Why Inflation Will Destroy Your Net Profit In 2022 Unless You Do This One Thing

We’ve been hearing some pretty lame excuses from governments around the world in 2021 who have been trying to convince us that inflation is ‘transitory’ and ‘temporary’.

Additionally the Chairman of the Federal Reserve has suggested there is no link between increasing the money supply and inflation, which has prompted many economists to label him ‘delusional’.

Whatever your thoughts on government policy, as a business owner it's important to understand the consequences of what is currently happening in the global economy and how it will affect your building company in 2022.

And I’m not talking about continued supply chain issues, I’m talking about the silent tax, inflation.

Before I go any further, it’s important to understand that governments need inflation, which is why they target a 2% - 3% increase each year.

However, it’s also important to understand that governments are terrified of deflation. This is where the cost of goods actually declines rather than increases.

And because they are so scared of the effect of deflation which will effectively increase the true cost of the debt they are racking up, they will do ANYTHING to ensure it doesn't happen on their watch.

What that means for us as business owners is that we have to be aware that there is a very high chance that inflation will be allowed to get far worse before it gets better in order to avoid the risk of deflation.

In our industry we have already seen increases in the cost of construction materials and labour of between 15% - 50% depending on where in the world you are located. 

So for builders on fixed price contracts, that has resulted in huge losses on projects even before the cost of delays due to lockdowns, labour shortages and supply chain issues are factored in.

Price Increases Likely To Continue 

The price increases experienced in 2021 are unlikely to be reversed, in fact it’s more likely they will continue through 2022 as wages increase and the surge in fuel prices continues to have an inflationary effect on the construction industry.

Most builders are now protecting their building companies from future cost increases in their cost to build by using cost escalation clauses, inserting allowances, refusing to sign contracts until construction can be started or adding a hefty contingency that allows for construction inflation.

All of these solutions come with their own challenges.

In some countries, cost escalation clauses are illegal in residential construction.

Financial institutions don’t always agree to providing finance on a contact containing open-ended provisional sums.

Delaying the signing of a contract exposes the builder to a large risk if the consumer will not sign the contract when they are ready to start.

And contingencies are nothing more than a bet that will be big enough to cover future increases while being small enough to be acceptable for the client to sign the contract. 

However, regardless of the strategy you use there is still a massive hidden risk in your pricing that could destroy all of your net profit and more if you do not address it.

The risk I am referring to is the effect of inflation on your fixed expenses.

Take a look at the expenses listed in your profit and loss (P&L) statement for the last 12 months.

Fuel, wages, utilities...all of these costs are likely to rise during 2022.

Hopefully, you do not have any outstanding loans for your business, but if you do, you can expect the interest to increase in the coming year.

Even Australian builders are likely to experience an increase in interest rates despite the claims being made in the press by the Reserve Bank where they state they are committed to holding the rates until 2024! It’s not going to happen.

You Don't Get A Second Chance At Pricing Contracts

The reason it is so important to calculate the effect of these rising costs on your fixed expenses is because all of the contracts you are signing right now will need to cover these future expenses.

You won’t get a second chance at this, your contract prices are fixed…

And even those builders who are operating on open book or cost plus contracts (which we don’t recommend) will be affected by a rise in their fixed expenses.  

Which means as a residential home builder, you only get one shot at this.

So while average builders out there are ignoring this situation as it unfolds (either because they don't believe they can predict future increases or because they don't believe there will be any future increases), professional builders are factoring in salary increases, continued fuel increases, utility increases and anything else they can reasonably assume will go up in price during 2022 in order to ensure they are pricing their jobs for profit.

Speaking of pricing for profit (P4P), this is a key strategy currently being used by members of the Association of Professional Builders to price their jobs using the P4P Calculator.

The calculator allows them to factor in their predicted fixed expenses for the year ahead on a per job basis and adds that figure to the cost of labour and materials enabling them to add a net profit to their jobs rather than a gross profit.

However, this calculator also factors in the duration of the job as well, which means the longer the job runs for, the more fixed expenses have to be applied to it. 

What this means for you as a builder is you need to ensure that not only is your budget a fair reflection of your cost of materials, labour and fixed expenses, but you must also update your job schedules to reflect the revised timeline you expect to be operating on as supply chain issues continue because that will also have a big impact on your bottom line.

Rob Drechsel from Sherbrooke Design & Construction in Melbourne, Australia has openly stated to other builders that P4P was an instrumental tool in moving forward with their business modelling and understanding what they needed to do in order to achieve the best results for their business.

So for those of you who are members of the Association of Professional Builders, make sure you download the P4P Calculator inside your members’ portal and start using it to price your jobs today.

But for all owners of residential building companies, update your budgets for 2022 to cover inflation.

Because if you commit to today’s rates with your clients and pay tomorrow’s prices to your suppliers...you’ll find yourself in a very tricky situation at the end of the year and one that may be very difficult to get out of.

If you’d like to follow the APB step-by-step process to ensure your building company always achieves a healthy profit and yet is able to cope with inflation, then click on the link below and take a look behind the curtain in order to see the templates and tools we are providing to our members.

This video will reveal how you can generate more quality leads and more sales at higher margins while improving the building experience for your clients.