Do you want to know the average profit margin in the construction industry? If YES, here is an estimate of how much construction companies make annually.
It is an unarguable fact that the construction industry is a profitable industry, but the fact remains that the profit margin in this huge industry can be hard to predict. In 2013, contractors were seeing a commercial profit margin of 2.96% on average.
However, in busy years like 2018, the figure seemed to go higher than in slower years. This however means that the profit margin in this industry is generally dependent on how busy the industry has been. With the rise in construction works the world over, about 54% of contractors expect to see their profits rise over the next year, and 29% of contractors expect to see a 7% increase in profits or higher.
Costs to Take Note of That Can Affect your Overall Profit Margin in the Construction Industry
When construction companies prepare their bid for contracts, they typically look at a lot of costs including the overhead and profit of the project. They also have to take note of labor, materials, equipment costs, bonding, supplies, and every other cost associated with the execution of the project.
Overhead is one of the costs to take note of when running a construction business. These costs are rent, support staff, insurance, tools, bookkeeping, legal costs, owner’s salaries, debt payments, and other costs associated with operating the business.
Profit is what remains when you subtract job costs and your job overhead. This profit is the reward of the construction company. It is what allows the business to grow and make investments in itself. Without a construction company earning a reasonable level of profit, the business will be in trouble.
Types of Profit in the Construction Industry
There are various types of profits that come into play when you think of the construction industry, and they include;
Adjusted Contracted Revenues
This is one of the costs construction industries incur that other industries don’t usually have to go through. The adjusted contracted revenue means that a set amount can be earmarked for a contract, but when the buyer and the contractor go to the closing table, the contracted price is reduced.
In new home construction, this runs around 9 to 11% of the contracted price. For remodelers, restoration contractors, and those contractors doing additions, this runs less than 2%. This is mostly due to allowance issues.
Gross Direct Profit (Direct Margin)
This is the dollar value of the adjusted contract price less the actual direct costs of construction. These costs include land, materials, subcontractors, labor, and other direct costs (permits, insurance/bonds, engineering, site utilities etc.).
Gross Indirect Profit (Gross Margin)
This equals the direct profit less the indirect costs of construction. Indirect costs are those costs associated with construction but cannot be directly assigned to a particular project. Examples include management, transportation, communications, workman’s compensation insurance, payroll taxes, equipment, tooling and supplies.
It is important to understand that these types of costs are shared among the projects. These types of costs generally run about 18 to 21% of total contract revenues.
Business Profit (Gross Profit)
This is not the actual net profit of the company; it generally does not include the taxation deduction to the company or owners. If the owner has not included his compensation in either the indirect expenses or the overhead section, then this number should be referred to as the Gross Profit.
The value is calculated by subtracting the overhead costs (office operations, marketing, and corporation fees) from the gross margin. For most small contractors, the overhead runs around 7% of contract revenues.
This is the final number; no other deductions can reduce this number. In general this is the after tax costs. For most small businesses, a reasonable tax percentage to use is 23% to cover federal and state income taxes. This is the kind of profit that we would be trying to estimate for the construction industry.
Average Profit Margin in the Construction Industry
From the new home builder to the re-modeler, a reasonable profit given the risk is usually pegged at 9%. This is the take home or actual bottom line profit; the amount that is left at hand after taxes for the business. It does not include a reasonable salary to the owner for his management role
So why should the profit be 9%? Well, this is the necessary profit to reward the owner(s) for starting and assuming the responsibility of owning the company.
A reasonable expectation of any business owner is 3 to 5%. If a typical small contractor has adjusted sales of $1,200,000 per year, then he or she is looking at about $36,000 to $60,000 for owning the business. This is reasonable all round.
Factors That Influence the Income and Profit of a Construction Company
The Capacity of the Construction Company
When it comes to the income and profit a construction company is expected to make, one of the key factors that should be considered is the capacity of the construction company. The fact that different construction companies have different capacities means that they are expected to generate different incomes and profits.
As expected, there are construction companies that can only handle local construction projects, while there are ones that have the capacity to handle massive projects such as rebuilding a city, construction of bridges, airports, dams, underground tubes, tunnels, et al.
In essence, the larger the capacity of a construction company, the larger the projects they can handle, and of course the larger the income and profits they are expected to make.
The Clients the Construction Company is Working For
Another major factor that can influence the income and profit of a construction company is the clients the construction company is working for. A construction company that is working for individual clients or handling projects for businesses will likely make lower income and profits when compared to a construction company that is handling projects for the government.
The Type of Construction Company (Niche)
Despite the fact that the construction business is a viable and profitable business, it is important to note that different niche ideas in the industry also attract different levels of income. Although most major construction companies are known to be jack of all trades and master of all, medium-sized construction companies usually settle for a niche idea that they are known for.
The Location of the Construction Company
The location of a business is one of the key factors that will always influence how profitable the business will be. When it comes to the construction business, places that are opening up and underdeveloped are known to attract massive construction projects.
That is why most international construction companies usually have their offices in countries across Africa and some countries in Asia.
Come to think of it, a construction company that is in the heart of New York, London, Paris, or Rome will be less busy when compared to a construction company that is located in places like Libya, Syria, or even Ukraine (post-war). This is so because there are fewer construction projects that will be needed in a city that is already developed than in a city that is just recovering from war or that is underdeveloped.
The Management Style of the Construction Company
In business, it is one thing to attract opportunities, but another thing to be able to maximize those opportunities. The truth is that what makes many companies declare profits annually is the management style of the construction company.
As expected, a construction company that has tested and trusted management style will always outperform a construction company that is still trying to find its footing in the industry. With the right management style in place, a construction company can easily attract construction projects.
The Level of Competition
Another major factor that can influence the income and profits of a construction company is the level of competition the construction company is exposed to. In business, competition usually determines how much a new entrant into the market will likely make.
A construction company that is located in a highly competitive market or city will likely make far less income when compared to a construction company that is located in a less competitive market or city.
The Reputation of the Construction Company
Lastly, another major factor that can influence the income and profits of a construction company is the reputation of the construction company.
In business, a good reputation is an asset, and a bad reputation can ruin your business. In essence, a construction company that has an excellent reputation for constructing sold structures will continue to get referrals and handle more construction projects which will translate to more income and profits for the company.
A construction company that has all the factors listed above will no doubt generate massive revenues, and of course, become more profitable.
So, if you are looking towards starting your own construction company, it will be to your advantage to critically examine the factors listed above, and make sure you adjust your business plan to align with them and you will be glad you did.