There are five key numbers (Key Performance Indicators or KPIs) in a residential building company's financials that you must be completely across on a QUARTERLY basis…
It needs to be quarterly because most residential building companies generate less than $10 million in revenue a year, and their claims can be six to seven weeks apart, which means their monthly income can be a little volatile…
So it makes sense to look at your financials quarterly rather than monthly when comparing to the previous period, or the same period last year.
Of course, if you are not calculating your work in progress accounting adjustment (WIPAA) each month, then your financial reports are not going to make too much sense to anyone, no matter if you look at them monthly, quarterly or even annually!
So, calculating your work in progress accounting adjustment figure each month is the first number you must be across in your financials…
The next one is revenue…
And this is why we look at the numbers quarterly rather than monthly, because revenue can easily get distorted by the timing of your invoices to your clients.
However, over a 90-day period of time, things tend to even out, so it’s important to look at your revenue and compare it to your budget, last quarter’s revenue and your revenue for the same period last year.
That helps with taking seasonal fluctuations into account…
The third most important number to look at in your construction financials is your gross profit margin.
This is your gross profit, which is the revenue from your projects less the cost of sales relating to your projects, as a percentage of your total revenue…
A lot of builders confuse this with markup which is totally different, so don’t get caught out.
The benchmark for custom home builders is 25% margin, which is a 33.3% markup…
So, make sure you are checking your gross margin every quarter and comparing it to your target gross margin, last quarter’s gross margin and your gross margin for the same period last year.
When you do that, you’ll see how much margin you are actually getting out of your jobs compared to how much margin you are adding to your jobs when you price them…
And that may be a bit of an eye-opener for you, especially if you are not achieving the industry benchmark.
Financial KPI number four is your fixed expense ratio.
Fixed expenses are any costs that cannot be directly attributed to a project, things like, rent, admin staff and software costs…
On its own this figure does not mean too much...unless it’s higher than your gross profit!
The way to look at your fixed expenses is as a percentage of revenue, which is known as your fixed expense ratio.
The benchmark for a residential building company is 15% which includes the owner’s salary at market rate and a healthy investment in advertising and marketing of around 3% of revenue.
It is possible to artificially lower this ratio by either not drawing a salary, or by investing very little in marketing and advertising. So they are the two key areas to look at closely when you calculate this number and compare your building company to others in the industry.
And finally, financial KPI number five for custom home builders is net profit margin.
Net profit margin is the profit left over in your building company after accounting for all of your project costs and fixed expenses and then calculating it as a percentage of your total revenue.
If you are not taking a salary and instead are drawing the net profit the company makes as income, then your building company isn't really making a profit, it’s just breaking even…
And that’s a very risky situation to be in, because after a few quiet months, you are out of business.
The industry benchmark for a custom home building company is 10% net profit margin.
A well-run building company will operate between 10%-15% net profit depending on where they are in their growth cycle and market conditions.
Sadly though, most custom home building companies are not achieving double digit net profit margins because they are focusing on revenue rather than margins and ratios.
A professional builder will look at all five financial KPIs in order to understand how well their building company is doing, rather than just focusing on the bank balance!
So if you would like to increase your profits by gaining a better understanding of your financials, then make sure you join us for an online presentation covering Construction Financials.
And when you register for this online presentation we’ll send you the Professional Builders’ Secrets To Increasing Margins FOR FREE.
When you have this checklist, you'll be able to...
- Understand the difference between markup versus margin.
- Understand the difference between the cost of sale versus your fixed expenses and why it’s critical to factor this into your pricing strategy.
- Calculate your fixed expenses as a percentage of your revenue.
- Determine the exact net margin your building company needs in order to be profitable.
So go ahead, click on the button below and we’ll send you the Professional Builders’ Secrets To Increasing Margins FOR FREE.