Are You Leaving Money on the Table?
BUILDER blogger Jim Haffner reveals four ways to increase profits from each closing.
By Jim Haffner
One of the measures of success for every home building company is the number of closings each month. Success or failure is a simple calculation of closing goal minus actual closings. After a discussion of how to increase the number of closings (easy answer is more sales = more closings), the conversation turns towards, “Can we make more money from each closing?”
As an IT executive for a home building firm, I have written many variations of closing reports that show the details of every closing including the community, lot, customer name, and the final selling price. My first year in business school, I learned the formula for profit = sales – cost. There are many factors in the calculations to determine your selling price including market pressures, cost to build, expected margin, economic stability, and customer expectations. One of the critical components of this equation is the cost to build. If you can reduce the cost to build your homes you will see an increase in the final profit for each home. The difficulty is to know how to analyze your building costs to minimize waste.
I will discuss four mechanisms that need to be reviewed to increase the profit from each closing:
--The first area to understand is the gross and net profit generated from each closed home. The gross profit is a sum of the total building cost (include all of the physical material costs + labor which are referred to as “hard” or “direct costs”) subtracted from the sales price. Don’t forget to include that “free” refrigerator (or any other sales incentive) you threw in at the last minute to lock in the sale. Add up the cost for every physical component in the house plus the labor cost to install. Once you have finalized your calculations ask yourself a question, “What is the gross profit you budgeted for the sale?” Did the final gross profit for this house stay in line with your budgeted gross profit? You should save the gross profit at time of sale (in your signed contract folder) and compare the percentage to the final value calculated after the home closes. Did your gross profit decrease? Did the material or labor costs increase between sale and closing? Was there an excessive amount of variances that increased your job costs? These questions need to be researched to know your job costs.
--The next step towards understanding your job costs is to calculate your net profit from each closing. Your net profit is calculated by taking your gross profit and subtracting your soft costs. “Soft” or “indirect costs” are the variable costs associated with the running your business (“costs to keep the lights on”). Some examples of soft costs include your internal and external agent commissions, office rent, employee salaries, financing costs, and marketing costs. These costs when subtracted from your gross profit reveal the “net profit” for the closing. The net profit represents your profit after all direct and indirect costs are paid. Did the net profit meet your goal? You have to know your costs to understand where you money is going. A complete review and analysis of your hard and soft costs is the first step towards understanding your expected monthly revenue.
--The third area to review in order to understand your profit is an evaluation of your job cost variances. This evaluation is a review of the budgeted cost for each trade as compared to the actual cost paid. The key to this evaluation is to have a variance process that captures the details and allows for an analysis of the reasons that created the cost variance. Assuming your variance process provides the details, there are some questions you need to answer. Which job trades had variances? Does the number and total amount of variances vary by house plan, field manager or community? Does one particular vendor contribute more than their share of variances? The goal of this analysis is to create accurate cost budgets for your house plans. The selling price of your homes is based on knowing your building costs and adding your expected profit margin. Track your job costs on a monthly spreadsheet to view trends and track material price and labor increases.
--The fourth mechanism to increase profits is an analysis of your production timeframes. There are three primary production stages to track and analyze: contract to construction start, construction start to construction complete, and construction complete to closing. The first stage is the number of days from contract acceptance to construction start. What is your process to prepare homes for construction? Do you have a process to review contracts for errors and submit the necessary paperwork for permits? Can you reduce the number of days to get a permit approved by the city? Review and document all the steps to prepare a lot for construction and track the timeframes to complete your vendors their lead times but quickly build the homes.
The second stage is the number of days it takes to build the home. Every day a home is in inventory is a delay in getting paid for the closing. Can you build your homes faster? Are you using an automated scheduling system? Do your field managers accurately follow their construction schedules? The goal is to quickly build homes and schedule closings. Any days that you can remove from your construction schedule will bring a reduction in your carrying costs. Reducing your carrying costs will bring an increase in the margin return on your homes.
The third timeframe to consider is the number of days from completing the construction of the home to the closing date. Ideally, the closing date is scheduled for the day following the completion of construction (normally, the certificate of occupancy). If the closing gets postponed then you pay for extra carrying costs which cut into your profits. Do your field managers routinely ask to delay closings because their jobs aren’t ready? Are there extra days in your schedule that can be removed? Do your homeowners delay closings (make sure your contract discusses this topic)? Do your lenders contribute to the closing delays (research other lenders)? The goal of this review is to reduce the number of days to close your homes.
Set up a process to track and review each of these three production stages for each contract. A good rule of thumb is that it costs $75 per days to carry a home. Imagine the profit you can add to your bottom line if you can reduce the time from contract to house start by three days for each home (75 x 3 = $225 per closing). That’s $225 to the bottom line of your company for each home. Challenge your team to reduce the number of days in your production timeframes.
To increase your profit you can either increase the sales price or reduce your building costs. Reducing your costs allows you to stay competitive and make more money from each home. At the close of each month, make a concerted effort to review your building costs and production timeframes and you will see your way toward higher profits.
This article was originally published by Builder magazine on February 9, 2017.
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