Markup vs margin for contractors: the formulas, a conversion table and a worked job

Most contractors know their job costs well. They know what a square of shingles costs, what a condenser costs from their distributor, what a crew-day costs in wages. Where pricing goes wrong is the step after that: turning cost into a price. Somebody says "we mark up 40 percent" and somebody else hears "we make 40 percent," and those are very different businesses.

This guide gives you the two formulas, a conversion table you can pin next to your desk, a worked job that follows the money all the way from direct cost through overhead to net profit, and a simple way to set a target margin for your company. The dollar figures are illustrative examples, not market prices. The math is exact, and you can check every number with the markup and margin calculator.

Markup and margin, defined

Both numbers describe the same gross profit: the selling price minus the direct cost of the job. Direct cost means the money that only exists because this job exists: materials, field labor with burden, subcontractors, permits, disposal, equipment rental. The difference between markup and margin is what you divide that profit by.

Markup is handy in the field because you multiply it against a cost you already know. Margin is how your P&L, your accountant and your bank look at the business, because every line on the income statement is a share of revenue. Overhead is a share of revenue. Net profit is a share of revenue. That is why the target should be set as a margin and only then converted to a markup.

Markup to margin conversion table

Use margin = markup ÷ (1 + markup) to go from markup to margin, and markup = margin ÷ (1 − margin) to go the other way. Here is what common markups actually produce, rounded to two decimals.

And the reverse, for when you already know the margin you need:

A worked job: from direct cost to net profit

Here is a roof replacement priced two ways by the same company. Every figure is an illustrative example. The company did $4,000,000 in revenue last year and spent $1,200,000 on overhead: office salaries, the owner's salary, rent, trucks, insurance, software, marketing. That makes overhead 30 percent of revenue. The owner wants 10 percent net profit on every job.

The required gross margin is overhead plus net profit: 30 percent + 10 percent = 40 percent. Now compare the price the owner meant to charge with the price the estimator actually charged after hearing "use 40 percent."

The job looks fine at a 40 percent markup. There is $5,800 of gross profit on the estimate and the crew does good work. But this job also has to carry its share of the office, the trucks and the marketing that produced the lead, and at 30 percent of price that share is $6,090. The job loses $290. Quote a year of jobs this way and the company is busy and broke at the same time.

Costs you pay as a percentage of the price

Some costs grow with the price itself: a sales rep's commission paid on the contract amount, or card processing fees. If you pay them per job, subtract them from the denominator too. With an 8 percent commission, the illustrative roof becomes $14,500 ÷ (1 − 0.40 − 0.08) = $14,500 ÷ 0.52 = $27,885. Check it: the commission is $2,231, total job cost is $16,731, and gross profit is $11,154, which is exactly 40 percent of the price. How you handle card fees is covered in how to get paid on the day of the job.

How to set your target margin

There is no single correct markup for contractors, because the right number depends on your overhead. A lean two-truck shop and a 40-person company with a showroom need very different margins to end up with the same net profit. Build yours from your own books.

1. 1

   Pull the last 12 months of overhead

   Add up everything that is not a direct job cost: office and sales management salaries, the owner's salary, rent, utilities, vehicles not charged to jobs, insurance, software, marketing, accounting. Use your P&L, not your memory.

2. 2

   Divide by revenue

   Overhead ÷ revenue for the same 12 months is your overhead percentage. In the example, $1,200,000 ÷ $4,000,000 = 30 percent.

3. 3

   Choose a net profit target

   Decide what the business should earn after paying everyone, the owner included. Pay the owner a real salary in overhead first, so profit is actually profit.

4. 4

   Add them to get your target gross margin

   Overhead percentage plus net profit percentage. 30 percent + 10 percent = 40 percent. This is the margin every average job needs to hit.

5. 5

   Convert it to a markup for your estimators

   Markup = margin ÷ (1 − margin). A 40 percent margin is a 66.67 percent markup, or cost × 1.667. Put that multiplier in your catalog so nobody does it by hand.

6. 6

   Check your labor rate separately

   If you sell by the hour, make sure the hourly rate carries its share of overhead too. The job cost and hourly rate calculator works that out from your wages, burden and billable hours.

7. 7

   Review it every quarter

   Overhead percentage moves when revenue moves. If sales drop 20 percent and overhead stays flat, your overhead percentage rises and your old markup quietly stops covering it.

Many companies also set a floor margin, the lowest margin a rep may sell at without approval. The floor is usually your overhead percentage plus a small cushion, because anything below overhead percentage loses money on every sale, no matter how busy the crews are.

Different margins for different work

One company-wide number is a starting point, not the finish. Work that uses more office time, carries more warranty risk or needs your best people usually deserves a higher margin. A plumbing or HVAC service department that sells many small tickets often marks up parts on a sliding scale, with a higher percentage on a $40 part than on a $4,000 water heater, because the handling cost is similar either way. A remodeler with long design time before the contract may need a higher margin on design-heavy kitchens than on a simple bath refresh. Check each job type against the same test: after its share of overhead, does it leave the net profit you planned?

Common pricing mistakes

• Using markup and margin as if they were the same number. As the worked job shows, a 40 percent markup is a 28.6 percent margin, and that gap can be the difference between profit and loss.
• Marking up materials but not labor. Labor has to carry overhead too. If you pass labor through at cost, the material markup has to do all the work, and labor-heavy jobs lose money.
• Leaving overhead out of the target. A job that covers its direct costs has not broken even. It breaks even when it also covers its share of overhead.
• Discounting off the top. On the $24,167 job, a 10 percent discount drops the price to $21,750. Gross profit falls to $7,250, overhead recovery is $6,525, and net profit falls from $2,417 to $725. A 10 percent discount cut net profit by 70 percent in this illustrative example.
• Pricing from last year's costs. Material and labor costs move. If your catalog still holds old costs, your markup is being applied to the wrong number.
• Counting the owner's pay as profit. If the owner is not paid a salary inside overhead, the net profit number is really just the owner's wage, and the business has no profit of its own.
• Doing the math on every estimate by hand. Every manual calculation is a chance to type 1.4 when you meant to divide by 0.6. The case for moving pricing out of a spreadsheet is laid out in estimating software vs spreadsheets.

How margin feeds good, better, best tiers

If you quote three options, every tier needs to be priced from its own cost and its own margin, never by adding a flat dollar amount to the tier below. The tiers in good, better, best pricing only work if Good is still a profitable job. Here is the same illustrative roof built three ways, with the owner's 30 percent overhead applied to each.

Good carries a slightly lower margin so the entry price stays approachable, but it stays above the 30 percent overhead line, so it still makes money. Better sits right on the company target, because it is the option most homeowners should choose. Best carries a slightly higher margin, because premium work usually brings more coordination and warranty exposure. The resulting steps, about 36 percent from Good to Better and about 32 percent from Better to Best, land inside the spacing the good, better, best guide recommends.

Build tiers this way in a catalog, with cost and margin stored on each item, and prices update correctly when a material cost changes.

Frequently asked questions

Further reading: to turn these margins into three options the homeowner can choose from, see good, better, best pricing. To stop recalculating prices in a sheet, see estimating software vs spreadsheets, and to keep the margin you priced from leaking out while you wait to be paid, see deposits, draws and stage payments.