Grasp the importance and tactics of properly determining and applying markups in a business setup. Understand the significance of including all costs, the sequence of adding overhead and profit, and the potential impact on accounting analysis.
Key Insights
- The article elaborates on how markups and add-ons should be applied in a business scenario. It underscores the necessity of adding all potential costs prior to any markups, including overhead percent first, then the subtotal, and finally multiplying the overhead subtotal by the profit percent.
- Applying profit in the same manner as accounting analysis is vital. A misalignment between these two can lead to variations in profit, even if the business meets its budget. For instance, a minor deviation like 1.5% can occur.
- An example is provided to illustrate the application of overhead and profit separately on construction costs. Following this method can increase the overall price but aligns with the way accounting might analyze the project based on the estimated budget.
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So let’s talk a bit about markups, add-ons, and the order in which we apply them. Note that when I refer to the term "above, " providing the cost above markup basically means before the markup is applied. Generally speaking, what we’re trying to establish is having all of your costs included as a lump sum or as a dollar amount, even if some are additional add-ons.
Just make sure that any of these add-ons—any of these potential costs—are added prior to any of the markups. Always add the overhead percentage, calculate the subtotal, then multiply that subtotal by the profit percentage. This ensures that you’re adding profit on top of your overhead.
This can make a big difference, depending on how your accounting department analyzes your job costs. If you don’t apply your profit in the same way that accounting analyzes profit, you could be off by 1.5%, even if you stayed within budget. Here’s an example of that.
Construction costs are $100,000. Overhead at a straight 25% is $25,000, for a total of $125,000. Now let’s look at it if we apply the overhead and profit separately.
Construction costs $100,000. Overhead at 15% is $15,000, giving you a subtotal of $115,000. Then we apply 10% profit, which is $11,500, bringing the total to $126,500.
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Your price did increase—it’s $1,500 more than the straight 25%. But technically, this is how your accounting department might analyze the project if you based it on your actual estimated budget. If your company wants you to do it differently, follow their lead on this. Otherwise, make sure that your markup is applied on top of your overhead.
If you look at your handout and refer to the markup section, you can see the breakdown: overhead, then subtotal, followed by profit, which is calculated as a percentage on the subtotal plus overhead. First, we applied overhead at 8%, then calculated a subtotal, followed by a 10% profit. This is different—as noted in the earlier example—because 18% is not equivalent to 8% with 10% applied on the subtotal.
