Building & Construction Accounting 101: Analysing Margins

Understanding Margin

Margin is all about tracking the money flowing into your business from clients, the costs you incur to build the project, your overheads like rent and marketing, and ultimately, the profit you’re left with at the end. Let’s break it down with some practical examples to understand this better.

Example 1: Custom Residential Builder

Imagine a custom residential builder with a total revenue of $3,000,000. Here’s a typical breakdown of Costs of Goods Sold (COGS), Overhead Costs, and Profit:

• COGS: These are direct costs related to specific projects – materials, subcontractors, and direct labour costs.
• Overhead Costs: These are not project-specific – marketing, admin staff, showroom or office expenses. Ideally, these should run at a maximum of 10% of revenue.
• Profit: What remains after paying COGS and overheads.

In our example:

• Total revenue: $3,000,000
• COGS: $2,400,000
• Overhead Costs: $300,000
• Net Profit: $300,000 (10% Net Margin)

Gross vs. Net Margin

• Gross Margin: Gross Profit (Total Revenue – COGS) / Total Revenue. For our builder, this is 20%.
• Overhead Costs: As mentioned, these include expenses not directly tied to specific projects. For our builder, overheads are $300,000, which is 10% of the total revenue.
• Net Margin: Net Profit / Total Revenue. In this case, 10%.

Achieving these margins over multiple projects can significantly boost your annual profit. For instance, five similar projects could yield a net profit of $1,500,000 in a year, in addition to the owner’s wages.

Example 2: Maintenance Plumber

Now, let’s compare this with a maintenance plumber’s business model. While the net profit might be the same, the margins can differ greatly due to varying cost structures and business models.

Imagine a maintenance plumber with a total revenue of $1,000,000. Here’s a breakdown:

• COGS: These costs for plumbers often include direct labour, parts, and materials.
• Overhead Costs: Like builders, plumbers have marketing, admin staff, and office expenses, but these may be a larger proportion of total revenue due to the nature of their work.
• Profit: What remains after paying COGS and overheads.

In our example:

• Total revenue: $1,000,000
• COGS: $600,000
• Overhead Costs: $300,000
• Net Profit: $100,000 (10% Net Margin)

Gross vs. Net Margin for Plumbers

• Gross Margin: Gross Profit (Total Revenue – COGS) / Total Revenue. For our plumber, this is 40%.
• Overhead Costs: These include non-project-specific expenses. For our plumber, overheads are $300,000, which is 30% of the total revenue.
• Net Margin: Net Profit / Total Revenue. In this case, 10%.

Example 3: Project PAIN!

Using the same concepts around COGS, Margin, and Overhead Costs, we can look at a project that has gone off the rails and one where COGS have been tightly managed, and overheads are under control – and what the net profit looks like as a result.

In the project on the left, clearly, COGS have blown out – maybe the estimate was wrong, maybe there were material price increases, caught in a fixed price contract… whatever the case – COGS blew out and reduced the Gross Profit on this project to 10%. Overheads are also running hot in this business, at 15%. Combined with cost overruns, the project was completed but put the business in a $50K hole. We saw a lot of this through COVID with projects that went south.

The reality of this is that the $50K has to come from somewhere – the harsh reality being that not only is this project a drag on profit itself, but it will eat away at other projects.

Example 4: Margin Perfection

The project on the right is what you’d really like to see: a healthy Gross Margin of 25%, single-digit overhead resulting in a very strong 17% Net Profit margin. A million-dollar project – that dropped $170K out the bottom for the business owner – after wages.

Key Takeaways

Understanding why margins differ between trades like builders and plumbers is crucial. Builders typically have higher material and subcontractor costs, while plumbers might incur lower direct costs but face higher overheads or operational expenses.

By closely analysing and monitoring your margins, you can make informed decisions to enhance profitability and sustainability in your construction business.

Next Steps

Margins are a critical aspect of your business’s financial health. By understanding and managing them effectively, you can ensure steady growth and robust profits.

If you want to gain a better understanding of your margins or find out what margins you should be making for businesses like yours, reach out to us today. We’re here to help you optimise your financial performance and achieve your business goals.