How to Know if You Are Marking Up Your Bids Properly
Are you bidding your construction jobs correctly? Learn the crucial difference between margin and markup to boost your profits. We’ll show you how to reverse engineer your bids for success and maximize your cash flow. Watch now and transform your bidding strategy!
Topics we cover on this episode include:
- 01:21 – Reverse engineering profit margins
- 03:23 – Understanding break-even point
- 05:45 – Markup vs. margin explained
- 08:55 – Defining job costs
- 12:20 – Importance of cash-based profit
- 15:36 – Introducing Profit First website
- 18:58 – Conclusion and feedback request
LINKS
Get the free breakeven calculator
Join our free community for construction contractors
Join the conversation on our LinkedIn page: https://www.linkedin.com/company/CarpenterCPAs
FIND US ONLINE
Wade Carpenter, CPA, CGMA | CarpenterCPAs.com
Stephen Brown, Bonding Expert | SuretyAnswers.com
GET IN TOUCH
Questions? Want to find out more? Get in touch, we’re here to help! Fill out the form below to get started.
TRANSCRIPT
[00:00:00] Wade Carpenter: Are you confident you’re bidding your jobs correctly to ensure profitability? Do you know if you’re using the right figures to bid properly? You’re not alone. Today, we’re going to show you how to reverse engineer your jobs for success.
This is the Contractor Success Forum. I’m Wade Carpenter with Carpenter and Company CPAs. With me, as always, my co host Stephen Brown with McDaniel Whitley, bonding and insurance. Stephen, do you often see contractors struggling with their bidding?
[00:00:20] Stephen Brown: Yeah. Wade. I like the reverse engineering, the mindset. You’ve got a great topic. And when we bring something up to some of our listeners, thinking about things at a different angle, coming at things from a different perspective is a huge help.
Reverse engineering profit margins. What else are we going to talk about today?
[00:00:39] Wade Carpenter: This is on my mind because I have a contractor in Texas that struggles with this concept and it was current. As well as I’m getting the first draft of the book finished up, and this is part of my Profit First for Construction book that leads into essentially bidding for cashflow, not bidding for your financial statement, but how are we going to bid to ensure that we have cashflow? And that was what we started talking about a couple of episodes ago, but I didn’t get very far into the topic.
So I’m hoping to give a little more detail today and hopefully it makes some sense. I know some of it’s basic math, but it’s something that probably a lot of people don’t think about. The question of margin versus markup is sometimes still very confusing.
[00:01:19] Stephen Brown: Okay. So what’s on your mind? What are we going to talk about?
[00:01:22] Wade Carpenter: If it’s okay, I’m going to show a little calculator and we actually were going to put a nicer version of this on the website.
Let’s just assume we have a company that has a hundred thousand dollars in overhead per year, and they typically have a gross profit percent of 20%.
[00:01:36] Stephen Brown: Okay.
[00:01:37] Wade Carpenter: So what are we trying to do? Obviously we’re trying to chase profit. But in trying to reverse engineer that, there’s simple math, but a lot of people don’t know this formula. So what does it take if we have that scenario right here to break even? How much revenue do we actually have to do to break even? Do you know how to calculate that?
[00:01:55] Stephen Brown: I guess you have to know how much overhead? What other factors?
[00:01:59] Wade Carpenter: So again, how much revenue do we have to do to achieve that goal?
The break even formula is essentially overhead of $100,000 divided by our 20 percent margin, gives us $500,000. So it would take $500,000 of revenue to have zero profit.
[00:02:17] Stephen Brown: That makes sense.
[00:02:18] Wade Carpenter: It makes a little more sense when we put the proof on that. So if we have 500, 000 and we have a 20 percent margin, that’s what we’re saying, that would mean that job cost was 400, 000, right?
[00:02:29] Stephen Brown: Okay.
[00:02:30] Wade Carpenter: And then we know we had 100, 000 of overhead and net income was zero.
[00:02:34] Stephen Brown: Got it.
[00:02:34] Wade Carpenter: All right. So with that said let’s do easy math. Let’s just put another, 100, 000. So we want to target net income of 100, 000. Okay. So maybe we’re looking at our year and we want to plan our year and we know our overhead is going to be 100, 000 and we want a certain amount of profit. How are we going to back into that?
We can use that same breakeven formula and we can just add in the profit. So the formula is just overhead of 100, 000 and then you add the desired profit of 100, 000 and then divide it by that gross profit percentage.
You’ve got to do 1, 000, 000 to be able to do that. And so to show that proof, then, we have 1, 000, 000, 20 percent margin, overhead was still 100, 000. Makes sense, right?
[00:03:22] Stephen Brown: Absolutely.
[00:03:23] Wade Carpenter: So if we’re going to build on that and we know that’s our goal, and like I said, we can take this and maybe reverse engineer, we think we can do 750, 000 and our margin is 25 percent or whatever the numbers are, then we can back into this.
So the bottom line goal is we want to all make profit. So if we’re trying to do that, we have one job of 800, 000 or 10 jobs of 80, 000 or whatever combination to get us to a million dollars in revenue, how much would we have to mark that up?
The calculation is simply, if we just take 800, 000 and add 20%, that’s only 160, 000, right? That only gets us to 960. And our goal to actually make a million, then we’re going to be 40, 000 short.
[00:04:05] Stephen Brown: Ah, yeah.
[00:04:06] Wade Carpenter: And a lot of people think about it that way, because profit and losses are expressed that way. If you see it in percentage, and accountants speak, that’s the way we talk. That’s the margin, gross profit percentage, you may see it and hear it different ways, but we can’t just add 20%. And I see contractors do variations of that and they’ll add 10 and 10 or something like that.
But they’re chasing the wrong markup fee. So part of the idea here is how are we going to get to the right markup fee? We can walk through some more examples of this, but margin is, we’re taking 20 percent and dividing it by our revenue, right?
[00:04:43] Stephen Brown: Right.
[00:04:43] Wade Carpenter: And that gets us our 20%. To get the markup we want 200, 000 of gross profit. We have to divide it by the cost. That’s all we really have to do to get 25%. Now that’s one thing when you’re sitting there planning out a year, and that makes perfect sense maybe, but when you’re bidding a job, most people don’t, maybe not.
The proof of that is this 25%, you’ve got 800, 000 times 25 percent mark up is 200, 000, add that on to 800, that gives us your desired revenue of a million dollars, right?
I know we’re playing with figures and not trying to get too deep in the math. I know nobody wants to listen to me talk about math. But easier math is if you want to earn 20 percent on it, all you really have to do is take that 20 percent divided by one minus the 20%.
It’s sort of a reverse of this break even calculation.
[00:05:31] Stephen Brown: Right.
[00:05:31] Wade Carpenter: So that’s just 20%. And then this is the cost represents 80%. And then we get to 25 percent margin, right?
[00:05:39] Stephen Brown: Okay.
[00:05:40] Wade Carpenter: So we could walk through that any kind of way, but hopefully everybody’s following me in this.
[00:05:45] Stephen Brown: Sure. It makes perfect sense to me, Wade. I guess my question is what is it you see so many of your customers that don’t get about this? When did they figure this out? Or do most, of your customers not set these kind of goals for profit?
[00:05:59] Wade Carpenter: A lot of times they just think okay, I’m getting 20%. So I just need to mark it up 20 percent.
[00:06:04] Stephen Brown: Okay.
[00:06:04] Wade Carpenter: And they don’t understand the math and they don’t understand why they’re perpetually, there’s other reasons in construction with cashflow, which is part of where I’m going with this. There’s another step to this that we want to get to.
They’re not chasing cash based profit. And the main premise of Profit First, the whole goal is to see profit in cash at the end of the day. And that’s the difference between me meeting with a contractor, and they go in and talk to their CPA in April, and they say, you’ve got all these taxes to pay.
How can I possibly owe that? Because cash is not in my pocket. Is it in your pocket? Because it’s not in my pocket. How can I possibly owe that? The answer is we’re not solving for cash. It may be different because you’ve been paying on debt. Paying down some of those things.
And we also get into this cycle of, let’s just buy another truck at the end of the year to knock down our taxes. We’re going ahead and using some future expenses to knock down our profit then and it’s artificial.
The cash flow effect is not the same as the financial statement.
The main goal of walking through this calculation, and yes, for a lot of our contractors, they probably know this. It’s probably second nature to them.
It was actually a study I saw on Contractor Forum, where they were talking about how people see this. An estimator may see markup, but maybe the owner or somebody that’s not bidding it they look at it as we had here from your profit loss sample and they’re using the wrong figures. Again, Profit First is all about how can we reverse engineer this so that we have cash at the end of the day?
[00:07:36] Stephen Brown: Okay.
[00:07:37] Wade Carpenter: To be fair, contractors have a lot more moving parts than most. Construction is a tough industry. We have all the cash flow. And especially if we’re in a growth mode, it’s tough to chase that cash.
So where am I going with all this? I developed this more in the book, we started this a couple of podcasts ago, but the idea between how can we actually solve for profit, not for financial statement profit here.
And I’m not sure we’re going to get into all that today, but the idea is, what are the inputs that we’ve got here? Remember when we went up here to the top, we have overhead. A lot of these contractors have no idea what overhead is. They can look in their P& L and maybe figure, but they have no idea what that percentage is to add to their their bids.
[00:08:19] Stephen Brown: And you might can figure out what your overhead is by looking at your year end financial statement that your CPA did for you, but it changes, doesn’t it?
[00:08:27] Wade Carpenter: It definitely changes.
And you go hiring somebody else or you get, buying another truck or whatever it is, there’s a lot that can change your overhead from one period to the next. And the difference between that and cash flow, the other part of this is what’s the definition of job cost, right? We talked about that many times on this podcast. What’s the definition of job cost?
And there’s a lot of different definitions depending on who’s looking at it and in profit first, the original version Mike Michalowicz came up with materials and subcontractors. And in several ways that’s. that’s brilliant. That’s not your money. Materials and subs is money that has to go out on your job, that’s not internal to your people. And in my book that is still in editing, but it’s still got a ways to go, I sort of take that concept and we’re going to, what I refer to as JobEx.
It’s not job costs. It’s not just materials and subs. For construction, you may have things like equipment rentals, you may have bonds, obviously, but what we’re looking at is, what are the cash outflows for a construction company on a job?
[00:09:32] Stephen Brown: Okay.
[00:09:33] Wade Carpenter: And, the idea is, your people, if they’re your labor, If you don’t send them home, if they don’t have anything to do, if they don’t get paid, they’re basically an employee. They’re essentially overhead. And, there’s a blurred definition between what’s a subcontractor and what’s an employee.
And a lot of people err on like calling people subs that are really employees and vice versa. But you may also put a day laborer on W 2. And so , I don’t want to go deep into that today, but the definition that I have basically separates like, would these people be working?
Would you have this cash out on this job if they if you didn’t have a job? If that makes any sense. As opposed to a project manager, estimator, or whatever, you’re going to pay them regardless. You’re going to pay the laborers on your job regardless, then that is more of overhead, the way we’re thinking about it.
I just love talking about this. The other part of the overhead function is more of, what is the cash out? And so if we’ve got a basic definition of what I call JobEx, Job Expenses for short, as we call them.
Overhead, OPEX, we have an account for that. If we know exactly what those inputs are, then everything else going out that’s not profit or going to the owner’s comp or covering their taxes that would be in the profit bucket has to be overhead or OPEX. Operating expenses.
I know I use these terms all the time but OPEX is not something that also that you’re going to see on your profit and loss. There are a lot of things you will see on your profit and loss, but our definition like job expenses of materials and subs may be at the top, but there may be a lot of other stuff.
But you may also have depreciation on that equipment. You may have all these other things on that expenses that are going out, but we have to back out this depreciation. But what about all the cash that’s going out? On, paying on your trucks and paying on your bulldozers, excavators, paying on that equipment, that’s cash out. So we’re going to add that in to , what I refer to as OPEX.
And we’re going to use that as a surrogate measure of overhead.
[00:11:37] Stephen Brown: Okay.
[00:11:38] Wade Carpenter: The JobEx with the materials and subs mainly, we’re backing into that number. What people will see is that their overhead on their profit loss is actually lower than actually their cash out because they’re not factoring in the cash out from paying on all their notes, all their debt.
For the contractors that I’ve taught this over the last few years, they’ve made some dramatic turnarounds in their profitability, and that’s part of where I’m going with my book.
There’s so much in Profit First and even the derivative book that was also written for construction that just does not really explain how to do things like dealing with the real revenue and how to do the allocations. I won’t go into that part either, but the multi step type allocation.
I did actually have a couple of people reach out and cause I put out a call, it’s if anybody’s listening to this, I’m looking for people to maybe test this out. I want to see how it resonates with people in the book. I want to understand and see how they– because one of the biggest things I found, I think I told you the story, was I ran my own team through the instant assessment in the original book.
CPA in the room, somebody with 35 years experience was in the room. I had two other people with a CPA candidate, another one with 10 years experience, another one with six years, and another one has been with me 15 years and talked about Profit First. And I had them try to work through this instant assessment in the original book, as well as the derivative book, and they couldn’t get it either.
And my concern was that, if they can’t, couldn’t get it, I know contractors struggle with this. And I truly have seen, this is what has been enlightening for me is over the last six years that I’ve been helping contractors as well as implementing my own business, is that, it works and it, just like the one I was just talking about, had dramatic turnarounds in short period of time.
It doesn’t happen overnight. But it does start to happen. You start getting to a point where you’re not chasing cashflow every Wednesday and Thursday to make sure you got payroll covered on Friday.
[00:13:34] Stephen Brown: Sure.
I like the way you’ve termed certain things, where they make sense. Cause this is a, paradigm shift, if you call it in and how you think about profit and OPEX for operating, expense factor, you’re going to go in and you’re going to figure out how to make it simple because.
Accounting can be extremely frustrating and complicating to everybody that doesn’t do it 24 seven, wouldn’t you say?
[00:13:59] Wade Carpenter: Absolutely. And part of the premise of the book too, is , even if you’ve got a contractor that has very poor books or no books at all, I can teach you to pull out these factors so that you can reverse engineer this. Obviously you’re a lot better off. If you’ve got some good job costing records or at least good books, but I can teach a contractor how to pull out just materials.
Anybody can go add up their subs for the year. They probably have to do that for their 1099s. They can go add up their supplier bills for the year and get some kind of factor of it. Even if you have nowhere to start, even if you’re starting with zero, I really, truly believe in Profit First because it works in my business and I’ve seen it work in many others.
And quite frankly, of all the industries out there, I believe construction is one of the hardest with cashflow. And it’s one of the major factors why contractors do not make it in this business is, the survival rate of construction is actually worse than the national average of businesses across the board. So I don’t mean to sound–
[00:14:58] Stephen Brown: No, well, you’re not. I agree with that a thousand percent. Wade, I see it all the time. I’m not an accountant, but I look at financial statements all day long. It’s how you and the bond underwriter gauge whether to give surety credit, it’s that simple. And then you see certain trends and you worry, you’re just like, oh no.
And if I was a construction company and not a bond agent, I would definitely contact you about being your guinea pig. Because I know you got this book just about roughed out and you’re trying to fine tune it right now. How would someone get in touch with you that wanted to talk to you about that some more?
[00:15:34] Wade Carpenter: I appreciate you saying that. And we have actually put together a new website to go along with the book as well as we’re trying to build a community. And I know Stephen’s going to be in there, but we may have some stuff in the Contractor Success Forum.
We went ahead and started a free community to allow me to give some of these like calculators. So it’s not out the world. I want to make sure the contractors get the benefit of this and there’ll be some more teaching in there. But this is a place where I want to share some of the ideas as well as maybe , we can have some question and answer sessions or if you’ve got questions about how to do it.
But , it’s more about right now for me, I’m just trying to get feedback and more insight into the book and how people might apply this.
And I’ll tell you right now, the way I’ve written this book is very different from, there’s several different Profit First derivative books now. And they all essentially have the same formula, essentially doing that instant assessment and nobody gets it.
And I’m walking people in a very different way. And we talk about a lot of things: seasonality, infrastructure, we talk about the ups and downs in the economy, what to do when the things start crashing, the market goes down or, if figuring out stuff like this, if you’re bidding properly.
[00:16:49] Stephen Brown: Yeah.
[00:16:50] Wade Carpenter: So if you all found this helpful and want to dive deeper in these concepts, I would invite you to join me at that ProfitFirstConstruction. com as a website. It’s completely free, and I’ll have this calculator up there as well as improved on that target allocation percentage calculator we did several weeks ago.
And it wasn’t all working as we had hoped and now we’ve figured all that out so you can go in there and just plug your own numbers in and get a whole report based on your own numbers. But again, you can follow along with some of the things we’ve been doing and hopefully give me some feedback and insights into doing this.
[00:17:22] Stephen Brown: Yeah. Give me that address again?
[00:17:24] Wade Carpenter: It’s just ProfitFirstConstruction.com And, again, you’re signing up for a free community. It’s nothing to buy, but, at some point we may have some paid courses in there. There is actually a couple of Free courses that I did with three other Profit First professionals several years ago, it’s not construction specific, but that is all free in there right now.
But again, this is all about me wanting to get some feedback as well as engage with I’ve had some great feedback from this podcast on over the years. And feel it’s a shame that a lot of people still struggle applying Profit First to construction.
[00:17:58] Stephen Brown: Okay, great. Wade, I’m really excited about exploring the website and helping you however I can with the book. I think it’s great. And, keeping things simple, making things where folks can understand it, and also at the same time, understand all these moving parts and how they affect your profit. It just seems like, how many years have we been doing this, Wade? I don’t even remember.
[00:18:20] Wade Carpenter: Three and a half now. I guess we’re closing in on four, but.
[00:18:23] Stephen Brown: Three and a half years, we’ve been slogging through different topics that we thought would be of interest to our listeners. And ,everything that we do in bonding and everything that you do in accounting for our contractor customers, it all comes back to the exact same thing.
And I can’t tell you how many times during the podcast, that you or I make this comment. This is what we talk about all the time. So I guess if we’ve been able to break this down for three and a half years and come right back around to the same point is, reverse engineer for profit.
Make sure you’re putting your right markup versus profit margin. Check out , ProfitFirstConstruction. com. Check that out and let’s get going. Let’s see what happens.
[00:19:04] Wade Carpenter: Okay, great. If any of our listeners have any thoughts or feedback on today’s discussion or any of our discussions, we always love to hear from you and hear your thoughts and other topics you’d like us to cover put them in the comments, we’d love to see what you got to say, but thank you for listening to the Contractor Success Forum.
Visit the ContractorSuccessForum. com or check out Carpenters CPA’s YouTube channel for more information or you can actually go to that Profit First construction if you want. But if you enjoyed the episode, please share and subscribe and follow us every week as we post a new episode and we will look forward to seeing you on the next show.