What’s a Profit Margin?
Quick – what’s your profit margin? Do you know?
Profit margin is one of the most important metrics for evaluating your business. Yet in our experience, many decorative and stamped concrete contractors – or other business owners, either – don’t know it off the top of their head. But you really should.
To make sure you’re actually making money with your business, it’s not enough to simply have a lot of revenue from your projects. It is possible, after all, to do a lot of work and deal in big numbers – and at the end of the day not really come out ahead.
Let’s have a look at what “profit margin” means, how to compute it, and what you need to be aware of. In the end, your profit margin is going to be a key factor in determining how much you charge. And it’s essential to the success of your business.
What is Profit Margin?
To begin, let’s have a look at what “profit” by itself means. It may seem obvious, but are you computing your profit correctly?
If you search for a definition of “profits” in Google, you’ll get this. “a financial gain, especially the difference between the amount earned and the amount spent in buying, operating, or producing something.” Just what you always thought, right? But the important part is that you recognize all your expenses first.
As we’ve talked about in other articles, profit isn’t just the difference between what you get paid and the materials you use. You also have to remember to deduct the cost of labor and overhead. That includes your gas to get to the job, your office expenses such as rent, and what you spent to get the job in the first place – your marketing. Basically, profit is what’s left after you’ve paid for everything.
Of course, taxes a chunk out of your profits, too. But for now, let’s just deal with pre-tax profits.
“Profit margin” is the percent of your total income which is profit. So it’s not only about how much profit you make, but how that relates to the total amount you’re charging for your work.
How to Calculate Profit Margin
Figuring out your profit margin is relatively simple. It’s just important to take everything into account. But there’s no fancy math involved; it’s just a matter of some subtraction and division.
The short formula is:
Profit ÷ Gross revenue
And it’s as simple as that!
But there’s a couple of steps to take before you get there.
Let’s look at both gross revenue and profit to figure out how to come up with those numbers.
Gross revenue is the simpler of the two. How much income did you have from the product? Basically, how much were you paid to do the installation? Let’s say, just to keep things simple, that your gross revenue on the project is $10,000.
Next, let’s figure out your profit. As you know, that’s your revenue minus your expenses. The tricky part is figuring out how much you actually spend on a project because it’s not just the cement or other materials you put into it. It’s vital that you don’t leave out any expenses.
Fixed overhead relates to costs that are costs that are constant and don’t really vary from month to month. One example would be rent. Another would be the insurance you carry. The cost of work vehicles could fit here as well. The cost of your business license, since it is a stable expense, can even fit.
Variable costs relate to aspects that aren’t as consistent. These vary from project to project. A big one, of course, is labor costs. It could also include gas and vehicle and equipment maintenance.
There aren’t hard-and-fast rules about where certain expenses fit. For instance, advertising and marketing costs can be included under either section. It kind of depends on your marketing strategy. Legal fees are another example – if they are general and expected fees for doing business, they align more with fixed overhead. But if they’re only occasional expenses or relate only to a specific project, you might classify them as variable costs.
Again, the most important idea we want to get across here is to include all your work-related expenses. Develop your own way to classify them since these are rather arbitrary designations.
Being consistent helps make it easier – for instance, you could say that labor is a direct cost, not variable overhead. But once you put it into one category, keep it there for all your projects so that you don’t confuse yourself.
So now we get back to profit.
Profit = Gross revenue – [fixed overhead] – [variable costs]
So let’s use real numbers as an example.
You charge $10,000 for a project. Variable costs are $2600 and fixed overhead is $3400.
Total expenses: $2600 + $3400 = $6000
Your gross revenue minus your costs are $10,000 – $6000 = $4000 profit.
And your profit margin is $4000 ÷ $10,000 = .40, or 40%
Why Does It Matter?
Ultimately you should set a goal for the profit margin you make on each job. Your first consideration, of course, is going to be whether you’re making enough money from the work you’re doing.
If you don’t know how to prepare an estimate correctly, taking all these factors into account, you can actually lose money – even if your gross revenue is high and you’re always busy. That often happens when you forget to include some aspect of your overhead in your costs. But you know – or you’ll soon find out – that there’s a ton of work that goes on “behind the scenes” and it’s not just the actual costs of materials and labor on a particular job site that you need to worry about.
At the same time, you don’t want to have too high a profit margin. Actually, you might want to but it’s a bad business choice. Customers are more knowledgeable than ever, and the internet makes it easy for them to investigate and find out what your costs are. It’s easy to shop around and choose other contractors or even decide to do it themselves instead of hiring you. So your profit margin has to be reasonable and in line with your industry and region.
What to Look Out For
One big reason to know how profit margins work is to avoid falling into traps. Not saying it’s done intentionally, but at times you might hear from suppliers or contractors in other specialties that it only cost X amount per square foot to do your work. Especially when you’re starting out, it can sound incredible and like there’s room for 100% profit margins or more!
But more often than not, they’re only including your variable costs and not talking about your overhead. It may very well be true, as it is in the concrete industry, that the cost of the actual material is very low. Don’t ever forget, though, that there’s much more that goes into the cost. Remember, you have to look at all your costs when you’re deciding what prices to set and how much you’re really making. Otherwise, you’re soon going to be looking at an empty bank account and a buyer for your business.
We don’t want to get into what your profit margin should be. That can vary depending on the type of project and many other factors you need to take into account. In stamped and decorative concrete, it can even come down to what patterns you’re using, which affects the labor costs and materials. It can depend on your region. If you’re in another industry it’s also going to vary. But it’s important to assess the market and make realistic choices in order to both be competitive and be profitable.
You should know your profit margin right off the top of your head because it’s one of the key aspects of determining the health of your business. While it can vary depending on the job you’re doing, it’s important to keep it in mind both on an overall basis and for each project. Working to establish it at a suitable level will keep you competitive and in the black!