Construction Profit Margins

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What are the fundamental concepts of construction profit margins and overheads?

Construction OHP are fundamental concepts that help determine the profitability of construction projects. In a construction company, the profit margin is the total amount of revenue that remains after the costs have been incurred. In simple terms, it is how much profit the company has actually made. On the other hand, overheads are the expenses of the business, and are not always related to specific construction projects. We discuss the various types of OHP of construction in more detail below. 

There are essential elements that shape both profitability and overhead costs and these are often intertwined. Here are some of the influencing factors:

• Efficient project management -  helps to ensure that projects are completed on time and within budget, in order to avoid overruns and therefore increase profit margins in construction.

• Cost control measures - such as a precise budget, improved allocation of resources, and negotiating with suppliers for better prices can minimise overhead costs. 

• Market conditions - which considers both demand for work and costs of materials, both of which can affect OHP in construction.

• Competition - which is fierce in the construction industry, which often influences companies when bidding for contracts. If pricing is inaccurate, it can impact  overall profitability.

Types of profit margin in construction

There are three types of profit margins in construction: gross profit margin, operating profit margin and net profit margin.

1. Gross profit margin refers to the direct profitability of a construction project. It’s calculated by removing the costs of labour and materials from the revenue. 

2. Operating profit margin considers the overhead costs of a construction business, such as rent, utilities and salaries.

3. Net profit margin covers all the financial obligations of a construction company, including taxes and interest. It is the total revenue that remains after all other expenses have been subtracted.

Profit margins in a construction company are crucial in measuring its financial health and how well it manages pricing, costs and expenses. 

Types of overheads

There are two types of overheads in construction: direct overheads and indirect overheads.

Direct overheads, also referred to as project overheads, are the costs of a specific construction project, including site management and its utilities and facilities, as well as costs of hiring equipment used solely for that project.

Indirect overheads, also called general overheads, are not linked to a specific project but rather cover the operational costs of a construction company. This includes rent and utilities, salaries of staff and marketing expenses. There are also the other costs of running a business, such as insurance and legal fees. General overheads are spread proportionately in the pricing of all projects, in order to support the functionality of the business.

How do overhead costs influence construction profit margins?

OHP, meaning Overheads and Profit in construction, are linked in both direct and indirect ways. The direct impact of overhead costs in construction profit margins is when they are considered for specific projects, which of course affects profitability. For example, if there is a revenue of £1 million for a project, and the direct costs of labour and materials lead to £600,000, it may seem at first that £400,000 is the profit. However, if project and general overheads are £200,000, this only leaves £200,000 as the actual profit.

The indirect impact is when a construction company overcompensates for overhead costs by increasing its bid prices on contracts. This may make it more difficult for the company to secure contracts amongst other competitors. On the other hand, if overhead costs are underestimated in bid prices, it may lead to lower profits or even losses upon completion of the construction project. 

We break down the various stages of a construction project to give you an example of where overhead costs come into play and influence overall profitability. 

• Pre-construction stage - this phase is important as the construction company will need to pay those carrying out project estimation, bidding and planning expenses.

• Construction stage - during construction, there will be direct overheads such as site management, utilities and facilities, as well as rental equipment.

• Post-construction stage - after the project is complete, there will be administrative costs such as project close-out, warranties and final reports. 

Generally, industry benchmarks suggest that overhead costs are expected to be between 10% to 20% of the total revenue. However, this depends on the size of the construction company and how efficient its management is, as well as the type of project in question.

Strategies for overhead management

It’s important that construction companies have effective strategies in place for overhead management. This can help to ease the impact of overhead costs on construction profit margins. We list 6 strategies below:

1. Conduct regular audits - it’s important to conduct regular audits of your overhead costs to find areas in which you could save money.

2. Implement technology - there is plenty of software that you can use for project management and financial budgeting to minimise costly errors.

3. Outsource admin tasks - certain tasks such as payroll and marketing can be outsourced, which works out to be more cost-effective than hiring in-house.

4. Adopt modern methods - Modern Methods of Construction (MMC) is a way to reduce overhead costs by utilising prefabrication and modular construction.

5. Adapt to building regulations - companies should be up-to-date with building regulations to avoid complications that can lead to delays, as well as to find innovative ways for cost savings.

6. Invest in training - training staff is a great way to develop your business in order to increase productivity and improve efficiency to reduce overhead costs.

Overhead costs can have long-term effects on the financial health of a construction company. If there is consistently high overheads over a period of time, this can regularly cut into the profit margins of the construction work. This can make it difficult with competitors as well as impact growth.

How can construction companies manage both profit margins and overhead costs?

It can be difficult to achieve a balance between maximising profit margins in construction and managing overhead costs, which is why companies need to implement effective strategies. This would include improving operational functions to be more efficient, as well as implementing innovative approaches. 

You could also take into consideration the Construction 2025 Strategy, which can support construction companies to achieve efficiency, sustainability and profitability. 

Risk mitigation in overhead management

A crucial part of effectively managing and forecasting overhead costs in construction is risk mitigation. This is when you identify financial risks early so that you can proceed with contingency planning to minimise their impact. Risk mitigation involves detailed budgeting and forecasting to cover all possible overhead costs.

Contingency planning is important in risk mitigation, as it requires delegating part of the budget for unexpected issues. This could be price hikes of construction materials, delays due to external issues, or changes in regulations. By doing so, construction companies can protect their financial health against uncertainties, in order to effectively manage overhead costs and improve profitability. 

Construction profit margins: FAQs

What is a good profit margin in construction?

A good profit margin for a construction company would range between 15% to 20% for net profit margins. By achieving this level of profit, it shows that the construction company is pricing accurately, managing overhead costs and in a strong position to grow their business further.

What is the profit margin on construction in the UK?

The profit margin on construction in the UK has been found to only be 3.9% on average, which is statistically the lowest margin in the world according to a 2021 study by consultant Turner & Townsend.

By effectively administering your OHP (meaning Overheads and Profit in construction), you can minimise overhead costs and maximise profitability. 

Disclaimer: The information contained on this page is intended as an overall introduction and is not intended as specific advice from a qualified professional. Travis Perkins aims to avoid, but accepts no liability, in the case that any information stated is out of date.