As his reputation grew, the builder gave up the tiresome tasks of counting and recounting his gold. He paid himself lavishly and spent much of his spare time dallying in the royal court. Soon, his newfound wealth was gone. Best Defense: Track Your Numbers.
Dollars & Sense
Poor accounting practices will cost you and your company more than you can afford.
By Alison Rice
The accounting oversights just kept coming and coming. A $500,000 check that was never recorded. A half-million dollars in "materials inventory" that evaporated, leaving only a washer and a dryer. An unsold Parade of Homes house that everyone in the company had forgotten.
By the time the Lee Evans Group was done, the financial picture for this builder (which did $30 million in revenue annually) had changed dramatically for the worse. "They started with a $1 million profit for the year, and they ended up with a $1.5 million loss," says the management education firm's Emma Shinn. "They had a swing of almost $3 million because of basic accounting mismanagement."
While the sheer volume of this builder's problems may be unusual, the mistakes the company made were not. Sloppy accounting, nonexistent procedures, and convenient but shortsighted accounting decisions plague builders of every size. "Typically, these things do not occur with the really small companies but with the bigger companies, which blows me away," she says.
It's easy to understand, if not to excuse. "Nobody got into the building business because they love accounting and the financial end," says John Wilcox, executive director of business management at the NAHB. "They got into the business because they love creating a product that people will live in the rest of their lives."
But you won't be doing that for long if your books are in disarray. "The opportunity cost to builders is that they don't know [what's happening in their business]," Shinn says. "They cannot make sound decisions based on what the situation is today because they don't know where they stand in their finances."
Here's how you can get a handle on your cost of doing business:
Pay yourself in salary, not profits. "This is a novice mistake, but it's distressingly common," Wilcox says. "[The builder is] not thinking of the business as a business--he's thinking of it as an extension of his expertise as a carpenter."
Not only are you giving away your time and knowledge (because the cost of your supervision hasn't been added to the house price), you may be risking an audit. "At the high end, accounting can be an IRS issue," says Wilcox, who mentions a builder who paid himself $1.1 million from his company's $10 million in revenues. "That's excessive salary," he says. "There are tax laws against that."
Use purchase orders. If you follow it, a P.O. system can save you 2 percent to 4 percent by allocating and controlling costs. "[Builders] need to have these guys on firm prices, or the subs will eat them alive," Shinn says.
Look at your variances. A minor variance from a ballpark estimate doesn't sound like much, but that adds up quickly, especially for builders with growing volume. Proud of consistently positive variances? You've probably got too much fat in your construction budget.
Manage your checks. Checks should be run weekly in numerical order, not written as needed to subs and suppliers. Manual checks should be avoided; if that's impossible because of unpredictable building-permit costs, establish a separate petty cash account just for permit fees. If that sounds too involved, consider the cost of bouncing a $500,000 land-deposit check that no one ever recorded.
Avoid using "materials inventory." Supplies get appropriated, and the costs rarely get assigned to the proper job, making costs impossible to track. That's what happened with the builder mentioned above. "This is devastating because that's $500,000 that should have been against the houses that sold, but now it just becomes a straight write-off," Shinn explains.
Use detail appropriately. Too much, and you'll drown in minutiae, but excessively broad categories prevent you from discovering how much land development truly cost you as a percentage of a home's sales price.
Categorize your expenses. Builders often list expenses alphabetically, which is no help to anyone. "If you don't classify them, it's hard to see how effective you're being in each area," says Shinn, who suggests the following categories: construction, sales/marketing, financing, and general and administrative.
Develop procedures for opening and closing homes. Without them, you, too, could end up with three conflicting lists of under-warranty homes from sales, production, and accounting--and one Parade of Homes house on nobody's list.
Should you fire your bookkeeper?
|Home Sales Price Basis|
|Net profit, before taxes||12%|
|Playing the percentages: To thrive, builders should remember the above benchmarks when pricing their homes, running job costs, and evaluating their company's performance.|
|Source: Lee Evans Group|
Home building often begins as a family affair. You build the houses, your spouse does the books. As builders grow, though, so do their accounting needs, and your bookkeeper may not have the background and knowledge required. But it's awfully difficult to fire your wife--or anyone else who has been with your company since the start.
"Builders feel so much loyalty that they lack the fortitude to talk to them," says Emma Shinn of the Lee Evans Group, who suggests the following approach: "'You've been great, but we really need someone to oversee the department, someone with more professional training. But I still want you to be my watchdog in the department, if you're willing.'"