3 Bidding Mistakes that are Killing Your Profit Margin
Posted May 22nd, 2019
In its most basic form, a bid is the sum of estimated project costs, overhead expenses, and net profit margin. There are countless factors that must be considered when drafting a bid, and in some ways, it can be more of an art than a science. One job that goes wrong could take years to financially recover from.
Here are 3 bidding mistakes that are putting your profit margin on the line:
Pitfall #1: Profit is Caught Up in Retainage
If you build in a 10% profit margin and your general contractor is withholding 10% retainage, stop kidding yourself. You are dependent on that retainage in order to make money on the job, and you shouldn’t be. Waiting to pull a profit from retainage leaves you at a huge risk of a cash flow shortage until the job is completed and your retainage is paid out, which can take a long time to be released.
You might think, “Well, that’s all right! I have another project that is wrapping up now, I’ll get my retainage from that, which will be my financial cushion.” Answer: It’s not all right. What if you have a common setback like a weather delay? Or if one of your subcontractors, material suppliers or vendors make a mistake on the job or their costs suddenly increase? What if the property owner is delaying payment to the general contractor for an outside reason? Essentially, what if that other job’s retainage payout doesn’t come by the time you need it or worse, doesn’t come at all?
Given the construction industry’s chronic problem with payment delays, leaving your profit margin tied up in retainage is one way to lose it.
So before you bid, be sure you know how much retainage the general contractor will withhold. If it pushes your bid far above your comfort level you can attempt to negotiate a lower retainage but if that doesn’t work, you’ll need to increase the amount of your bid to ensure that for each billing, you’re bringing in some profit.
Pitfall #2: Not Accounting for Overhead Expenses or the Cost of Capital
There aren’t many subcontractors operating today without funding from outside sources. Whether you use a factoring company, bank line of credit, SBA loan, merchant cash advance, or mobilization funding, no funding source is free. The cost of the funds you need must be built into the project costs of your job (or depending on the type of capital, into the overhead calculations), rather than digging into the project’s profit margin.
If you have an established relationship with a lender, you can use a term sheet or other breakdown of the cost of the funding you need for this particular project and include that in either the project costs or overhead expenses in your bidding calculations. If you will be securing funding for the first time on this job, do some shopping to identify the lender you want to work with first, and get a cost estimate based off of your business’s needs and expected cash flow.
Note: Beyond the term sheet, be sure you understand the details of your agreement with that lender. For example, if you are working with a factoring company and your rate doubles if the invoice takes more than 30 days to be paid, you may need to use that higher figure in estimating the cost of that capital.
Pitfall #3: Lowballing a Bid to Land a Dream Job
Many companies will submit an artificially low bid, thinking that by accepting a lower profit margin now, they will land the big job they’re looking for and open up bigger and more profitable projects going forward. (You might also think you can generate profit through change orders, which is another risky approach.)
The problem is that if anything goes wrong, that ambitious new project could mean financial ruin for your company, late paychecks for your employees, delayed payments to your vendors and sleepless nights for you, the business owner.
This puts you on thin ice from the start. Murphy’s Law states that whatever can go wrong, will go wrong, and there’s an awful lot that goes wrong on construction projects. When you start to feel that ice start to give way, you will be forced to do things you normally wouldn’t, like cutting corners on the job, taking out last minute daily debit or Merchant Cash Advance (MCA) loans you can’t afford and ultimately, damaging your reputation with the general contractor you were trying to impress in the first place.
Subcontracting companies are known for operating on thin margins, but that doesn’t mean you have to. If you’re still reading this article, you likely have experienced the disastrous results of at least one of the pitfalls listed here. You understand the problem, and how easy it is for everything to turn upside down. You deserve to sleep soundly at night, to take regular paychecks home to your family, and to be compensated for the risk you took by being an entrepreneur in the first place.
Yes, if you avoid these common mistakes, you likely will be bidding more than your competitors, but the economy is booming and the iron is hot. Your work is valuable, and it’s needed now more than ever.
Now go out and get paid.