In the world of contracting, one of the most critical yet misunderstood aspects of business is setting the right markup. Many contractors struggle with balancing competitive pricing and profitability.
Using the Profit First for Contractors methodology, as opposed to just winging it and hoping to make a profit, you can confidently set a markup that ensures your business thrives financially while staying aligned with your goals.
In this article, we’ll walk you through a proven process to calculate and apply the right markup for your projects.
What is a Markup, and Why Do Markups Matter For General Contractors?
Markup is the percentage you add to your job costs to determine the selling price. It ensures you cover all expenses, pay yourself, and achieve a profit. While many contractors focus on profit margin (profit as a percentage of revenue), markup is calculated based on costs, making it the foundation of accurate pricing.
Without a proper markup, contractors risk undercharging and eroding profits. When done correctly, markup allows you to cover all costs, meet financial goals, and provide exceptional service without financial stress.
What is the average markup for general contractors?
There is no one-size-fits-all answer to this question, as markup rates can vary widely based on factors such as the type of project, location, competition, and other considerations. That said, industry experts generally recommend marking up labor costs by at least 25% or more, while material costs are typically marked up by 30% to 50%.
According to the Construction Financial Management Association, builders typically achieve an average pre-tax net profit of 1.4% to 2.4%. In comparison, subcontractors tend to have slightly higher pre-tax net profit margins, averaging between 2.2% and 3.5%.
Builders and subcontractors operate on slim profit margins because most of their revenue goes toward direct costs like materials, labor, and equipment, as well as indirect expenses such as office overhead, insurance, and compliance fees. Financing costs, permits, and warranty reserves also eat into profits. Additionally, taxes, marketing, and business development further reduce the bottom line.
The Benefits of Increasing General Contractor Markup
Raising your markup as a general contractor offers numerous advantages that can significantly impact your profitability and long-term financial success. Here are five key benefits of increasing your markup:
Higher Profit Margins
Increasing your markup directly improves your profit margin on every project. This additional revenue provides more financial flexibility, enabling you to reinvest in your business and fuel future growth.
Greater Financial Stability
A higher markup creates a financial cushion to absorb unexpected costs or market fluctuations. This stability ensures you can cover overhead expenses and maintain healthy cash flow, even during challenging times.
Improved Quality of Service
With increased financial resources, you can invest in training your workforce, adopting advanced technology, and sourcing higher-quality materials. These improvements enhance the client experience and boost customer satisfaction.
Better Risk Management
Higher markups allow you to allocate funds toward comprehensive insurance coverage and compliance with regulatory requirements. This proactive approach helps reduce liability risks and prevents costly legal or operational setbacks.
Opportunity for Business Growth
When your financial foundation is strong, you’re better positioned to pursue growth opportunities. This might include expanding into new markets, securing larger contracts, or diversifying your service offerings.
Understanding the Profit First Formula for Contractors
The Profit First methodology flips the traditional financial formula. Instead of calculating profit as what's left over, you prioritize it from the start:
Traditional Formula: Sales - Expenses = Profit
Profit First Formula: Sales - Profit = Expenses
By prioritizing profit, contractors can build a sustainable business model where profitability is planned, not accidental. This mindset shift is the key to long-term success.
Key Factors to Consider When Setting Your Markup
To set your markup accurately, consider these factors:
Job Costs
Include all direct costs like materials, labor, subcontractors, and permits. These are the core expenses directly tied to the project.
Overhead Expenses
Factor in operational costs like office rent, software subscriptions, insurance, and equipment maintenance. These are often underestimated, leading to financial shortfalls.
Desired Profit
The Profit First system emphasizes allocating a specific percentage of revenue to a Profit Account. This ensures profit is always part of your pricing.
Owner’s Compensation
Your salary isn’t an afterthought—it’s a planned expense. Use the Owner’s Compensation Account to ensure you’re properly paid.
The Owner’s Compensation Account is a dedicated bank account where a contractor sets aside money specifically for paying themselves. Unlike traditional accounting methods where the owner gets paid only after covering all expenses, Profit First prioritizes owner pay as a necessary and planned business expense.
How The Profit First Bank Account Formula Works:
- Separate Bank Account – Instead of lumping all business revenue into one account, you allocate a percentage of every deposit into the Owner’s Compensation Account.
- Consistent Paycheck – This ensures that you, as the owner, receive a regular paycheck rather than waiting to see what's left over after expenses.
- Not the Same as Profit – Many contractors confuse Owner’s Compensation with profit, but they serve different purposes:
- Owner’s Compensation covers your salary for the work you do in the business.
- Profit Account is money set aside as a reward for owning and running a successful business.
- Financial Stability – Paying yourself first prevents you from operating in survival mode, giving you the financial stability to make better business decisions.
By setting up an Owner’s Compensation Account, you ensure that your business supports your personal financial needs, rather than running on whatever is left over at the end of a job.
Taxes
Reserve a percentage of revenue (usually 15-20%) for taxes to avoid surprises at the end of the year.
Industry Standards and Market Rates
Research typical markup percentages in your niche and region. Strive for competitiveness without sacrificing profitability.
Investment in Software: A Smarter Way to Set Your Markup
One of the biggest challenges contractors face when setting their markup is ensuring accuracy while considering all cost factors, including labor, materials, overhead, and profit. Investing in software can significantly simplify this process, reduce human errors, and save valuable time.
Construction estimation software, such as Handoff, can automatically calculate markups based on real-time material and labor costs. Instead of manually crunching numbers and risking underpricing your services, these tools provide instant, data-driven estimates that ensure profitability while maintaining competitiveness.
Key Benefits of Using Estimation Software for Markup Calculations
- Automated Cost Tracking: Software solutions integrate real-time material costs, labor rates, and overhead expenses, ensuring your markup calculations reflect actual expenses.
- Accurate Profit Allocation: Tools like Handoff allow contractors to set profit targets and ensure every project contributes to the company’s financial goals.
- Time Savings: Instead of manually adjusting figures, software automates the process, allowing you to focus on delivering high-quality work rather than spending hours on financial calculations.
- Pricing Transparency: Providing clients with detailed, itemized estimates built with software improves transparency, helping justify markup rates and build trust.
- Scalability: As your business grows, software allows you to standardize your pricing model and streamline operations across multiple projects.
If you’re still crunching numbers by hand or relying on spreadsheets, you’re making things harder than they need to be. Using the right software can take the guesswork out of setting your markup, helping you price jobs faster and more accurately. Instead of stressing over whether you’ve covered all your costs, you can focus on running your projects and making a solid profit. Investing in the right tools isn’t about adding more tech—it’s about making your life easier and your business more profitable.
Step-by-Step Process for Setting Your Markup
Step 1: Calculate Total Costs
Start by adding up all direct and indirect costs for a project. For example, if a project’s materials, labor, and permits cost $20,000, your base cost is $20,000.
Step 2: Allocate for Profit
Decide on your desired profit percentage. For instance, if your goal is 10% profit, allocate $2,000 to your profit account.
Step 3: Include Owner’s Compensation
Add your personal salary to the equation. If you’ve determined that 15% of revenue should go toward your compensation, that’s an additional $3,000.
Step 4: Cover Taxes
Reserve 15-20% of revenue for taxes. For this example, let’s allocate $4,000 (20%). Also, keep in mind that in most states, both materials and labor are subject to sales tax, and failing to account for this can eat into your profits or cause compliance issues. Be sure to check your state’s tax requirements for contractors. You can find more information on contractor sales tax laws through the Construction Industry Audit Technique Guide
Step 5: Determine Operating Expenses
Ensure the remaining markup covers your business’s fixed and variable expenses. If your operating expenses are $6,000, account for that in your markup.
Step 6: Apply the Markup Formula
Now, use the formula: Selling Price = Total Costs x (1 + Markup Percentage)
For example:
- Total costs: $20,000
- Markup percentage: 50% (to cover profit, owner’s compensation, taxes, and expenses)
- Selling price: $20,000 x 1.5 = $30,000
If all of this seems overwhelming to you, then you could look into using estimation software that does the math for you and simplifies markups. Apps like Handoff provide estimates in minutes and provide a markup based on labor, material, and the project. From there, you can easily adjust your markup as you see fit.
Avoiding Common Mistakes When Setting Markup
Underestimating Costs
Many contractors forget to include indirect costs, leading to insufficient pricing.
Failing to Account for Overhead
Ignoring overhead expenses is a common reason for profit loss.
Not Reviewing and Adjusting Regularly
As market conditions and job sizes change, so should your markup strategy.
Confusing Markup with Margin
Markup is based on costs, while margin is based on revenue. Know the difference to avoid underpricing.
How to Discuss Markup Changes with Clients
Transparent communication about markup costs is essential to building trust and avoiding disputes with clients. Here are some tips for navigating these conversations effectively:
Maintain Professionalism
Approach pricing discussions with respect and professionalism, even if disagreements arise. A calm, solution-focused tone can prevent conflict. Using construction software can further enhance professionalism by centralizing emails, proposals, invoices, and reports, ensuring clear and organized communication.
Choose the Right Time
Initiate pricing discussions early in the project to set clear expectations. Providing detailed, itemized estimates upfront can prevent surprises later. If adjustments to pricing are needed during the project, explain these changes transparently and back them up with itemized details.
Communicate the Value
Help clients understand the value they are receiving for the cost. Highlight your team’s expertise, the quality of work, and the overall benefits of working with you. Emphasizing the value behind your pricing helps clients see it as an investment rather than an expense.
Offer Alternatives
If a client is concerned about pricing, be ready to provide options. For instance, if the cost of specific materials increases unexpectedly, present alternative materials or approaches that align with their budget. Showing flexibility allows clients to make informed decisions about how they want to proceed.
Listen and Address Concerns
Treat the conversation as a partnership by actively listening to client concerns and questions. Acknowledge their feedback and respond promptly to reduce misunderstandings and build rapport.
Document Agreements
A detailed contract is essential for every project. Clearly outline agreed-upon pricing, project scope, and how pricing changes will be handled. Construction software can streamline this process by enabling contractors to create, share, and store contracts and related documents digitally alongside other project information.
Improve Your Business Efficiency with Handoff
Managing markups, project budgets, and client invoicing are essential for running a successful construction business. Handoff's innovative AI-driven construction software simplifies these tasks while helping you stay on track with your projects. Here's how Handoff can improve your efficiency:
Accurate Estimating
Handoff provides advanced tools to create detailed and precise construction estimates. Input material costs, labor rates, subcontractor fees, and other project-specific expenses, while seamlessly incorporating markups to meet your desired profit margins. With flexible adjustment features, you can easily modify quantities and pricing, ensuring your estimates remain accurate and competitive.
Generating Budgets
Handoff enables contractors to develop comprehensive project budgets based on their estimates. Organize expenses into categories like materials, subcontractors, and overhead. The platform tracks your budget’s progress in real time, comparing it to actual expenses. With built-in change order features, you can adjust for pricing changes on the fly, helping you cover costs and achieve revenue goals.
Simplified Invoicing
Streamline your invoicing process with Handoff’s user-friendly tools. Generate professional, itemized invoices directly within the platform, reflecting project-specific details and cost breakdowns. This ensures transparency, accuracy, and consistency in your billing, fostering trust and professionalism with clients.
Managing Documents
Handoff offers a centralized hub for all your construction documents, providing easy access to contracts, estimates, budgets, and project details. This organization not only keeps all parties informed but also helps address pricing questions or concerns quickly and efficiently, saving time and avoiding disputes.
Handoff's cutting-edge features take the hassle out of construction financial management, giving you the tools you need to streamline operations, maximize profits, and focus on delivering high-quality work.
How Profit First Simplifies Markup Calculations
The Profit First system takes the guesswork out of pricing. By allocating funds into dedicated bank accounts for profit, taxes, and expenses, you gain clarity and discipline. This approach ensures that every dollar you earn is intentionally managed.
Tools and Tips for Accurate Markup
- Use Estimating Software: Tools like Handoff can help calculate costs and apply markup accurately.
- Review Historical Data: Analyze past projects to identify trends in costs and profits.
- Stay Consistent: Regularly review your finances to ensure you’re meeting your profit goals.
Conclusion
Setting the right markup is about more than covering costs—it’s about building a sustainable, profitable business. By applying the Profit First for Contractors methodology, you’ll ensure your pricing strategy prioritizes profit, pays you properly, and keeps your business financially healthy.
Start implementing these steps today, and take control of your business’s financial future. You’ve got this!
