Let’s look at some issues to consider in arriving at the proper profit percentage for your business. First, what is profit? Merriam-Webster defines profit as money that is made in a business, through investing, etc., after all the costs and expenses are paid; a financial gain: the advantage or benefit that is gained from doing something.
In other words, profit is the reward you should receive above the costs you incur to perform a service for the consumer including a salary for you, and, for your spouse if he/she works in the business.
Proper identification and calculation of your legitimate business expenses is essential to determining your true cost and necessary to attain a proper profit percentage. By legitimate expenses, I mean those that make common sense and are necessary to the operation of your business. Example: You are a contractor with three techs who each require a service vehicle to perform their duties. And, you must leave the office to visit clients and supervise those techs, which requires another vehicle. Those vehicles are legitimate expenses. However, if you choose an outrageously priced luxury vehicle for your duties, the legitimacy of your vehicle as an expense would be questionable.
There are two types of business expenses — variable and fixed. Each will include tangible and intangible costs. A tangible cost is one where you know the amount you must pay for a specific item or service before purchase. An intangible cost is one in which the exact cost is unknown to you at the time you are drawing up your expense budget, but it can be estimated based on past history or an educated guess.
Once you establish your true cost, you must choose the profit percentage you desire to earn as your return on your business investment. Before choosing, you must decide whether you want to apply a markup on cost or profit margin method of reward above your operational costs.
Profit percentage methods
The markup on cost method consists of totaling your labor, overhead, and material cost of a task, and then multiplying that amount by your desired profit percentage.
If your labor, overhead and material cost is $1,000.00, and you want a 10 percent markup on cost, you would do the following:
a) $1,000.00 (cost to you) x 10 percent (markup) = $100.00 (markup dollars)
b) $1,000.00 (cost to you) + $100.00 (markup dollars) = $1,100.00 (selling price)
The flaw in this method is twofold since you would not have maximized your profit dollars (I’ll show you later), and, if you decided to offer a discount (such as senior citizens, veterans etc.), you could lose money. Offering a ten percent discount would cost you $10.00 above the $1,000.00 the job cost you to perform.
$1,100.00 (selling price) x 10 percent (discount) = $110.00 (discount)
$1,100.00 (selling price) - $110.00 (discount) = $990.00 (selling price)
$1,000.00 (cost to you) - $990.00 (selling price) = $10.00 loss
I prefer the profit margin method where the profit percentage is part of the whole (100 percent) selling price. Warning: This explanation could bring up bad memories of algebra lessons of long ago. If you didn’t pay attention then, pay attention now, it will help you maximize your profit dollars.
Using the profit margin method, you would:
a) Subtract your desired profit percentage from 100 percent:
100 percent (reflects whole percent of selling price) less 10 percent (desired profit margin) = 90 percent Profit Margin Divisor
b) Divide your labor, overhead and material cost to perform the task by the profit margin divisor:
$1,000.00 (your cost) ÷ 90 percent (profit margin divisor) = $1,111.11 selling price
You made $11.11 more than the mark up method, and, if you offered a 10 percent discount, you don’t lose money.
$1,111.11 (selling price) x 10 percent (discount) = $111.11(discount)
$1,111.11 (selling price) - $111.11 (discount) = $1000.00 (selling price)
$1,000.00 (cost to you) - $1000.00 (selling price) = No profit – No loss
However, if you are going to offer discounts, the discount percentage should be lower than your profit margin percentage so you can still bring in more money than it costs you to operate your business.
Figure 1 shows your selling price with the markup method only makes you 9.1 percent of the selling price as a profit, and the cost of the task to you is 90.9 percent of the selling price while the profit margin method makes your desired 10 percent profit percentage and the task costs you 90 percent of the selling price.
Performing the example job once a day per tech using the profit margin method could bring in an extra $2,710.84 ($11.11 x 244 workdays) per tech annually.
If you use a 30 percent profit margin instead of a 30 percent markup on cost, you profit reward will be higher yet. The same job at a 30 percent markup on the cost would give you a gross profit of $300.00, but, using the profit margin method, you would earn a profit of $428.57. That $128.57 difference in profit dollars would amount to $31,371.08 per tech annually ($128.57 x 244 workdays) if performed once each work day.
When choosing your profit margin, remember the fact that maximizing your profit makes your business financially stronger while trying to keep things close to the bone by being the cheapest in town brings you closer to failure.
Consider the actual time you have to sell
Next to consider is how many hours you will actually sell. In a 52 week, 40 hour per week year you pay your techs for 2080 hours. If you allow your techs two weeks for vacation, personal time, and six holidays, you must deduct 128 hours from the 2080, leaving only 1952 hours. However, techs will also lose a minimum of one hour per workday for time spent on daily non-revenue producing duties such as truck inventory, paperwork in your office as well as breaks etc. When you subtract the vacation, personal and holiday time from a year you only have 244 workdays left (52 weeks multiplied by five days / less 16 days = 244 work days). Therefore, another 244 hours must be subtracted from the 1952 hours which were left. This gives you an annual maximum of 1708 potentially revenue producing hours per tech.
However, the number of hours you actually sell are less since no one, but the liars, sells all their tech hours all the time.
Currently, the minimum cost in the U.S. for any legitimate contractor to place a qualified service tech in a vehicle is between $100.00 and $250.00 per hour based on that contractor selling all his/her available tech hours all the time. If you don’t believe that, call me immediately — you need help.
At the low $100.00/hr. point of the range, the annual minimum cost to contractor per tech/vehicle would be $170,800.00 (1708 hours multiplied by $100.00).
The risk associated with the unapplied labor/overhead factor should be addressed by your choice of profit margin. If you normally sell only 70 percent of your available revenue producing hours, you would need a 30 percent profit margin in order to address your unapplied labor factor and just break even on labor and overhead costs.
$100.00 (cost per tech hour) ÷ 70 percent (profit margin divisor) = $142.86 (selling price per hour).
1708 maximum available hours per tech x 70 percent of 1708 maximum hours = 1195.6 hours sold.
1195.6 hours sold x $142.86 (break even point) = $170,803.41
In that instance, if you want to maximize your profit which will give you more money than you spend to operate your business, your profit margin would have to be higher than 30 percent. And, if you are planning on offering discounts your profit margin must be higher yet.
I write my column under the headline “Contractor Profit Advantage” because I want to give you information that could help you attain your profit advantage as a contractor, and give you the wherewithal to consistently deliver excellence to your clientele. To further assist you, I have developed Contractor Profit Advantage programs and coaching sessions, which can be done over the phone and show you how to maximize your profit advantage.
I have also created tools to help you reach your advantage point. My book, “Solutions Management Theories & Methods for the Contracting Business,” explains the necessary fundamentals needed. And, my Readily Available Pricing Information Digest, customized to your labor/overhead costs and profit margin, gives you prices at your fingertips so you can quote prices to your clients rapidly and get to the work of attaining your contractor profit advantage.
If you have any questions about these products, services or any business matters; or don’t believe your true cost per hour falls within the aforementioned $100.00 to $250.00 per hour range for a qualified service tech, give me a call. I look forward to speaking with, and assisting, you.
Richard P. DiToma has been involved in the PHC industry since 1970. He is a contracting business coach/consultant and an active PHC contractor. FOR INFORMATION about the CONTRACTOR PROFIT ADVANTAGE or to contact Richard: call 845-639-5050; e-mail firstname.lastname@example.org; mail to R & G Profit-Ability, Inc. P.O. Box 282, West Nyack. NY 10994.