Welcome back! This month we are backing up a little and taking a detailed look at a broad concept which is one of the mainstays in business accounting: Gross Profit. We’ll talk about how it’s calculated, the importance of this number, and how to maximize profits.
Gross profit represents the difference between total revenue and the cost of goods sold (COGS), excluding overhead expenses. It reflects the profitability of a company’s core operations before accounting for indirect costs such as rent, utilities, and administrative expenses. Gross profit margin, on the other hand, is expressed as a percentage and measures the proportion of revenue that remains after deducting COGS. A higher gross profit margin indicates greater efficiency in managing production costs and generating revenue.
Here at Moose Creek Bookkeeping we specialize in large project and construction bookkeeping, so for this article will focus on that niche. If your company is on the smaller side, that’s ok! We can still help since we are versed in working with companies of all shapes and sizes.
The calculation of gross profit involves subtracting the cost of goods sold (COGS) from the total revenue generated. In the context of construction projects, COGS encompasses direct expenses which are directly attributable to the project, such as labor, materials, subcontractor costs, and equipment rentals. The formula for calculating gross profit is as follows:
Gross Profit = Total Revenue – Cost of Goods Sold (COGS)
For example, if your company had $100,000 in revenue and $40,000 in direct project-related expenses, your gross profit is $60,000.
Now, to calculate the gross profit margin, divide your gross profit ($60,000) by your revenue ($100,000), multiply the result by 100, and you get a 60% margin. Gross Profit Margin is a percentage metric used often when discussing profits.
The average gross profit margin for construction businesses can vary depending on various factors such as the type of construction, project size, location, market conditions, and business model. But wait, our example has a very high margin of 60%, which in actuality is not a true metric of company health because we haven’t deducted ALL expenses. Once you subtract both direct and indirect expenses you are left with Net Profit which is considered the gold standard metric for a company’s health. Let’s take a side quest and make sure you know the difference between direct and indirect costs.
Direct costs in the construction arena are based on project-specific costs such as labor, materials, subcontractor costs (more labor), equipment rentals, project permits, etc.
If we deduct those items and are left with 60% margin, we are doing great! However, we can’t forget about the indirect costs. Indirect Costs support the overall project but aren’t tied to any specific construction activity such as insurance, office rent, PPE, manager salaries, and even what you pay your bookkeeper.
Businesses of all kinds need to maximize their gross profit and minimize expenses. If your Gross Profit margin is high, but your Net profit margin is low, you know that your indirect costs are too high. At Moose Creek Bookkeeping we have a keen eye for finding those troublesome expenses. They can be hiding in plain sight, like paying too much for materials or it might be a less obvious issue that takes some digging. Either way, we are ready and able to help your company reach its maximum margins.
It’s important to note that gross profit margins can vary significantly among different segments of the construction industry. For example, residential construction projects typically have lower gross profit margins compared to commercial or industrial construction projects due to differences in project complexity, scale, and market dynamics.
Big or small, let’s take a look at five ways to maximize your Gross Profit
Accurate Project Estimation: Consider all direct project costs, including labor, materials, subcontractor expenses, equipment rentals, and other project-related expenses. Referencing historical data will help refine the estimating processes and ensure competitive yet profitable bidding.
Efficient Resource Allocation: Optimize resource utilization by aligning labor, equipment, and materials with project requirements and timelines, adjusting frequently, as needed.
Vendor Management and Negotiation: Establish strategic partnerships with reliable suppliers, subcontractors, and vendors to negotiate favorable pricing, terms, and discounts. Conduct regular vendor reviews to ensure good long-term relationships.
Cost Control: Monitor project budgets, track variances, and identify cost-saving opportunities to mitigate overruns and optimize gross profit margins.
Risk Management: Identify potential risks and uncertainties early in the project lifecycle and develop comprehensive risk management plans. Risk mitigation strategies such as insurance coverage and contractual protections to minimize the impact of unforeseen events.
These five steps are a great starting point for every project when it comes to profitability. We are eager to help you meticulously track direct and indirect costs, then you can derive an accurate profit figure that gives you transparency into the financial health of each project. Prioritizing this aspect of your accounting will pay off in the long run, trust us.
In the dynamic landscape of construction bookkeeping, mastering the calculation and analysis of gross profit, net profit and profit margins is essential for providing accurate financial insights and driving informed decision-making. By understanding the components of gross profit, accurately tracking project expenses, and analyzing gross profit margins, Moose Creek Bookkeeping can play a crucial role in optimizing project profitability and ensuring the financial success of construction endeavors. We encourage you to reach out any time, we are happy to answer any questions in a no-obligation discovery call.
