Calculating Net Profit Margins Is a Tricky Business

When we began discussing overhead last month, we recognized that a number of variables affect the recovery of overhead expenses, and also that overhead expenses not only depend on contractor size, but also on operational efficiency. The pie chart from the “Financial Performance Report,” National Electrical Contractors Association (NECA) publication Index No. 1055, graphically indicates where overhead fits into the contractors’ financial picture. For example, a pie chart of the average sales dollar distribution indicates: Materials 31 percent; Income Taxes 1 percent; Direct Labor Wages 30 percent; Other Direct Job Expenses 4 percent; Labor Adder 13 percent; Subcontractor Expenses 5 percent; Total Overhead Expenses 13 percent; and Net Profit After Taxes 3 percent. People’s first comments about the above percentages concern the average three percent net profit margin. Most people reason that this is a paltry sum for all the risks involved, at a time when a progressive investment will bring a gain of close to triple that amount. A contracting operation earns money based on a product. The more products can be made, the better its net profit margin will be, exponentially rather than linearly. A major factor is the contracting operation’s efficiency. The net profit margin percentages also show that these dollars are only committed to helping the business grow or to providing capital for future projects. The net profit is what remains after all expenses have been subtracted, including executive salaries, and dividends paid to shareholders for their equity in a firm. This is why understanding the sectors of the dollar flow is so important not only to management, but also to estimators who must build in sufficient funds to cover the “nut.” Analyzing overhead costs as compared to direct job costs can be tricky, because some cost items can be spread over the needs of the project as well as the administrative duties performed for a company. Typical expenses that occur in both areas include such things as communication expenses, office supplies, trucks and their maintenance, utilities, insurances, repairs and maintenance, tooling, rental expenses, and some other costs that may be shared with the administration as well as other jobs. Since there is such a diverse list of possible dual accounts, a specific job cost reporting system is essential for meaningful figures to come from financial reports, the basic source for the usable overhead figure. A list of their value and percentage weights for the overhead expenses of all reporting firms can shed some more light on the subject. The “Financial Performance Report” indicates percentages for the industry as well as categories of firms as sorted by payroll size. It represents the average of reporting firms of all sizes, and should be considered only as a reference. Financial statements do not all have sections that duplicate the chart, but they do have some variation of these expenses. There are some salient items for future discussion. The estimator obviously can not control many of these costs as far as the office is concerned, but he or she can control all predictable expenses at the job site. A more important point that will recur is the relationships of the percentages on the “Total Overhead” line. Percentages change as they are applied to the overhead dollars in relation to the sales, prime cost, or labor percentages. Considering that these dollars remain constant, only the relevant percentages change. This indicates, in part, that a labor-only project must carry more overhead than one with a mix of materials supplied by the contractor as well as the labor. The averages show clearly that, to generate the money required to operate a business, a like percentage for all types of work will not work. The “Financial Performance Re-port” charts are divided into four groups and nine geographic districts. The relationship of overhead to sales, direct costs, and labor indicates the variances according to the contracting firm’s size. Another salient fact is the varying percentage relationship of the same dollars of overhead across the three percentage columns. The relationships are important facts for estimators to realize. For example, a planned $2,000 overhead expected to be garnered from a project selling for $10,000 is equal to 25 percent of the cost of $8,000, but equals only 20 percent when compared to the sale price. In the next column we’ll apply the overhead factors to the bid. DAVID is a professor of electrical technology at Long Beach City College, Calif., a consultant, and an expert witness. He can be reached at (562) 597-1877or by e-mail at

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