You have a variation for $100. You apply a 25% builders margin and charge the client... $133.33
What if your margin on variations was only 20%? You'd charge $125.
Part 3 of 3
Link To Part 1: How Builders Can Learn From Jetstar
Link To Part 2: Earning Money From Client Variations
Why? Because margin is the amount of profit as a percentage of the sale price.
So how exactly do you apply a margin to a cost price? You don't, instead you use MARKUP.
Markup is the amount of profit applied to a cost price. Therefore markup and margin are completely different and should never be confused.
For instance, a 33.33% markup equates to a 25% margin. A 25% markup equates to a 20% margin. A 20% markup is a 16.66% margin.
We discovered this sobering article on the building advisor website.
"THE MISTAKE OF MARKUP"
If a builder wants to make a 20% margin (also called “gross profit) to cover overhead and profit, he has to mark up his hard costs by 25%. This little twist of math manages to confuse many people – and has probably lead to the bankruptcy of more than a few small contractors who thought they could mark up their jobs by 20% for a 20% gross profit. The math, shown below is simple. To achieve a 20% margin (for overhead and profit), you need to mark up your costs by 25% (see box below)."
Are You Applying A Margin As A Markup?
If you are, you are leaving money on the table. Money that should be added straight on to your bottom line.
Let's assume you are doing $20,000 in variations a year and you allow for a 20% margin in your contract.
If you apply the 20% as a markup instead of a margin you are only charging out $24,000 instead of $25,000.
$1,000 may not seem like a massive amount of money on a $1m turnover, but that's the point.
This $1,000 goes straight onto your NET profit.
How much is your net profit each year? Would an extra $1,000 help out? If you are making $10k after wages and expenses, then correctly charging for variations would increase your net profit by 10%!
So why are over 85% builders applying markup instead of margin? (Source: Builders Base)
The Great Building Scam
We have no idea.
We're serious. Associations, accountants, bookkeepers even some business coaches are allowing builders to continue undercharging without offering any advice that would help them to turn a borderline project into a profit.
And we don't know why they do it.
But what's worse than giving no advice?
Giving the wrong advice.
A well-known association used to have an excellent document that was available on the web which clearly explained the difference between markup and margin. It was great. But then, they took it down.
And now they publish a 'Contract Information Statement' that must be supplied to the customer along with their contract which clearly shows builders margin being incorrectly calculated.
We called the association numerous times for an explanation but our calls were never returned (and we are members!)
The correct advice for builders can be found on a Government Website here.
What Does This Mean For Builders?
It means that even though you now know how to charge correctly, you can't. Because a client can use the example in the contract information to argue against the correct calculation for margin.
And we can't tell you why they have done this because they won't return our calls.
We have to assume it is an embarrassing lack of knowledge by a Senior Executive that has resulted in builders losing out YET AGAIN.
Why should builders always be the ones taking a hit?
Since researching this subject we have seen examples of (very large) building companies charging the correct margin but not receiving any support from their association when a dispute was raised. We have also spoken to an accounting company that presented at an association event in Victoria and demonstrated how builders were undercharging. When we asked what the reaction was from the association to this 'ground breaking information' the replied, "It was low-key," and there was no attempt to get this information out to more members.
A thread on a home building forum shows an interesting example involving Simonds Homes, the HIA and consumer interpretation. The client felt they had been overcharged when a 33% markup was applied to a variation. The HIA (incorrectly) agreed with the client which meant that without any support the builder was forced to back down. However, the last word went to another independent observer who commented.
"I would have said that Simonds got it right and the HIA got it wrong - margin is margin. Do remember that it is Simonds (or any builder) who must administer the job and guarantee the work."
So, What Can You Do?
Well, you certainly need to be charging the correct amount, that's what you are entitled to. But, read through any contract and additional contract information you are supplying to the client and ensure it does not contradict your position. Being right won't matter in a court of law if the information you are supplying is misleading and the association will not back you up.
To discover how you can earn more from every home you build, click on the link below. Right now, we're searching for a few more professional builders in Australia, New Zealand, North America and the UK.