Crisis Management For Custom Home Builders
Material and labour shortages combined with price increases and fixed price contracts are turning what appeared to be a dream start for custom home builders at the beginning of the year, into a nightmare reality.
However, according to a recent panel discussion covering crisis management for custom home builders, this is just the beginning.
Builders have been dealing with an explosion in demand for their services since Q3 2020 due to the COVID-19 pandemic restricting consumers' ability to spend their discretionary income on luxury holidays and entertainment.
As a consequence, the increase in demand has pushed supply chains to the limit with weekly price increases destroying the net profit built into fixed price contracts.
If that wasn’t bad enough, according to Tye Alroe, founder and director of Alroe Constructions, things are about to get a whole lot worse as cash-starved subcontractors are being forced to close their doors.
Avoid Relying On One Contractor
Tye issued a stark warning to custom home builders that continue to rely on a single subcontractor or supplier in their businesses.
“Don’t use one quote when estimating your jobs right now, make sure you get more than one because we are seeing a lot of subcontractors and especially cabinet makers go under right now due a shortage of supplies, which prevents them from continuing to trade, which in turn destroys their cash flow.”
So, what can custom home builders do to protect themselves during these fast changing and challenging times?
To start with, it’s imperative that you review your contracts before commencing construction. A lot has changed as a consequence of natural disasters such as bushfires in Australia and the United States, as well the global pandemic that has affected every building company in the world.
Lawyers Should Review Contracts
Therefore it is essential that builders have their existing contracts reviewed by professional lawyers who act in the builders' interests to explore ways in which the escalation, in costs can be passed on to the consumer.
It makes no sense for a building company to commence work on a fixed price contract when they know they will be losing tens of thousands of dollars by executing it, especially if they don't already have that amount of cash in reserve to pay suppliers and subcontractors as, and when, their bills become due and payable.
It is far better to have the difficult conversation with the client now regarding cost escalation rather than putting other small businesses at risk in the future through payment defaults.
Additionally, no new fixed price contracts should be signed using standard contracts. These are exceptional times which means special conditions will need to be drawn up by a professional lawyer and inserted into any new contracts.
Protect Your Building Company
It can be argued that the current situation could not be foreseen by a small business that has never experienced a situation like this before.
However, continuing to sign fixed price contracts without protecting your business against future price escalations and delays caused by material and labour shortages, could be seen as a demonstration of negligence by the business owner from this point forward, so make sure you protect yourself and your business.
The next thing builders must do during the current crises is to ‘over communicate’. Your clients are experiencing just as much stress as you are and are not prepared for how the current situation will impact their finances and timeline.
The worst thing you can do is ignore the situation and delay addressing it until the last possible moment. Getting on the front foot is the key, keep your clients in the loop, update them on revised timelines and pre-warn them regarding potential price increases.
Manage Expectations In Advance
Builders using Prime Cost items and Provisional Sums (Allowances) in their contracts are protected against price increases. They are in a fortunate position of being able to easily pass those increases on to their clients...providing they can demonstrate that the initial allowance was realistic at the time of the contract being signed.
However, do not take anything for granted, your clients will be shocked to receive any additional invoices over and above their original allowances so it’s your job to educate them and manage their expectations in advance.
Finally, it’s really important at the best of times for builders to be completely on top of their cash flow forecasting and their work in progress liability on a monthly basis.
However right now, it is absolutely critical that builders are reviewing their financials weekly. This means revising their forecast ‘cost to complete’ for every job and then recording and monitoring the change in gross margin in order to assess the trend.
Builders Don't Prevail During A Boom
They also need to be reviewing the estimated ‘stage completion dates’ for each job and then use that information to update their cash flow forecast.
Monitoring the work in progress accounting adjustment (WIPAA) figure is now more important than ever as is ensuring there is always enough hard cash in the reserve account to cover that hidden liability.
As jobs continue to slow, building companies with little or no liquidity will be exposed, forcing them into liquidation in the coming months.
There is a myth that builders do well in boom times and make a lot of money. However, the reality is very different as Tye Alroe explained in this video.
“The busier you get, the less money you make. We’re busy, but we are making less money from our jobs because our margins are being eroded.”
If you missed the live discussion but would like to discover more about the importance of issues and crisis planning and what can go wrong if you are not prepared, then click here to watch the recording free of charge for a limited time.