project.
The Ontario Home Builders Association published a report a few years ago that stated that their “best” remodeling contractors averaged something under 4% net profit. I can tell you that in my experience, too many contractors make no profit at all. That’s why so many construction-related businesses fail.
So, if you’re focused on finding the cheapest contractor to do your job, you have a very good chance of selecting a contractor who will go out of business while trying to build your job.
There’s an old saying, “A fool and their money are soon parted.” Any owner who selects a contractor based on their price has no one but themselves to blame when things go sideways. Markup isn’t profit, it is the money needed to make sure the contractor can complete your job, pay his bills and if he’s doing things right, make a profit on the job as well. Just like your doctor, your mechanic, your grocer and every other business.