If you’re unfamiliar with cost-plus contracts, here is the short of it: You buy stuff for a job, you add a markup to that stuff, and your customer pays you for that stuff plus your markup. But how do you design your cost-plus system so you’re competitive, profitable, and efficient? In the ultimate guide to cost-plus pricing, Adaptive and Monthend break down everything you need to know.
In part one, we’ll discuss these three pillars to set up your business for success using the cost-plus pricing model.
- Choose the correct markup
- Get paid for more than just your markup
- Keep perfect records for every single cost on every single job
What is cost-plus pricing & how to execute a time and materials contract using this model
Have you ever written a check at closing to pay for the house you just built? Yes, you read that right.
Underestimating your job costs and selling a house for less than you paid for it is the cardinal sin of homebuilding. You only have to go through that pain and shame once before you re-evaluate your business…and maybe your whole life.
Unpredictable commodity prices and wild inflation have led a lot of builders to rethink their pricing model. We’ve seen a lot of builders pivot to cost-plus pricing in an attempt to protect their downside.
So, what is cost-plus pricing? If you’re unfamiliar with this pricing model, here is the short of it: You buy stuff for a job, you add a markup to that stuff, and your customer pays you for that stuff plus your markup.
Cost-plus pricing comes with a lot of challenges. Margins are usually smaller, record keeping is burdensome, and invoicing takes forever. However, if you use these three tips, you can jump these hurdles and nail your cost-plus strategy.
Choose the Correct Markup
The first question you’re probably asking is “How much should I charge?”. The answer is simple: Charge as much as you can! Yes, you’re a fair person, you build a great product, and your clients love you, but don’t forget the primary reason you’re in business: To make money.
The goal is to do much better than break even, but let’s start there to determine the absolute minimum you need to charge to not lose money.
What is my bare minimum markup? What does it take to break even? You have to charge enough to at least cover your operating expenses (aka overhead). This will get you to breakeven and nothing more. Calculating this amount is a simple math problem:
Remember that this is just the minimum you can charge without losing money for the year. You need to adjust up from there if you want to actually make money. Good builders are getting at least an additional 5% points on top of their break even percentage, great builders are getting at least an additional 10% points, and the best builders might get an additional 15% or more after covering all operating expenses. We see total markups ranging from 7.5% to 40% depending on the nature and the scale of the builder.
The primary factor limiting the amount you can charge is your competition. If the builder down the street has a 15% markup, it’s going to make it harder for you to get 23%. But don’t let that stop you from trying. After all, you know your numbers, and the builder down the street doesn’t and they will be out of business soon.
Get Paid for More than Just Your Markup
Once you’ve figured out the sweet spot for your markup percentage, it’s time to turn your attention to other items that you could be charging your customers for, such as:
- Self-performed labor: The work that your employees are actually doing at the jobsite. This is often job supervision, project management, cleanup, or light carpentry.
- Indirect costs: The costs you incur through the course of building, but the cost isn’t directly attributable to a specific job. We commonly see things like insurance in this cost/markup category.
- Overhead: The costs that aren’t directly (or indirectly) part of building, like rent, marketing, and salaries of your administrative team.
- Change orders: This is defined by you in your construction contract, but usually include changes to scope and price. Make sure this is clearly spelled out in the contract so you’re properly compensated when changes meet that definition. Charge for the time and materials related to the change order, but don’t forget to charge for change order administration. Properly managing change orders isn’t easy!
Keep Perfect Records for Every Single Cost on Every Single Job
Our advice to ensure profitable cost-plus billing is the same advice we have for people looking for the best strategy to keep their taxable income as low as possible: Keep perfect cost records. This is rarely executed properly, but it’s not hard to do if you have the right workflows in place and the right people managing and monitoring those workflows.
Here are a few things you can do to make sure your recordkeeping is on point.
Perfect your bookkeeping
If you miss recording a cost on a job, how much does it actually cost you? Probably a lot more than you realize. You’re going to miss out on the reimbursement, the markup, and the tax deduction related to the cost. If the problem is severe, you’ll actually start seeing cash problems which could impact a ton of things like how quickly you pay your subs, which can lead to missing out on timely or early pay discounts at a minimum…which then exacerbates the cash problem further. It’s a vicious cycle.
The best way to ensure your numbers are telling the truth and that you’re not missing anything is to make sure that you have correct information on every single transaction that flows through your company. Every. Single. Transaction.
You should even look for transactions that have NOT flowed through the company. You read that right. We often see transactions show up in the accounting record when that transaction didn’t actually exist in real life. You need to look out for this. It happens more than you think and it’s rare that bookkeepers actually catch these things. In fact, they are often the unknowing perpetrator of this mistake.
Perform reconciliations (the cornerstone of good accounting)
How do you ensure you capture every transaction? You perform monthly bank reconciliations that analyze:
- Completeness: All of the transactions that appear on bank and credit card statements have not been omitted in the accounting record
- Occurrence: All of the transactions that show up in the accounting record have actually occurred
- Accuracy: The dollar amounts are accurately recorded
- Classification: Transactions have been recorded to the correct vendor, job, and cost code or account/category
- Cut-off: Transactions have been assigned to the appropriate date
Use great technology for your accounting and construction contracts
Good technology helps you achieve your objectives better, faster, and cheaper. Great technology helps you evolve your objectives altogether.
Calculators were a revolution in the accounting industry. They allowed accountants to create more accurate financial statements much more quickly. A calculator is good technology. Accounting software is great technology. It eliminates human calculation all together and allows the user to spend their time analyzing the business instead of tabulating it.
Automate Your Construction Accounting Processes & Get Your Bookkeeping in Order
The latest and greatest in technology is automation software, which can save businesses an immense amount of time and money by eliminating manual processes. Adaptive is combining artificial intelligence with simple software to help homebuilders and remodelers automate their accounting and project financials. We integrate with popular accounting software like QuickBooks, and can complete onboarding in under 30 minutes. To learn more and see how Adaptive can streamline your construction accounting processes, book a demo today.
Need help getting your bookkeeping in order using your existing tech stack? Monthend provides bookkeeping, accounting, tax, and construction technology consulting services for construction businesses that want to leverage accounting and technology to become more profitable. Schedule a free consult call with Monthend today!