While most contracting firms understand that profits are critical for growth, the factors that impact construction profit margins can be somewhat of a mystery. Contractors begin projects to earn money, but during the build their profit margins often seem to shrink under the weight of growing project costs and ballooning overhead.

This article will discuss some factors that can affect construction profit margins, and how to optimize them for healthier profit margins.

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What are construction profit margins?

A profit margin is the money left over after all project expenses are accounted for. There are two calculations businesses use to analyze their profits:

• Gross profit margins are the total billed amount minus project costs
• Net profit margins are the total billed amount minus all expenses, including taxes, administration, and overhead expenses such as office staff

Contractors benefit from tracking profits so they recognize the trends that impact them. Tracking profits also provides a metric to judge the success of individual profits and the health of a construction company over time.

While profit margins are critical for healthy construction companies, the actual percentage profit margin tends to be quite low in construction, with the average net profit margin amounting to 2-15% of project totals. Those narrow margins mean that when it comes to profit, every dollar counts. Contractors must understand and control the factors that eat into profit margins in order to survive and thrive in a competitive construction market.

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Factors that impact profit margins

Profit margins in construction can be impacted by both external forces and internal processes. Astute contractors will work to buffer their businesses against outside threats and improve their processes for greater opportunities.

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Economic factors

Long construction timelines and periodic payment schedules mean contractors often rely on credit products to maintain a healthy cash flow and keep construction projects on track. However, it’s easy to forget the cost of debt in overhead expense calculations. Interest payments can chip away at a construction business’s profit margins, especially when interest rates rise significantly during the project timeline.

For instance, if a contractor took out a deferred payment loan for $100,000 over a year to float project costs, the cost of borrowing could double if interest rates rose just a couple of percentage points over the course of the year.

Further, interest rates and other economic factors like inflation can cause materials and labor costs to rise, both of which can also impact project costs.

Changes to government policies can impact the price of building, too. When governments change accessibility rules, building plans may have to change accordingly. Government policies that encourage investment in infrastructure or housing can impact availability of resources and construction project costs.

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Market conditions

As with any industry, construction is subject to the forces of supply and demand. A high demand for construction work may impact construction prices for better or for worse.

Contractors in an active marketplace may build up long backlogs of construction work, which allows them to charge more for their services. However, in busy conditions the competition for labor, materials, and equipment is also likely to result in price increases, thus driving up the cost of building and diminishing profit margins.

A high number of contractors in any market area can cause contractors to price their bids lower to remain competitive, impacting project earnings. Competitors who use pricing strategies that seem to increase their value will compel contractors to make similar changes or engage in race-to-the-bottom pricing, resulting in lower-quality work and, ultimately, loss of client trust.

Instead, contractors can find ways to improve internal efficiencies to keep client prices low while protecting profit margins. For instance, Truss Payments allows contractors to pay bills and collect invoices digitally while avoiding transfer fees. 

Further, with Truss, contractors can offer clients convenient options to pay invoices, like including a direct payment link right on digital invoices. Using technological means to improve efficiency while offering clients more value can help contractors retain profit margins, even in a competitive construction market.

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Labor and material costs

There are many factors that could impact the cost of labor and materials, some of which contractors may have no advance notice of but could nevertheless increase the cost of building. During 2020 and 2021 material costs soared because pandemic shutdowns slowed supply chains. Labor shortages can drive the cost of worker hours up, as can regional labor rules.

Fostering solid relationships with materials suppliers can help contractors control materials prices and availability. Contractors can use digital solutions like Truss to help manage payment schedules to track materials expenses and recognize when they fall out of budget. Truss even allows contractors to tag and filter expenses to keep better tabs on expenditures.

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Project management

Effective project management may be one of the most powerful tactics a contractor can take to help control overhead costs and protect profit margins. A collaborative effort toward efficient project planning and scheduling can help decrease costs by maximizing equipment rentals and making the most of the time specialty trade contractors spend on site.

Open communication, including widely accessible project documents, can help keep all construction stakeholders aware of the latest project updates. This open and collaborative effort helps avoid change orders and rework, both of which can cause delays and drive up costs.

Effective project management includes controlling daily expenditures to maintain the construction budget. Truss Payments simplifies cost control measures by allowing construction managers to set up individual spend limits on cards and track purchases in real time.

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Technology and innovation

The right digital solutions can help any contractor operate with greater efficiency, thus lowering direct and indirect costs and protecting profit margins. Project management technology can help plan and guide daily activities and keep communication organized and accessible. Workforce planning platforms can help optimize employees to put workers’ skills to best use and decrease downtime. Building Information Modeling (BIM) helps designers produce more accurate cost estimates to plan for and actually realize healthy profit margins.

Using products that work together can save even more time by decreasing instances where manual data entry is needed. Truss integrates with other construction technologies like accounting software for greater efficiency and cost savings.

Increasingly, contractors are using automation to create greater productivity within their processes. For instance, Truss uses automation features to streamline billing, invoicing, and reconciliation, reducing the administrative burdens within these processes and reducing manual entry errors.

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Understand and control the factors that impact profit margins

Profit margins are slim in the construction industry to begin with, so general contractors should do all they can to protect their earnings by controlling costs throughout each project to create buffers against economic changes, market conditions, and rising costs that may impact their budgets. 

Internally, contractors can maximize efficiency through project planning and wise use of digital tools to safeguard their profitability. Embracing innovative tools and practices, such as those offered by Truss Payments, empowers contractors to enhance efficiency and sustain their competitive edge.

Book a demo to get started with your free Truss account today.