What is the Average Profit Margin for Construction Companies?
Do you ever come to the end of your financial period with the characteristic itch to know your profit margin and how your construction company has performed?
And then, when the end-of-year financial statements are eventually released, you realize your profit margin is pretty decent, at least compared to the previous year, and you thrust your fist in the air, excited by the numbers you are seeing.
A week or so after, you hold a party and toss to a year of success and triumph.
But when the dust starts to settle, you realize that several companies in the construction industry posted even better profit margins, and your exuberance soon wilts away.
Here’s the lesson.
If you are in business, it’s crucial that you understand not just your company’s profit margin — but also the average profit margin in your industry.
Here’s why.
What Is Profit Margin?
Profit margin is a financial metric that measures your business’s profits relative to its sales. Put differently, profit margin is profits as a fraction of sales, a measure expressed as a percentage.
Because it’s a fraction of sales and expressed as a percentage, profit margin is never a dollar amount.
As a rule of thumb, you should aim for a high profit margin. A high profit margin means your profit is high — relative to your sales.
It also means your costs are low.
Therefore, a construction company that has posted a 17% profit margin has — all factors constant — performed better than another construction company that has posted a profit margin of 13%.
This is especially true if the comparison —
- Is based on a similar period
- Is based on companies in the same industry
- Is based on companies of a similar size.
Sometimes, you’ll find that profit margin is also called—
- Operating income margin
- Return on sales, or
- Operating margin
How to Calculate Profit Margin
Profits can take many forms. There’s Net Profit. There’s also Gross Profit. Because of this, Profit margins can also include —
- Net Profit Margin
- Gross Profit Margin
Net Profit Margin
Net Profit Margin is the net profit of a business expressed as a percentage of its sales. It’s crucial to remember that both metrics: net profit and sales — should be in the same financial period.
For instance, if your revenue is $600,000 in 2023 — and your total costs, including direct costs and administrative expenses, total $450,000 in the same period — your net profit will be $150,000.
As a result, your net profit margin; net profit as a percentage of sales, will be {(150,000 ÷ 600,000)*100}. This gives 25%.
Gross Profit Margin
Gross profit margin is gross profit expressed as a percentage of sales.
And while Net Profit is sales minus all expenses, Gross profit is sales minus direct expenses only — not all expenses.
As a result, if your end-of-year revenue is $600,000, for instance, and your total costs are $500,000, half of which are direct costs, it means your gross profit is $350,000 ($600,000 - $250,000, half of the total costs).
Consequently, your Gross profit margin will be {(350,000 ÷ 600,000)*100}. This gives 58.3%.
Why Should You Know the Profit Margin of Your Construction Business?
The main reason you will want to know your profit margin is the need to asses how profitable your construction business is. And as you’ll see, there are several crucial things your profit margin communicates.
For instance, if your Gross profit margin is healthy, you can comfortably cover your overheads — and still invest in crucial assets and equipment necessary for business expansion.
On the flip side, if your Gross profit is low, your growth prospects will be dim, even if you can still scrape by.
Then again, if your Net profit margin is high, it means your construction business has generated substantial wealth — which you can either draw or reinvest in the business.
However, if your Net profit margin is low, you may need to implement innovative strategies to make your construction business profitable — so you can reap the fruits of your labor.
What’s the Average Profit Margin In the Construction Industry?
As we’ve cautioned, in the construction business, it’s suicidal to live in your own world, in your echo chamber. You’ll want to know how your business has performed, but you’ll also need to keep your ears on the grounds for trends in the industry.
The following is a snapshot of the average profit margins in the construction industry.
We’ve gleaned these figures from the 2022 Cost of Doing Business Study, a survey by the National Association of Home Builders covering the 2020 fiscal period.
The average Gross profit margin: 18.2%
The average Net profit margin: 7.0%
Here’s the thing. If you’re in the construction industry, you should aim for a minimum of 10% net profit. Alternatively, a Gross Profit margin of at least 25% would be excellent.
What Can You Do to Increase Your Profit Margin in Construction?
If your Net profit margin is low — or even decent, but you want to ramp it up slightly — you may want to consider the following options.
- Incorporate technology: If you integrate tailored construction software into your systems and process — and leverage the efficiency this comes with — you can help track your expenses better and reduce unnecessary wastage.
- Reduce costs: You can reduce your operating costs by negotiating better prices with your suppliers, for instance, outsourcing certain tasks, and automating some processes.
- Increasing your income streams: At the end of the day, reducing costs can only go so far. A more impactful way to increase your profit margins is dabbling in other related services. A good example is landscaping or even design services.
- Expand into new markets or locations. You can venture into areas with relatively higher demand for houses.
Do You Want To Have Support Navigating Complex Financials?
Here’s the truth. Your construction business will stand or fall on numbers. It’s that simple.
This means you should understand your numbers, including what each metric means. While you can try to do this by yourself, the eyes of experienced construction CPAs can also come in handy.
At Atlas Accounting Group, we help contractor & specialty trade businesses navigate complex financials and reach loftier financial goals.
