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Chapter 10: Setting Profit Margin for Bidding Profit can determined based on contribution margin and the

contribution margin ratio as follows:


The profit equation:
Profit = Contrubution Margin - FixedOverhead
For construction company revenues are in form:
and Profit = CM Ratio (Revenues)- FixedOverhead
- Payment from the project owners.
- From the sale of projects. Projecting Break-Even Volume of Work

Revenues are used for three key items; pay construction costs, Break-even volume of work: amount of work volume that is need
pay the general overheads, and to provide profit for investors in to be produced during the year to cover overhead cost and
the construction. provide a specified profit.

Construction costs: includes direct and non-direct (project Historical CM Ratio needs to be adjusted according to changing
overhead) cost from all the constructions of the project. market conditions.

General overhead cost: are the cost that are not attributed to Break-even Volume of work can be determined based profit value
any specific project. as follow:

Revenues = construction Costs + Overhead + Profit - Setting profit to be equal to zero.


Profit = CM Ratio (Revenues) - FixedOverhead
Profit = Revenues- construction Costs - Overhead 0 = CM Ratio (Revenues) - FixedOverhead
This is known as the profit equation. FixedOverhead
Revenues =
CM Ratio
The percentage of construction revenues that become profit The company will need amount of revenues to cover its
can be determined using the following equation: fixed overhead.
Profit - Setting profit equal to the required level of profit
Profit % =
Revenue Profit = CM Ratio (Revenues) - FixedOverhead
FixedOverhead + Profit
Contribution Margin Revenues =
CM Ratio
Overhead = Variable overhead + Fixedoverhead The company will need amount of revenues to cover its
Profit = Revenues- Construction cost - VariableOH - FixedOH fixed overhead and make specified profit.

Contribution margin: is the amount of money a project or projects Projecting Break-Even Contribution Margin Ratio
contribute to the company to be used to pay for fixed overhead - Setting profit to be equal to zero.
and provide a profit for the shareholders. Profit = CM Ratio (Revenues) - FixedOverhead
Contribution Margin = Revenues- Construction cost - VariableOH 0 = CM Ratio (Revenues) - FixedOverhead
FixedOverhead
Contribution Margin CM Ratio =
CM Ratio = Revenues
Revenues The company will need maintain CM ration to cover fixed
Revenues- Construction cost - VariableOH
or CM Ratio = overhead.
Revenues
If CM Ratio of company< ExpectedCM Ratio
Revenues Construction cost VariableOH
CM Ratio =
Revenues Revenues Revenues
it can not cover fixedOH and loses moneyin construction cost
Construction cost VariableOH
CM Ratio = 1 If CM Ratio of company> ExpectedCM Ratio
Revenues Revenues
CM Ratio of company ExpectedCM Ratio = Profit (%)
Also
- Setting profit equal to the required level of profit
Contribution Margin = CM Ratio (Revenues) Profit = CM Ratio (Revenues) - FixedOverhead
FixedOverhead + Profit
CM Ratio =
Revenues
The company will need maintain CM ration in order to
meet it profit requirements.

If CM Ratio of company< ExpectedCM Ratio



Companydoesnt meet its profit requirements
If CM Ratio of company> ExpectedCM Ratio

Companyexceedsits profit requirements

Adjusting the financial mix:

1- Change prices and need to be raised up.


2- Reduce the construction cost.
3- Reduce general overhead cost.

Profit and overhead markup:

The profit and overhead margin is not same as gross profit


margin. However they are mathematically related.

Gross profit Revenues - Construction cost


Gross profit Margin = =
Revenues Revenues

Gross profit Margin


P & O Markup =
100 - Gross profit Margin

There are some reasons for increasing the profit and overhead
markup.

1- The company is submitting a bid as courtesy to the


customer but it really doesnt want the project unless
it is profitable.
2- The project is a difficult project, has high degree of
risk, or the project owners are difficult to work with.
3- The company is bidding on the project to check its
prices but really doesnt want the project unless it is
very profitable.
4- The other companies are bidding on the projects are
expected to be charging high profit and overhead
markup or having higher construction costs.

Bid
P & O Markup = 1
Construction Costs