Critical Components for Calculating Gross Profit
One of the most critical things that you should be looking at in order to properly run your business is gross profit.
Yet, many are unclear what should be included in order to come up with a gross profit of a painting company.
What should be included and what should not be included?
My name is Scott Lollar and I’m a DYB Coach, and I want to give you what I think are the critical components to include in order to come up with your gross profit.
Now, you might wonder why an accurate gross profit is critical.
It is because all of the money you have left over after you pay for the actual expenses of a project is the money you have to run your business and pay yourself.
If it is off by 5 or 10 percent, it could be a disaster!
In addition, there are many companies using bonus plans, it could be a large mistake to pay extra money to employees based on an inflated gross profit.
Simply put, gross profit is the amount of money as a percentage that you have after every direct cost of doing a job is paid… these are called the cost of goods sold.
If you did not incur the costs because of that job and that job alone, it is not the cost of goods sold.
Some people want to put costs related to the field in the cost of goods sold like vans or supervision or benefits.
In my opinion, these are variable expenses and not directly related to the cost of completing their project, so it should not be included here.
I’ll address this more later.
The first component of direct costs is the painter’s wages.
This is the total gross wages paid to W-2 painters.
In addition to the gross wages, you need to include the labor burden.
So what is the Labor burden?
It is the cost, above and beyond the gross wages required to have a W-2 employee on the job site and there are several.
The first one is taxes, and of course, there are several of these…
Your contribution to the employer side of Social Security is 6.2% and for Medicare is 1.45% for a total of 7.65%.
Next is Federal Unemployment Insurance (FUTA), which for this year is 6% of gross wages but only paid on the first $7,000 of an employee’s wages annually.
Then you have your State Unemployment Insurance (SUDA). This one is not easy because it varies from state to state, so you’ll have to check your own state program.
I’m in Illinois, so for Illinois, the rate can change from 0.55% on the low side, to a maximum of 6.4% on the high side.
A new business starts in the middle at 3.225%, the rate goes up, the more employees that use the insurance from your company.
So, if you fire and layoff people in Illinois, you’ll pay the highest rate. And like FUTA, in Illinois, the tax is capped at $12,960 per employee, per year.
So as you can see, for federal and state unemployment, it is not the cleanest formula.
So with the FUTA cap of $7,000 annually per employee, you can pay a maximum of $420 per year for the employee, you pay $20,000, for an effective rate of 2.1%.
Or the employee you pay $50,000 a year, will pay an effective rate of less than 1%.
I recommend making an educated decision on the average and move forward. And on a side note, a little strategy here, being careful to churn your employees can save you money in unemployment taxes each year.
If you hire people that don’t make it past the threshold, you are paying that cost in full over and over again without having the benefits of the hours worked over the threshold.
Next, we have Workman’s Compensation Insurance and the General Liability Costs, which can be found on your declarations page of your insurance policy.
There can often be discounts and credits on an insurance policy, but with a little digging and math, you can find the percentages of each of these.
If you need some help, call your insurance agent and ask for the actual cost per hundred of each of these.
So what is the likely total burden for a painting contractor?
I see a range in most companies from 21% to 26% burden. So, to make it simple, when you pay someone $10, it costs you $12.10 on the low side, and $12.60 on the high side.
You might hear this called a ‘weighted labor cost’.
So, as you can see, if you have a painter at $20 per hour on a project for 100 hours with a 23% burden rate, the actual cost is $2,460, not $2,000.
The next direct cost is any subcontractor costs you incurred doing the project.
This may be a paint crew, or maybe you brought in a paper hanger, or a dry wall, or a carpenter.
Next are all the materials required to perform this project. Here is also where I add my sundries cost.
In my experience, you should surely, as you grow, be taking advantage of deep discounts given by ordering supplies in case quantities and ship to your shop.
Sundries invoices can easily be tracked in an individual category, in your chart of accounts to determine the cost of sundries as a percentage of revenue.
In my experience, this number is anywhere from 1.5% to 3% of revenue. This is also where you can allocate some money for replacement of more durable items like tarps and ladders.
This in effect rents these items to each job knowing they are required for the job but expensed over many jobs.
So I take the revenue of the project multiplied by 3% for sundries, plus the costs of the paint and this would be my costs for materials for this project.
You can then include any rental cost, say for a lift or a portable toilet or a compressor etcetera.
And lastly, any other additional job cost; was there travel or per diem?
Maybe a permit. Anything that you spent money on for this and only this project needs to be included here.
Now I want to address those of you that are owners and do the painting.
How do you allocate the owner’s time into the gross profit calculation? I’d simply put an hourly rate for the owner, based on the rate of pay for the top painter in your crew and include it in the labor portion.
If you are excluding yourself on a workman’s comp. as some states allow, then you might have a separate calculation for the owner’s hours, or put their hours and gross cost into the subcontractor category.
But when the owner is a painter, their time needs to be applied to the cost of the job.
So this is what the calculation looks like: Direct labor, including burden, plus subcontractor’s cost, plus materials including sundries, plus rental equipment, plus any other direct cost equals the total cost.
Take your gross revenue, minus the total cost, and you get your gross profit in dollars.
ake your gross profit in dollars, divided by revenue, and this would give you your gross profit as a percentage.
The target gross profit percentage here especially in residential repaint is 50%. Now, what do I not include in gross profit?
These things that while associated with the painter are variable and not directly incurred because of the project. These are things like employee benefits, paid time off, retirement plan, health insurance, company vehicles, and supervision.
I prefer to see these as a variable or overhead costs.
So, that is my take on gross profit.
Is this in line of how you look at it?
Or is there a big gap between this way and your way?
I’d love your feedback and as always if I can serve you in any way, please reach out to me at firstname.lastname@example.org.
Till next time…