The Gross Margin method – Take your cost of goods sold and divide by 1 minus the percentage of margin desired. (40% = .6)
The Markup method – Take your cost of goods sold and multiply by a number such as 1.7 and come up with a selling price. Which happens to be a 40% margin. Multiplying by 1.4 is a 28.6% gross margin.
“Double what I think is my cost” – The most comical method where a guy says, I have three thousand in the cost of equipment, “if I can just double my cost, that sounds like a good price. Six Thousand.”
I want to introduce you to a method that ensures you get paid for every hour that you plan on working. This is the Gross Profit per hour or day method. Gross Profit is defined as OVERHEAD plus NET profit. These supposed constants in a business can be divided out over the time it takes for your business to be open.
The simple formula is take your overhead and add it to your desired NET profit. That sum gives you your GROSS profit. If you don’t know this number you can call your accountant and get it from them. Take that number for the month and divide it over the DAYS you want to be productive. DO NOT plan on being busy everyday. There has to be some slippage or breakage. This is the time that your techs are waiting for parts, traveling, or simply just don’t have a job. Your company may have a replacement job every day of the month. Planning to be busy every day and then missing the mark can be disastrous.
We always liked to attach our gross profit to our installation department. Then we knew the service department’s contribution to gross profit was then NET profit. And as long as my installation department prices weren’t over what the market would bear, we were good.
So let’s look at an example. There are generally 20 work days in a month. Let’s plan on our installation department being busy and doing productive work for 12 of the 20 days. Keep in mind it is the responsibility of the owner, sales manager, and sales people to keep productive work for all of the 20 days. That is called your Sales Plan. The financial plan is the more realistic plan. One that makes sure you succeed even if you aren’t busy every day.
If I had 2 crews to do the work with, that is 4 people if it is a two man crew. Let’s also say our Gross Profit for the month is $50,000. $50,000/12 equals $4167 per day of Gross Profit. Based on 2 crews that is $2083 per day. If I wanted to divide it into an hourly rate, just divide by the 8 hours it takes to do the job. That happens to be $260 per hour, or $130 per hour per man.
Once you have this number you can add this to your Costs of Goods Sold. Keep in mind the commission and buydown rate are not added to these numbers.
Here is how the formula looks:
Best – $5,000 (COGS) and you add $2083 (GP/Day) for the day to that number your selling price becomes $7083.
Better – $4,000 (COGS) and you add $2083(GP/Day) for the day to that number your selling price becomes $6083.
Good – $3,000(COGS) and you add $2083 (GP/Day) for the day to that number your selling price becomes $5083.
Best – $2,000(COGS) and you add $2083 (GP/Day) for the day to that number your selling price becomes $4083.
In each job you get the same gross profit, your supplier gets paid and everyone is happy. There is some value to make that the higher climb in quality you could make a higher gross profit per day. Only because the Market will allow you to get more on this product. You can also make the case that your competitor is not actually showing this to the customer. For that reason, YOU are setting the market price.
A few warnings when using this model.
- If you are setting up your model this way, make sure the plan to get to the number of jobs for the month happens. If you plan for 12 jobs for 2 crews, that is 24 jobs. Only obtaining 22 jobs doesn’t allow you to make your plan. While you may surpass your breakeven point, the plan to reach the net profit number won’t happen.
- It is a great thing when you surpass the planned jobs. But it is a disaster when you don’t get there. Secondly, the salesperson is determining the number of hours or days attached to the job. Underestimating the number will significantly reduce the contribution to Gross Profit and Labor (COGS).
In summary, the GP/Hour and GP/Day model is a much more predictable method of pricing your work. There is a GP/Hour/Day calculator inside our program under the Help link at the top of the page in the admin area. Use it to help you figure out what this number should be.
You can view my video on youtube on how to determine GP$’s using my online spreadsheet within our program. GP$ Video
CEO and Co-Founder
Enterprise Selling Solutions
Fixed Versus Variable Costs
Wondering how to budget for a 40-50 percent profit margin? Distinguishing fixed versus variable costs is essential to obtaining a successful profit margin.
Fixed costs are reliable and constant. These include:
- Worker salaries–including supervisors, laborers, salespeople, owners, etc.
- Employee benefits
- Other office expenses–supplies, internet, utilities
- Auto expenses
Variable costs, or costs that tend to change, include:
- Hours of labor
- Materials used
Once fixed and variable costs have been established and recorded, the gross profit can be easily calculated.