Profit Margin Perils

The other guy probably knew the right people or saw something in the plans that wouldn't fly and would result in a big change order. Or maybe he convinced his crew to take a big pay cut just to be able to work.

Or maybe a little of all 3 plus a couple more.

Ed Weldon (just a layman here, not connected with the construction world)

As Kris says 25% is a lot. Perhaps the winner will end up with a loss margin!

Better to lose the contract than lose money on the contract.

Chas

Your dad's in business and there's always some risk with "being your own boss" and carrying the responsibility for others.

From what you've described, your dad's had enough experience to know what he's about, but really he if facing a decision tree that is quite simple.

Option 1: give up, consolidate his funds and wait this event out. (Consequences: He will need to recruit staff and expertise and to establish his enterprise at a later time.)

Option 2: maintain the business on a cost recovery basis, and provided he recovers costs of materials and effort plus the "overheads" expenses then when this is over he will still have a fully capable and ready business.

Where I am has taken a variant on the second option. Everyone is working shorter weeks, tightening our belts and moving forward.

For all of us, this is the best option, since the retraction that option 1 would cause would take far longer for the economies of the world to recover and get back to "business as usual"

From my experience, a couple reasons for a much lower bid is:

The low bidder is just trying to stay alive by optimistically cutting cost numbers in his bid. This will cause him to go into debt later or not pay subcontractors.

The low bidder and his subs have lower overhead (able to juggle what is union and non-union labor or has paid off dirt machinery are two examples) and thus has true lower costs.

If you are involved in your dads business try to get into his head without confrontation. If he has ran a successful sizable construction company for a while, he knows this and much more. If you have a good relationship, learn from it.

Does he have to make a profit? In harsh times, would it not be better to break even than to be without work?

I have never met a contractor who actually just breaks even. Most contractors consider breaking even as being able to cover project costs, bidding overhead, marketing, their home loan, their boat loan, their new pick up truck loan, their loan on their corvette, etc... Unless they are really extended and have more personal loans outstanding on luxury purchases. I mean a 1.5% mark up on a 20 million dollar school project is $300,000 profit. I see engineering firms all the time propose jobs with 0% or less mark up, just for labor, materials and overhead, just to gain a foot in the door with a large corporate or government client and get short listed for future projects. though enginering firms usually eprceive the loss of engineers because of downsizing as risky, since they aren't easy to recruit and usually cost more to hire new ones at the same skill level and then have to train them in corporate practices. I guess construction labor is easier to hire and fire, and the risk of short staffing when the labor is needed is readily overcome.

The true measure of a manager in a business is does he earn a premium above his cost of capital.

If not, he's no manager.

If you are saying that "That does not apply 'all the time' or that 'this time it's different'" you are suggesting that economic cannibalism of the enterprise is alright "just this once."

One cannot provide goods and services at one's variable costs unless one's fixed costs are covered.

You are wise to not say anything to your father. He is "intelligently managing his risk" by not 'selling the engine out of the corvette' and claiming that after the sale the corvette is worth what it was before.

Every village has an idiot. In competitive bidding situations its almost always the low bidder. Thats why so many contractors go bankrupt a couple of times.

I'll bet your father never has never gone bankrupt. He knows his costs and bids rationally. He may not win a lot of bids, but he doesn't go broke on the ones he wins...

If you do talk to your dad, tell him I'm a fan.

PS. To Shonover, No he does not have to return a profit, but if he doesn't get at least his cost of capital, he'll be working to make himself and the enterprise poorer. He'll be subsidizing the other party at the expensive of his own enterprise's net worth.

My advice would be for him to contact the low bidder to see if there are any areas where he might still be a provider of best choice compared to those he used.

milo

In my mind "break even" means to cover the costs, including materials, labour, overheads, monthly business loan payments, taxes and salaries, including that of the owner. Paying for luxury goods or giving oneself an overinflated salary is stealing from the business. Any cash left over after business expenses is the profit, which should ideally be reinvested in the business. This is just my understanding, as someone who has never been a business owner. Please tell me if I'm being naiive.

However, it is a pretty common practice amongst constractor to put the title, leases and so forth for their own luxury items under the business for tax purposes (treating loan payments a business expenses), and draw the cost of payments for such items against the company operating overhead. Corporations do the same thing for executives by providing them with expensive leased personal use vehicles, executive resorts, and such. It all gets rolled into the corporations overhead, and they use the expenditures to reduce tax liabilities.

Well, our tax man has all those tricks sussed out. Not much hope of getting away with that here any more. There is still some room for manoeuvring, but basically any benefit that falls outside of reasonable business use is considered part of personal income and is taxed as such.

Well those things are easy to get around. Drive your vehicle to marketing or client meetings once in a while, use that vacation home for executive meetings once in a while, etc.. though some of the luxury items do raise redflags, like boats, and eventually get the contractors audited, but that might be 7 years from now, which is forecasting way beyond their ability.

In the States we have a form of ownership called Subchapter S, where basically the owner is the corporation. there is no Corporate income tax, instead "profits" are taxed at the owners (Shareholders) tax rate. However, they still are shielded for liability.

Thats why its difficult to speak of expenses, costs and profits. They are more like cooked spaghetti than separate noodles depending on the corporate form of business.

milo

When times were good I could add 15% to 20% overall, and stuff my mattress with the profit. No advertising costs, and the discounts I received from my suppliers could be rolled over to the next job.

When times were tough, belt tightening and pencil sharpening were taken to extremes, just to stay afloat. This worked usually, until recession cycles got deeper. Advertising, specs and bidding, holding idle crew all began eating profit. I then diversified to accommodate niche markets. Moving small houses, post and beam construction, renovations and painting, and finally boat building. When the new cycle hit a rise I was too busy building boats to ever want to go back.

I'm retired now at 62. I still keep a hand in doing consultations, build a canoe now and then, and generally enjoy my SS pay cut and the time I have to enjoy life. I used to fill in my early spring doing outage work at power plants, but had to stop that after an injury. They still call each spring. i don't miss the construction bit at all.

Diversify!