One of the most common ways SMEs add their mark-up is to combine overheads and profit into a single percentage — the OH&P — and apply it to the direct costs. Figures of 15%, 20%, or 25% are commonly used, either historically or because owners have been advised these rounded numbers will work. But as projects get larger, this approach starts to create problems: owners begin losing tenders and complain that things are getting tight, when in fact they may simply have moved into a different segment of the market where the combined rate is no longer appropriate.
The Two Methods Compared
The alternative to a combined mark-up is to add overheads and then profit sequentially. For example: 10% overhead then 5% profit, or 15% overhead then 5% profit. The additions are done in sequence, one after the other.
Here is how the two methods differ in practice on a £1m project (overhead 10%, profit 5%):
- Method A – Combined (15%): £1,000,000 × 1.15 = £1,150,000
- Method B – Sequential: (£1,000,000 × 1.10) × 1.05 = £1,155,000
The combined method produces a sharper price, but at the cost of self-deception — the overheads are not fully recovered. The sequential method costs £5,000 more on this example, but gives you full recovery and complete transparency.
Why Sequential Is Better for Internal Control
With the sequential method, overheads can be adjusted easily depending on forecast workload, and the net profit recovery can be checked as the project progresses regardless of what is actually happening with the overheads. It is far more transparent and controllable. It also relates directly to the figures in the management accounts, and highlights to owners exactly what profit is actually being added — so they can determine whether it is sufficient for the risks being taken.
The combined method is better if you want to offer the sharpest possible price. The sequential method is better for repeat work and frameworks where there is full recovery and transparency.
The Recommendation
Know your numbers at every level. Track your real overhead rate from the accounts. Set a profit mark-up you will not compromise on, then adjust for risks. Price internally using sequential mark-up. Decide afterwards how to present it to the client — you can always back-calculate the combined rate if you need a single figure.
Getting this discipline in place means you will know exactly where your money is made — and where it is being lost — long before problems occur.
