While being highly fluid, the construction business can be impressively profitable. If you are thinking about becoming a general contractor, it’s imperative to understand where the money comes from.
By diving into overhead costs and profit margin calculations, it’s possible to get a clear idea of whether this business is the right choice for you. It’s worth noting that the competition in the construction business is fierce. The industry is growing steadily. The market size is expected to reach $1,819,106 million by 2025.
Let’s take a closer look at the general contractor’s overhead costs and profits.
Overhead costs are the ongoing expenses related to running a construction business. They include fixed expenses paid by the contractor.
These costs aren’t related to the number of clients a contractor can land or the size of the construction project. No matter how well the business is doing, the contractor incurs these expenses in order to keep it afloat.
According to contractors at AFS General Contracting, overhead costs are usually distributed proportionally across all projects.
1. Office Expenses
Any expenses related to renting or maintaining office space fall into this category. This also includes such costs as office supplies, utilities, security, office cleaning, and the like.
The contractor is responsible for bearing these expenses all year round regardless of the number of projects they currently work on. With the COVID-19 pandemic forcing people to rethink business operations, some general contractors opted out of renting offices, moving interactions to the digital realm, and considering it a permanent solution.
While some contractors prefer to hire subcontractors for different aspects of the project-based work, some staff can be permanent. Paying salaries to your staff is an overhead expense that doesn’t change based on your engagement.
Some of your employees could be getting part of their salaries on a project basis. However, you are still required to pay minimum wage. Meanwhile, anyone who isn’t involved in the project directly (e.g. accountants, executives, estimators, HR) need to get full salaries on regular basis.
3. Direct Overhead Costs
General contractors face a variety of direct overhead costs. Unlike indirect costs that have to be paid regardless of the number of projects you are working on, direct costs are unique to each project and may change from job to job.
Direct overhead costs include:
- Costs for space and structures (temporary office structures included)
- Salaries to subcontractors
- Equipment costs
- Site-related costs like utilities and drinking water
While these costs vary from project to project, you have to be ready to cover them. In many cases, general contractors face a disrupted cash flow because clients delay payments for previous projects. Meanwhile, you must pay overhead expenses in order to land a new project.
Due to these cash flow disruptions, many general contractors explore a variety of financing opportunities like loans, business credit cards, government programs, and the like.
While it’s possible to plan the majority of overhead costs, direct costs can differ. That’s why it’s imperative to have an emergency fund for unexpected expenses
Profit is the amount of money your business gets after you subtract all your expenses (both direct and indirect). Calculating the profit margin can help a general contractor put the right price tag on the next project.
To calculate the business’s profit margin, you have to:
- Subtract all direct and indirect costs from your revenue
- Divide the number you get by your revenue
- Multiply the result by 100 to see the percentage value of the profit margin.
This month you completed a project for $10,000
- Overhead costs – $2,000
- Labor – $3,000
- Materials – $2,500
After subtracting all of the above from $10,000, you get $2,500.
2,500/10,00×100 = 25%
To stay afloat, your profit margin should be at least 15%. An average general contractor works with a profit margin of about 30%.
To be successful in the highly competitive construction industry, you need to have a clear understanding of the expenses you are about to face. By calculating the profit margin and pricing your services the right way, you can help your business become profitable.
However, the key to success is still the ability to land major projects. This depends on your experience, marketing skills, and portfolio.
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