{{first_name}} A few years ago I was sitting across the table from an HVAC business owner during a valuation meeting. He was running a good business. He had twelve trucks, and was busy almost all year long.
During the meeting, I asked him what his gross margin was.
He said, "Twenty-five percent, we mark everything up 25%. We always have."
Then we opened his financials. His gross margin was 20%, not 25%. After overhead, he was keeping about 4 cents on the dollar.
Nothing was wrong on his job sites. His crews were good and his customers were happy. The problem which he never realized was one line of math he'd been doing the same way for 15 years.
He's not alone. I see this in almost every contracting business that I talk to. I've seen it from owners who can work out a roof pitch in their head faster than you can find the calculator on your phone.
Markup and margin are not the same thing
Markup is what you add on top of your cost. Margin is the share of the final price that you keep.
They sound alike, but they aren't. The gap between them also gets bigger the higher you go.
Here's one quote worked out both ways:
Your cost on the job: $80,000
You add a 25% markup: $20,000
Your price: $100,000
You made $20,000. That's 25% of your cost, but only 20% of your price. So your margin is 20%.
Which one you use matters because everything else in your business is measured against revenue, not cost. That includes your overhead, your own pay, your bank covenants, and what a buyer will pay you.
So if you need a 25% gross margin to cover overhead and still make money, a 25% markup won't get you there. You'd have to price that job at $106,667.
The quick way to get the price is to divide your cost by (1 minus the margin you want):
$80,000 ÷ 0.75 = $106,667
That's $6,667 more on one job, with the same crew, the same materials, and the same customer.
Now scale that up. A $3M business that thinks it's running at 25% gross margin but is really at 20% is missing $150,000 a year it thought it had.
That's usually the money that was supposed to be the owner's bonus, the new truck, or the rainy-day fund.
It again matters when you start thinking about selling your business. Buyers don't look at your markup. They look at your margin. If your margin is five points lower than you believed, the valuation conversation starts lower than you expected, and it's very hard to argue with your own financial statements.
The Number This Week. A 25% markup is only a 20% margin. Quick conversion:
Markup | Margin |
|---|---|
10% | 9% |
20% | 17% |
25% | 20% |
33% | 25% |
50% | 33% |
Tape this next to your estimating screen, then check your last three quotes against it.
The Question This Week?
What margin do you think you're making, and what does the math say you're actually making?
Markup and margin get mixed up about as often as a sub's "next Tuesday" turns out to mean "sometime this month." The difference is that one of these mix-ups costs you real money every single year.
Build deliberately.
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Why am I writing this? I've spent over 20 years working alongside construction and trade business owners across Canada. My firm, N3 Business Advisors Inc., has helped hundreds of contractors buy, grow, value, and sell their businesses. I started my career as a teacher, and that part of me never left. So once a week, I put one lesson in your inbox, for free, to help you build a business that buyers line up for. If this was useful, pass it to one owner who needs it. If it wasn't, reply and tell me what you'd rather read about.
Nitin Khanna, CFA · Founder, N3 Business Advisors · Mastering the Business of Construction