Introduction to profit
Estimated read time: 4 minutes
After reading this article you will better understand gross profit vs net profit and factors that can negatively impact the profitability of your building or trade business.
Our aim at JACK is to help builders and trades meet their full potential, whether that is assisting you achieve your business goals or improving your work/life balance.
To do this we want to help you gain a better understanding of the true financial position of your business. Our finance series articles will break down financial principles in a simple and easy-to-understand way.
We want to remove the ‘scary’ thoughts when it comes to financial terms, and hopefully, you will be able to stop saying that terrible phrase we so often hear in the building industry “My accountant usually deals with that”.
Everyone has different goals in their business and personal life, but at JACK we believe that if you ensure your business is profitable, the rest will follow.
Making a profit is the easiest way to ensure you are achieving positive cashflow, which in turn gives you the freedom to decide where you use that cash.
These cash reserves could be re-invested in the business to grow your revenue further or you could withdraw some owner drawings and take your family on a well-deserved holiday.
Without achieving healthy profit and understanding your true financial position you will never even have the option.
Understanding profit in building and construction businesses
First, let's define profit. Profit is defined most simply as the amount of money a business makes after subtracting all its costs from its total revenue.
Now you will often hear these two different references to profit: Gross profit and net profit.
These are two very different numbers but there is no need to be confused, a good way to remember which one is being referenced is to consider this payroll example:
Gross salary is the total amount of your wage, and net salary is the total amount of your wage less taxes (your take-home wage).
This means that gross profit is always a larger number than net profit.
Gross profit equals total revenue less building material and labour costs (variable costs), think of it as the revenue you sell your building services for less all the direct inputs required to complete the building work. This can sometimes also be referred to as builder’s margin.
Net profit equals gross profit (as defined above) less all your overhead costs (fixed costs). For example: total revenue less building materials and labour costs, and then further subtract your office rent, office salaries, and all other operating costs. This is the ‘bottom line’ profit. With bottom line meaning the very last figure shown at the bottom of a profit & loss statement.
Gross profit will be calculated at a job-specific level, while net profit will be calculated based on the performance of the entire business.
Key factors affecting profitability in building and construction
Below you will find some of the key factors affecting the amount of profit you can achieve in your business:
- Your customer's willingness to pay: There are many factors that will determine how much your customer is willing to pay. Economic factors such as high interest rates could influence all customers' spending patterns, your reputation for quality work could allow you to charge a higher amount, or lack of competition could allow you to charge a premium. You will need to find the right balance of achieving a healthy net profit whilst also not pricing yourself out of jobs.
- Preparing accurate estimates: Eroding profit margins will kill a building or trade business. If you are underestimating costs on your jobs and your gross profit is not high enough to cover your fixed overhead expenses, then it is only a matter of time before you run out of cash. You will need to put more capital in, or get a loan to keep the business afloat. A builder could make profits on ten jobs and then lose it all on one job with a large error made in the estimating process.
- Managing your overhead costs: Many builders and trades are surprised when they work all year to find that they made 1-2% net profit, broke even, or actually made an operating loss. The gross profit made on all your jobs must be able to cover all the business expenses and then leave a portion as net profit. Overheads will include insurance, motor vehicle costs, the owner's salary, superannuation, the list goes on. Inevitably there will also be something that goes wrong, like a van break-down or a trailer break-in so you should also try to build a contingency for bad news into your financial plans.
There are many other factors that can impact profit, but these are the main ones to consider.
So, after reading through these examples, can you confidently say you understand the profitability of your business?
If the answer is no, then you may need to look at doing further investigation to gain a better understanding of your true financial position.
How construction management software can help you improve profitability
Construction management software such as JACK can help you maintain or improve your profitability by ensuring your quoting process is fast and accurate.
Our estimate template features ensure you and your staff never have to start from scratch, and you will never miss any small costs as you prepare an estimate.
You will accurately quote your jobs and avoid any surprises down the track.
Providing your quote faster than your competitors also gets you off on the front foot.
Using JACK’s digital takeoffs feature will speed up the process whilst also ensuring you don’t make any measurement errors.
Costing estimates can be displayed in a proposal document without any double-entry required and you can customise how much or how little information you want to share with your client.
I hope this has been informative and we would love to hear from you about how you ensure your business remains profitable.
If you want more information, please set up a 10-15 minute demo so we can show you how JACK can help improve your building business.
Liam Cook is JACK’s financial management expert.
With 10+ years of experience as a chartered accountant ranging from small business advisory to CFO of an ASX-listed company, Liam can provide important insights into the financial management of your building or trade business.