Profit is the most important component of the gross margin that you apply to every construction project that you sell. Gross Margin is the difference between selling price and direct costs. Indirect costs include salaries, office overhead, general insurance, vehicle expenses, etc. Profit is over and above any salary and benefits the owner(s) are paid for the day-to-day operation of the business.
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At seminars and symposiums, I am often asked, "How much margin should a small volume custom builder charge?" My answer always is, "As much as possible!" Most successful builders that I know strive to achieve gross margins above 16% and some regularly make 20% or more.
Mark-up: factor applied to costs
Margin: percentage of sales price
Gross Profit: sales price less job cost
Net Profit: gross profit less overhead costs
ROI: return on investment
Mark-up Versus Margin
A 15% mark-up on a job costing $200,000 will yield a selling price of $230,000.A 15% margin on a job costing $200,000 will yield a selling price of $235,294. If you build10 houses per year, the difference between a 15% mark-up and a 15% margin is $52,940.Tosome degree, of course, your margin will be market driven, but not as much as you maythink. By differentiating your product, service, and company, you may be able to charge a margin substantially above the rest of your competition.
When discussing your fees with clients, lenders, and the Realtor community, never call your margin "profit," or even "profit and overhead". You always should refer to your fees as "Builder Margin". If the word "profit" comes up, kindly explain to them that while your business plan projects a net profit at the end of the year, you never can tell with certainty that this or any job will result in a net profit.
There are certain traits found among successful and profitable builders. These include:
- Have a Plan: Strategic, business and marketing.
Organized: Systems oriented.
Business Savvy: Exhibit good financial management practices.
Marketing Intelligence: Uses warranty work as a marketing tool..
- Delegate: Surrounds self with strong, talented people.
Plan For It
By far the biggest problem for small volume and custom builders is the failure to plan for profit. Often, smaller builders assume that profit is what is left over after paying all of the bills.
My advice is think "bottom up" instead of "top down." That is, determine what your profit goal (the bottom line) is first, and then work the numbers to determine what gross margin you must achieve at a realistic sales level. Remember that an increase in sales won't automatically generate a higher gross margin and you can't just raise prices if the market will not bear it.
The 1997 Cost of Doing Business Study can help you to set achievable goals. One of the ways to direct your company to profitability is to make sure that you are correctly gauging your risks and responsibilities. If the client maintains ownership of the lot during construction and provides the construction financing, it might be appropriate to charge a few percentage points less than a full general contract where you carry the construction loan and own the lot.
Some builders use construction management as an option for those clients who really want to be involved in the process. Construction management contracts carry less risk and responsibility for the builder and once again, may justify a lower margin.
The size and price of the custom home may also call for a lower margin. In my opinion, an $800,000 home is not as time consuming and risky as two $400,000 homes. Therefore, I'll charge a lower percentage margin on higher priced homes.
Other factors will also affect the margin. How far away from your office is the job? Is the land difficult or easy to work with? Are there many unique and difficult details to deal with? And finally, will the client be easy or difficult to deal with? Considering all of these factors will help in assuring that the margin you charge will result in a fair return for your efforts and risk.
Defining and planning for profit will do you no good unless you measure it with a good accounting system. Too many builders leave this to their office manager or, even worse, an outside accountant. Make sure that you understand the system and that it will generate timely and accurate reports that allow you to make adjustments quickly. Make sure that you have an accurate job costing system to help you quickly spot problem areas in your estimating and / or job site controls.
Attend seminars to help you understand cash flow management versus profitability. Many a profitable business has fallen victim to cash flow problems. Learn how to forecast your cash needs and monitor your business closely. You should review your income statement, balance sheet, job cost reports, and cash flow within ten days of the end of each month. While many builders really don't want to be bothered with the "books", I've found that the ones who are making above average profits are those who have a good grasp of their accounting system and watch it closely.
Remember that in order to build wealth and a successful business, you must understand profitability, plan for profit in your pricing structure, and then measure it accurately.
Tom Stephani is president of Custom Construction Concepts, in Crystal Lake. Ill. Tom is a nationally recognized speaker and trainer on issues relating to the residential construction industry. Tom draws on his 25 years of industry experience to give "meat and potato presentations" designed to improve the bottom line of small volume and custom builders.
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