There's a pretty big misconception with some homeowners that markup equals profit, especially when it comes to contractors.
I'm here to set the record straight.
Markup and profit mean two completely different things, and the terms aren't interchangeable. Markup is a general business term used to illustrate the difference between the cost of a service and its selling price. It combines overhead costs and profit and is generally the minimum amount of money that any given business needs to realize to simply keep the doors open and the lights on; in other words, it's the amount that a business charges above direct cost.
A general rule of thumb for most remodeling contractors is a markup of 1.5 over the estimated cost of the job. If the estimated cost of time and materials for a job is $10,000, you can expect a $15,000 sales price.
If you think that all of the $5,000 is profit going straight into the bank account of your contractor, you'd be mistaken.
Markups exist for a reason, and it's not so your contractor can get rich. There are far more tangible reasons for markups, the simplest of which is just keeping the business going for the next project. A few things to consider:
- Contractors have overhead: investing into marketing, general operating expenses, the cost of maintaining vehicles and tools, licensing, salaries paid out to subcontractors, insurance, taxes, filing permits. Operating a business is expensive when you get right down to it, and even that $15,000 kitchen remodel isn't taking the contractor very far once you break out associated costs.
- Profit isn't a dirty word. If a business -- any business -- is going to stick around for more than a few months, it has to turn a profit. If a contractor can't cover overhead expenses and make a reasonable profit, the doors might close on the operation before your job is finished.
- Your home is your single largest investment. You've heard me say it here before, and I'll say it again: do you really want hire a contractor because they're the cheapest to do the work on such a hefty piece of financial asset? I don't think so.
According to the National Association of Home Builders, the best remodeling contractors average around 5% net profit. The reality is that too many contractors make no profit at all because they're saddled by mounting overhead costs and consumers aggressively negotiating for the cheapest price. Consider this: You want your contractor to still be in business if you have a problem or issue arise 6 months or a year from now, don't you? Contractors who operate on little to no profit simply can't survive.
Remember that markup isn't profit. It's simply the money required for your contractor to complete your job satisfactorily and on time, cover his costs, and make a small profit to keep his business going.