Financial Management - Part 3

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In Financial Management - Part 1, we discussed the importance of setting up a solid accounting system to accurately measure what has happened in the past so we can make better decisions for the future. In Financial Management - Part 2, we discussed the importance of: We also introduced Chris Smith, a 45-year old custom builder who has been in business for six years.

April 01, 2005

Sidebars:
Earn Credit—CGB
Quick and Easy Tips for Organizing Your Work Space
Quick and Easy Tips for Organizing Your E-Mail
Quick and Easy Tips for Staying Organized with Phone Calls

In Financial Management - Part 1, we discussed the importance of setting up a solid accounting system to accurately measure what has happened in the past so we can make better decisions for the future.

In Financial Management - Part 2, we discussed the importance of:

  • Long-term financial planning
  • Setting business and personal goals
  • Putting the above into a simple action plan
  • Mark-up versus margin
  • Time value of money

We also introduced Chris Smith, a 45-year old custom builder who has been in business for six years. Chris is looking for better — and less stressful — ways to be more successful and is convinced that careful planning is the way to achieve this goal. Chris has been taking classes from the local Home Builders Association. He has received guidance from a Certified Financial Planner (CFP), and Katherine, a financial and business management consultant.

Chris wrote out several personal and business goals and met with Katherine to review them. Chris's personal goals were as follows:

  • Work fewer hours
  • Take two full weeks of vacation
  • Spend more time learning about personal and financial management
  • Prepare a month by month personal budget

Chris and Katherine spent the remainder of the day creating a solid plan of attack for the future.

Organization

Chris walked Katherine through a typical day and it was apparent that Chris needed to overhaul his time management skills. Chris wasn't using any type of formal time management system nor did he have any formal organizing system. Chris typically kept track of to-do's, phone messages and appointments on scraps of paper.

The first thing Chris and Katherine decided is that Chris would take two classes within the next two months. The first was a time management class that cost less than $300 and the second was an e-mail system class taught at a local community college two nights a week for three weeks which also cost less than $300.

In the mean time, Chris was going to purchase a legal pad, calendar and phone message pad (with duplicate forms) from an office supply store and utilize them for the time being. Just getting more organized would probably knock off five to 10 hours per week of work. For tips on organizing work space, e-mails and phone calls, see the sidebars on pages 54, 58 and 60.

Vacation

Chris had already picked out two weeks for vacation. Katherine had two pieces of advice. She said, "First, book all the travel arrangements now. If you spend the money ahead of time, you'll be less likely to back out of the trip later. Second, schedule meetings with your staff and key trades for the two days prior to your trip to let them know you won't be available and give them clear direction for the week you're gone. Make those meetings happen no matter what!"

Personal and Business Financial Management

Katherine told Chris she felt that blocking out two hours per week was impractical and probably wouldn't happen. The only way to successfully continue learning about financial management was to incorporate it into daily and weekly routines.

At Katherine's suggestion, Chris ordered two books on CD, The Millionaire Next Door by Thomas J. Stanley and William D. Danko, and Rich Dad, Poor Dad by Robert T. Kiyosaki and Sharon L. Lechter. Chris planned to listen to these books to and from job sites instead of making the harried phone calls that would probably cause an accident some day.

Katherine also suggested subscribing to some type of personal financial magazine and reading one article at the same time, every other day. "Small steps over a long period of time are always better than cramming a lot of information in short bursts," she said.

Preparing a monthly personal budget

Katherine suggested that Chris spend this year concentrating on tracking where the Smith family spends their money. Chris was becoming better with the company's accounting system and decided to set up the Smith family accounting using the same program with Katherine's help. Katherine moved on to how she felt they should set up Chris's company budget.

Developing Your Operating Budget

Developing an operating budget can be a time-consuming process, but well worth the effort. An operating budget is one of the key elements in the planning process. It provides a builder with a basis for determining the appropriate mark-up percentage as well as targeting the amount of gross profit needed in the upcoming year to cover overhead and provide for a reasonable profit.

To really make the best of an operating budget it's important to not only look at sales revenues and expenses for the year, but also to identify estimated sales revenues and operating expenses on a month-by-month basis. This will make it easier to analyze financial results compared to budget and will make cash flow forecast analysis much easier as well.

It's important to obtain an understanding of your current business and what it will look like in the year ahead before you develop your operating budget. Take a look at both the internal and external factors that have an effect on your business. Look at the jobs you sold and produced. What type of work provided the greatest gross profit? Were you more successful in a particular part of town or subdivision? Was there a particular customer profile that was easier to work with? Is this a year that would be safe to build a spec home or two or would that be too risky?

Take time to also examine your internal resources and systems. Are you getting the most out of your systems and people? Review your successes and failures during the previous years and make sure you plan to capitalize on successes and take corrective action to avoid future problems.

Before detailing your operating expenses, set some basic goals on the number of homes and/or dollar volume you would like to produce in the year ahead. Establish a target net profit you would like to make for your company. Net profit should be after paying yourself a "reasonable" salary for the work you perform for the company. Strive for a net profit between 7.5 to 10% of anticipated sales volume. Be realistic when it comes to increasing closings or sales revenue significantly in one year. It's very unlikely that you will be able to successfully increase revenues from $2,000,000 to $20,000,000 or increase net margins from 2 % to 13% percent in one year. Setting unrealistic goals will only lead to disappointment.

The best way to start your budget is to review your current year's activity on a month-by-month basis. Identify fixed expenses (those that won't change with volume) and plan for possible increases. Examine variable expenses (expenses that will vary with changes in volume) and link these expenses to your targeted sales goals.

It's easiest to budget by building one giant income statement on a month by month basis projecting sales revenues and direct costs. Then use the four main income statement categories — indirect costs, sales and marketing, finance and general and administrative expenses to develop the expense part of the operating budget. Using the NAHB Chart of accounts is the easiest way to budget. Industry experts added just about every expense category possible for the industry and made it easy to develop a budget. See the sidebar on page 52 for an idea of what part of an operating budget might look like. Because operating budgets are quite detailed, we're unable to show an entire operating budget.

Following are some general tips on budgeting and tips for costs in each of the four main income statement categories.

Indirect Costs

Some of the main indirect costs include:

  • Superintendent compensation
  • Production manager compensation
  • Estimators compensation
  • Purchasing compensation
  • Design & selection coordinator compensation
  • Warranty expense
  • Warranty personnel compensation
  • Field office/storage expense
  • Construction vehicles
  • Depreciation-field equipment
  • Other indirect expense

It's easiest to budget for your superintendents, assistant superintendents, production managers, estimators, purchasers, design and selection coordinators and warranty personnel as an overhead cost. If they are paid a salary, their costs will be the same no matter if you build 10 or 12 homes. Don't forget to include the related burden — payroll taxes, workers comp, health insurance and other payroll-related benefits given to your supervisory personnel.

Identify the gross wages and related taxes in the actual month they will be made (for example, for weekly payrolls you will have some months with 4 weeks and some with 5 weeks). For payroll taxes, budget for the time when your people go over the tax limits (for example, federal unemployment taxes are only paid on the first $8,000 of wages).

Sales and Marketing

Some of the main sales and marketing expenses include:

  • In house sales commissions
  • Sales manager compensation
  • Outside sales commissions
  • Advertising expense
  • Model home expense
  • Buyers concessions
  • Depreciation
  • Other sales & marketing expenses

It's also easiest to budget sales compensation as an expense. Budget your house sales compensation for the same months that you have projected home closings. If you intend to pay split commissions, budget half at the point of sale and the other half at closing for example.

If you use model homes to sell, challenge how many homes are really necessary to meet your desired sales volume. Also, constantly challenge buyers' concessions. If you're meeting or exceeding your sales goals, why continue to offer them?

Review the results of your marketing activities during the past year. How many leads and sales did you get from newspaper advertisements? Did most of your leads come from referrals or from architects? Develop a marketing plan, which targets the activities you plan to pursue next year. Attempt to identify the month you expect to incur the cost. For example, if you plan to participate in a parade of homes budget for the registration fee in the month it is due and the out of pocket costs for the parade when you expect to pay them.

Finance

Some of the main finance expenses include:

  • Interim interest
  • Interest on finished inventory
  • Interest on notes and mortgages
  • Construction loans - points and fees

It's important to separate your finance expenses. Too many builders lump all costs into one catchall category. When you separate out the different types of points, fees, and interest, you'll be able to compare them to industry benchmarks.

Make sure to budget for interest carry on any finished spec inventory. It's easy to miss the true costs of standing inventory.

General and Administrative

Some of the main general and administrative expenses include:

  • Owner compensation
  • Accounting and office compensation
  • Profit sharing & bonuses
  • Office rent and utilities
  • Insurance
  • Permits, licenses, and fees
  • Vehicle expenses
  • Personal property and real estate taxes
  • Professional services
  • Communications
  • General office expense
  • Computer expense
  • Education, training, and travel
  • Entertainment
  • Dues and subscriptions
  • Office depreciation
  • Other G&A expense

Most of the above categories are self-explanatory. Challenge insurance rates. Make sure you read the fine print on the quotes or have someone else read the fine print for you. The best time to shop for insurance is when you don't need it.

Challenge communication expenses often. Phone plans change frequently and you need to make sure the business takes advantage of the best offers. Try to rotate hardware replacement for computers and servers so you don't have to replace all your hardware in the same year. Make sure that all software licenses are up to date.

General Tips

After you have taken a first cut through your operating budget, sit back and examine the overall numbers. Add your targeted net profit to your operating expenses to determine the amount of gross profit you need for the year. Once you know the dollars of gross profit needed you can determine the mark-up you need to reach your goals.

For example, suppose you expect to produce five homes this year with an average sales price of $300,000 for total anticipated sales of $1,500,000. If you are looking to achieve a 10% net return, your targeted net income is $150,000. If your overhead for the year totaled $300,000 you will need $450,000 of gross profit (sales less direct construction costs — all costs not accounted for in your operating budget) to hit your goal.

To determine the markup you need, determine your targeted cost of sales by subtracting your target gross profit ($450,000) from your anticipated sales ($1,500,000). In this example, cost of sales would be $1,050,000. To determine your markup, divide sales by cost of sales ($1,500,000/$1,050,000), which totals a mark-up of 1.42.

If you see that the markup you must achieve to meet your goals is unreasonably high, it's time to go back and challenge your operating expenses. Have you built in capacity, which will be able to handle more volume? Will the market allow you to sell more than the five homes in your original plan? Make the necessary changes in your budget so that you can realistically meet your net income goal.

Evaluate your existing personnel. Do you have the right people in the right jobs? Will you need any more people either in the office or in the field to handle growth plans for the new year?

Challenge your benefit package. You may be offering some benefits (disability and life insurance, for example) that your employees really don't care about. If adding new people, make sure to budget for added health, workers compensation and other insurance benefits. You should also provide for increases in your insurance premiums when they renew.

In the next article, we'll review Chris and Katherine came to some of the final business decisions for the upcoming year.

Operating Budget
Year Ending December 31, 2003
Sept Oct Nov Dec Yearly Total Category Total
Indirect Costs
Salaries and Wages
Superintendents $
Laborers
Production manager
Architects and drafters
Estimators
Purchasers
Total Salaries and Wages $ $ $ $ $
Payroll Taxes and Benefits
Payroll taxes $
Workers' compensation insurance
Health and accident insurance
Retirement, pension, and profit-sharing plans
Other employee benefits
Total Payroll Taxes and Benefits $ $ $ $ $
Field Office Expenses
Rent, field office $
Repairs and maintenance, field office
Utilities, field office
Telephone, field office
Mobile phones, pagers, and radios
Other field office expenses
Total Field Office Expenses $ $ $ $ $


 

Earn Credit—CGB

The label says it all — Learn. In each issue we publish must-know material prepared specifically for Professional Builder by the best educators in the industry. This is the very information the NAHB has used in teaching Certified Graduate Builder and Graduate Master Builder classes.

Every builder who regularly reads this section will come away with the knowledge necessary to run his or her business more profitably. But the benefits don't stop there. Readers interested in the Certified Graduate Builder program can earn course credits through PB's Learn section. Each course is a series of six lessons.

  • To register for a CGB course, call the NAHB Education Group at 800/368-5242, extension 8153 for a course application. Complete the enrollment form and return it to the NAHB with a $50 course fee. Then read the Learn section each month, complete the monthly review quiz on PB's reader service card and send it in. Pass the test in the final issue for that course series and earn one course credit toward the CGB designation or toward maintaining it.
  • For questions about the CGB program or about the author of this course article, contact the NAHB Education Group at 800/368-5242, extension 8153. Contact your state or local association for additional CGB courses offered throughout the year on site in your area.

Quick and Easy Tips for Organizing Your Work Space

Managing your Desk

  • Make sure the top of your desk is cleared off.
  • Keep only necessary items on your desk (i.e., computer, phone).
  • If more than one person will be work in the office or work space, create an "In" box for each person.
  • Purchase organizers to keep track of magazines, catalogs and fliers you want to keep.
  • If you are using multiple checking accounts (personal, business), color code checks for an easy way to identify the different accounts. For instance, your personal checks could be yellow while your business checks are blue.
  • At the end of each workday, straighten up your desk and prepare a task list for the next day.

Managing Paperwork

  • Create folders for different actions you should take with your paperwork: paperwork to file; paperwork to read; paperwork for response (e-mail, voice, letter, etc.); and paperwork for immediate action.
  • When sorting mail and/or paperwork, assess each item for its usability. If you do not plan to refer to the item, toss it out. For items you intend to keep, file each piece of paper that comes across your desk according to the File/Read/Respond method. Act on each file accordingly (i.e., file paperwork in the "to file" folder).
  • When creating paperwork folders, designate a particular action. For instance, your "To File" folder could be yellow and your "To Read" folder blue. You can also separate parts of your business into color-coded folders as well: "Johnson Project": red folder; "Smith Project": blue folder.
  • Designate a location — somewhere near your desk —to hold paperwork until you can sort through it.
  • Do not feel the urge to fill each folder full of paperwork. Subdivide large files into smaller folders.
  • When you have finished a project, take a moment to file or store the paperwork related to that project. Try not to wait to file the papers.

Managing Contacts and Appointments

  • Purchase a planner. Planners are available just about anywhere and typically contain a space for a calendar, for addresses and contacts and for notes and ideas.
  • Use your planner to record ideas, addresses, dates — anything that is important to you.
  • Transfer the information that you previously wrote on scrap pieces of paper and put it into your planner. Having a one-stop resource for your appointments, contacts and ideas saves time because you don't have to scurry around to find the scrap of paper you were looking for.
  • If you are techno-savvy, there is a plethora of software available to keep track of contacts, appointments, etc. Consider investigating your software options as well.

Quick and Easy Tips for Organizing Your E-Mail

In this electronic age, e-mail is one of the most popular means of sending information quickly. E-mail, much like postal mail, can also come in droves. One day your inbox is empty, the next day, you've got 30 e-mails from clients, vendors and/or colleagues. Organizing and keeping track of your e-mail is quite similar to managing incoming postal mail. The following tips offer advice on how to keep your inbox clutter-free:

  • Create folders within your e-mail system where you can save your e-mails once you have read them.
  • Similar to a desk-type filing cabinet, create an electronic filing cabinet on your computer. Within your electronic filing cabinet you should set up folders where you can file e-mails and attachments (again, much like you would a desk-type filing cabinet). Because some e-mail systems impose limits on the number of megabytes you are allowed, it is wise to create folders and save items to your hard drive. This process will allow you to save space in your inbox.
  • Be specific when naming your e-mail and electronic filing folders (i.e., Johnson Project: Attachments or Johnson Project: Client Correspondence). Should you need to access your e-mails and/or files once a project has closed, the names will be helpful when finding a specific file or attachment.
  • Much like postal mail, once you have acted on or responded to an e-mail, move the e-mail from your inbox to an appropriately named folder you have created in your e-mail system. You should also save the e-mail to your electronic filing cabinet as well.

Quick and Easy Tips for Staying Organized with Phone Calls

  • Be sure to use a voice mail system or answering machine to record incoming messages.
  • When leaving an outgoing message for your voice mail or answering machine, be sure to state who you are (so the person leaving the voice mail knows he or she has reached the right person) and why you are unable to answer the phone (perhaps on another phone call or away from the office). Be sure to mention if you will be gone for an extended period of time (longer than a few hours) and how one could reach you or another employee in case of an emergency.
  • Make it a habit — if not a requirement — to return all phone messages within one business day. If you know you will be extremely busy or unavailable over the course of a few days, try to return the message stating as such, also remembering to include that you will be available to answer more specifically when you have a free moment.
  • If you do not know the answer to a caller's voice mail, you should respond to the caller and let him or her know you have passed along their inquiry to someone better suited to answer the question. Don't forget to pass on the message!

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