How to calculate profit margins
Knowing how to calculate profit margins is essential in the home improvement industry. Before taking on a job or bidding for one, you want to know how much you think you can make on it. If the profit margin isn’t big enough, you may be better off skipping it and bidding on a different job.
However, many businesses can slip up when calculating their profit margins, leading them to make less than they expected on a job or, even worse, break even or lose money on it.
Every project is different, so you’ll want to make sure to spend some time estimating your potential profit margin. In this article, we’ll walk you through the basics of making this calculation.
What is it?
Before we break down the formula for calculating your profit margin, let’s talk about what we mean by ‘profit margin’ in the first place. Put simply, it is the revenue percentage you take home after paying your expenses for a job. By calculating this, you can figure out how much money your business will make on a job.
The percentage can help you understand how much your business makes for every dollar you charge. In other words, if you have a 60% profit margin, you make 60 cents on the dollar. Over time, you’ll learn what your average is and you can make sure to try and avoid jobs that fall too far under this average.
What is a healthy profit margin?
Now that we know what a profit margin is, what percentage should you be aiming for as a home improvement business? These percentages can be good or bad depending on the industry. While some industries might consider 10% a good margin, other industries would consider that extremely low.
If you’re in the home improvement industry, you’re going to want your profit margins to sit around 15% on the low end and 45% on the high end. Of course, this can also depend on your location, the type of jobs you take, and more.
If you decide to set your margin between 15% and 45%, you’ll usually be in good shape. Just make sure you’re choosing one that works best for you and that you’re not having to dip into your funds to cover projects.
Markup vs. overhead
One last thing before we break down the formula for calculating profit margin — understanding the difference between markup and overhead.
The difference between the two is simple but important.
Overhead is the expenses that your business requires to run. So, this would include your utilities, upkeep of equipment, rent for your office space, employee wages, etc.
Markup is how much you’ll charge for a project on top of overhead expenses. Markup ensures that your profits and revenues stay consistent. Your markup percentage will change based on market conditions, costs, and various other economic factors.
Now, it’s time to look at the formula for calculating your profit margin. Here are the steps you need to take to get an accurate assessment:
- Add up your overall revenue
- Add up your overhead
- Subtract your overhead from your overall revenue
- Divide the above number by your overall revenue
- Multiply the above number by 100
Now, let’s break these steps down one by one and do a hypothetical calculation to figure out a quarterly profit margin. You can choose whatever period you want, but for this example, we’re doing a quarterly margin.
Step 1 — Monthly revenue: $15,000
Step 2 — Overhead: $5000, materials $5000 (total cost of $10,000)
Step 3 — 15,000 — 10,000 = 5,000
Step 4 — 5,000 / 15,000 = 0.33
Step 5 — 0.33 x 100 = 33%
Your profit margin for that particular month would be 33%.
1. Determine your overall revenue
First, you need to calculate your overall revenue for the quarter. Determine your quarter start and quarter end and add up all of your accounts receivable for that period. You should only include revenue from projects that could be counted for that quarter. So if you receive revenue from an older project or an early payment for a project that starts in the next quarter, that wouldn’t be included in your calculation.
For our hypothetical calculation, we’ll say that revenue was $60,000 for the quarter.
2. Figure out your overhead expenses
Once you have your revenue calculated, you need to add up your overhead expenses for the quarter. Let’s look at some of the most common overhead costs for home improvement businesses.
Common overhead costs
Every business has some form of overhead. Overhead can fall into different categories, such as fixed and variable costs. Make sure you get a comprehensive picture of your overhead costs and that you add them up as accurately as possible.
Here are some common overhead costs your business may have:
- Office rent
- Employee salaries
- Upkeep for equipment
- New equipment purchases
- Software platforms and tools
- Costs paid to subcontractors
- Material costs for projects
All of these can be considered different forms of overhead. Anything necessary to run your company or complete a job can be considered overhead. Make sure to track these expenses and add them up.
For our hypothetical equation, let’s say that overhead for the quarter was $40,000. Now we have $60,000 in revenue for the quarter and $40,000 in overhead. Figuring out your revenue and overhead is the most time-consuming part of this process. Fortunately, the next steps are simple once you have accurate numbers in hand.
3. Subtract overhead from revenue
All you need to do for the next step is take your revenue amount and subtract your overhead amount. In our hypothetical calculation, we’d subtract our $40,000 in overhead from our $60,000 in revenue for the quarter. This leaves us with $20,000 for the next part of the formula.
4. Divide this number by your revenue
Now you just need to take the number you get from the last step and divide it by your total revenue. So, $20,000 divided by $60,000 gives us 0.33.
5. Find the percentage by multiplying by 100
Once you have your decimal, simply multiply that number by 100 to get your profit margin. In our calculation, we take our .33 and learn that our margin for the quarter is 33%. This is pretty great for the home improvement industry and lands right near the middle of the spectrum, if not a little higher. If you find out your profit margin for the quarter is 33%, you may be pretty satisfied with that figure.
Of course, there’s always room for improvement. If you’re wanting to up your percentage, there are some strategies you can try.
Tips to improve your margins
If your profit margin is decent but not quite where you want it to be, there are things you can do to try and increase that percentage. Of course, everyone would like their percentages to be higher, so why not give some of these tips a try? Here are some of the best ways to improve your margins:
Lower your costs — Lowering costs is a great way to improve your margins. Some good ways to lower your costs could include cutting back on unnecessary overhead. See if there are software tools you don’t use, or if there are utility savings you could find. You could also try cutting some of your services, getting rid of the ones that have a low-profit margin so you can focus on higher-profit jobs.
Increase revenue — This is easier said than done, but increasing revenue is a great way to improve your margins. You may want to look at your prices and see if they’re in line with industry standards. You may be charging too little for your services. You may also want to make sure you’re bidding on jobs that will bring in a certain level of profit, making sure to skip bidding on jobs that won’t bring in the money you expect from the time you’ll put in. You could also optimize your sales process, making it easier for customers to pay you, get quotes, and sign contracts. Improving your sales funnel is one way to do this. Marketing your business effectively can also help increase revenue.
Are you looking for a tool that can help you win more jobs, get paid more, and get paid faster? Hearth can help.
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