It's a Numbers Game: Financial Benchmarking Can Guide Custom Builders to Success

During lean times, Mike Benshoof's father, a custom builder, would be so busy selling and managing projects that he had no time to work on the actual business. Once he started paying attention to financial matters, "things got easier for him," says Benshoof, a partner with SMA Consulting in Orlando.

Most small-volume custom builders are good at the design and construction side of the business. Some are also skilled at selling their projects and services. But not many are doing a good job of keeping accurate accounts, reviewing financial reports on a regular basis, and establishing benchmarks. Stephen Hann, owner of Hann Builders in Stafford, Texas, believes this is due to a lack of proper training in financial management.

"I think a big part of it is intimidation, and another part is that we're doers," Hann says. "The payback for spending time on financial matters is phenomenal, but most builders would rather focus on operations or sales. They have to understand what it all means and be convinced they can make a difference to their company by analyzing financial information proactively."

Managing the paper side of the business isn't usually a priority for custom builders, says Steve McGee, president and CEO of Unify International, a management consulting firm based in Santa Ana, Calif.

"They're pretty good at picking lots and building to their buyers' needs, but their biggest challenge is that they're not organized enough to really know the numbers in their business," McGee says. "They're not that good at knowing their projected versus actual gross margins at the close of a transaction. Often they're just looking at the checkbook, wondering, 'Do I still have enough cash to keep moving?'"

If you're working so many hours that there's little or no time left over to spend with your family, take a vacation or pursue personal interests, your financial house is out of order. The way to recapture a healthy work/life balance is to learn how financial reporting and analysis works, pinpoint problems and decide what benchmarks you need to hit.

Benshoof says small-volume custom builders struggle to get better gross margins for three reasons:

• They don't understand proper financial management.
• They don't understand how to control their direct costs.
• Only one out of every 20 small builders has ever had professional sales training, yet they try to sell their own jobs.

"Most builders, if they understand what's going wrong, are smart enough to fix it," he says. "But if their finances aren't in good order, they don't know where they're going wrong."

Small builders, says Benshoof, often lack control over their direct costs either through purchasing or estimating. Too many rely on the lumberyard or their trade contractors to do their estimating and takeoffs. The common excuse is that there aren't enough hours in the day.

Not convinced you should hire an estimator or do the work yourself? Ponder this: If you spent six hours doing framing takeoffs, you could probably figure out ways to save a couple of thousand

Hold trades accountable for their bids by giving them scopes of work. No builder is too small to adopt this practice, he says.

Provide standard details to trade contractors — how you want your doors and windows framed out, for example. Otherwise, 10 framers working on the same house will each use a different amount of studs for the door and window openings, says Benshoof.

He also suggests that builders put a purchase order system in place. "There are several low-cost solutions that are much better than QuickBooks. It's not as brutal as everyone makes it out to be." (For SMA's software recommendations, see sidebar, page 32.)

Because building practices and financial definitions are so different around the country, it's tough for builders to do apples-to-apples comparisons on a national level, says McGee. Instead, he suggests adhering to the old adage "Don't compare yourself to the rest; compare yourself to your personal best."

Rather than analyzing the entire business down to the last decimal point, custom builders are better served by focusing on their land basis and the four to eight biggest spend areas on the trade side (concrete, plumbing, framing, etc.): "Then they can back those numbers out to determine how they're doing on a linear-foot or square-foot basis."

McGee also suggests benchmarking cycle time and extra work order requests after cutoff dates. Late work orders tend to be "one of those profit thieves, because in the custom-home world, there typically aren't hard and fast cutoff dates with a well-organized process to educate [clients] and give them enough time to make their decisions by the deadline. When a work order comes in late, it leads to crammed cycle times because there are issues with materials. ... For instance, the tile the [client] wants is on back order for eight weeks and there are only three weeks to go before installation. Those are the kinds of things that tend to erode a custom builder's profit margins."

Builders who want to get a feel for what's going on in their business should focus initially on these bigger target areas rather than trying to get general and administrative expenses (a relatively minor part of the picture) down pat, he says.

One way to become more adept at "the business side of the business" is to hook up with a mentor. McGee's brother, a custom builder, established a relationship with a more experienced builder in his local market. "They would buy some lots together and the [mentor] would take a percentage of my brother's business in turn for helping to be his 'bank.' My brother was able to get some gut-level idea as to what he should be paying for key trades and land and how to negotiate successfully with his customers."

Benshoof and McGee strongly recommend that custom builders use the NAHB Chart of Accounts. It's available for free on the NAHB Web site (www.nahb.org). Look for the version tailored specifically for small-volume builders.

Dewhurst & Associates, a design/build firm in La Jolla, Calif., was founded in 1929 and has been managed by four generations of the Dewhurst family. In a typical year, the company builds one to three multimillion-dollar custom homes and completes 40 to 50 remodeling jobs.

President Don Dewhurst has found that doing more work doesn't necessarily lead to greater profits. "You don't want to get too big or take on too much. In our highest-volume years, the margins haven't been what we've hoped for, so we're scaling back a bit."

Hann, who builds nine to 15 custom homes a year, warns that pumping up the volume is a double-edged sword. "Personally, I'd rather do fewer jobs for a higher margin. Why have the additional risk, the additional work, the additional everything? But if you're trying for a 15 percent gross margin and not getting the sale, you have to decide if you'd be better off with two jobs at 13.5 percent. You've got to do the financial analysis and react to what's going on in your market."

Memberships in a number of organizations help Dewhurst keep his business skills honed to a fine edge. One is Vistage, a national organization that helps chief executives solve problems and learn about best practices in a cross-section of industries. He's also a charter member of the American Society of Professional Estimators. And Don and his children, Doug, Dave and Donna, are members of the Family Business Forum at the University of San Diego.

"I sit on several boards where I associate with other contractors, so we get to share information and network and tell horror stories," he says.

In addition to monitoring expenditures and staying on top of material costs, builders need to be aware of hidden costs and anticipate changes in health insurance and worker's compensation costs a year in advance. "That's where Vistage has helped me," says Dewhurst. "We share information regarding those overhead costs."

Tom DiBenedetto, owner of TDB Construction in West Nyack, N.Y., holds monthly meetings at his office with a small group of local builder/remodelers. "We don't open our books to each other, but it's a good forum for discussing various issues including financial management," he says. "We're talking about forming a buying group to increase our purchasing power."

DiBenedetto does most of the estimating for TDB Construction, which usually builds two custom homes and two specs a year and completes four to five large-scale remodeling jobs. He's also in charge of sales and overall project management.

"I got my financial management training from the school of hard knocks," DiBenedetto jokes. A Certified Graduate Builder (CGB) and Certified Graduate Remodeler (CGR), he's a strong believer in continuing education and teaches CGB designation courses for the NAHB University of Housing.

Financial reports, prepared by TDB's office manager, are reviewed in a weekly company meeting. Using QuickBooks, the office manager translates estimates and data from the field into dollar volume, cost per hour and other useful figures, plus a comparison of budgeted versus actual numbers.

"I'm very open with my guys; it's a team mentality," says DiBenedetto. "I look at where we're at with each job to see we've met the target margin. If not, we discuss why. Were materials not delivered on schedule? Did the trades take extra time to do this versus that?"

The most difficult part of the business, he says, is that clients always want to know what things cost, but may not understand why he charges more than Builder X. "They don't understand that it costs more to run a business the right way — being properly insured, paying good salaries to keep the right people on site and so forth. They might ask, 'Why are you tiling my kitchen for $3,000 when this other guy is charging $1,000?' The answer we give is, 'Our tile contractor is insured up to $3 million, the value of your house.'"

He makes sure he always has sufficient capital in reserve to keep the company going for six to eight months. Builders who maintain such a cushion won't have to rush through a project to get paid so they can move on to the next job.

In addition to a bi-weekly review of financial reports, Hann conducts an intensive monthly job-cost analysis with his staff. "On fixed-price contracts, I try to put in a 2 percent markup on the assumption that something is going to fall through the cracks or a price is going to come in higher than we expected," he says. "And as we've committed the time and energy to go through this financial analysis and monitor our job costs, over the course of the year that 2 percent falls to the bottom line. We're no longer spending it; we're saving it."

David LaRock, president of LaRock Builders in Hamilton, Va., believes much of the battle can be won by using systematic bookkeeping practices, maintaining adequate reserves and always being prepared for a downturn. "I've learned that if finances are treated like a trip to the casino where the strategy is always to 'let it ride,' the inevitable outcome is failure," says LaRock.

DiBenedetto has learned to keep personal and business finances separate. "A lot of builders are too tied to not making money for themselves unless the company makes money. I get a paycheck like everyone else." He adds, "If your company can stand on its own, the banks will throw money at you. They'll see you can repay a loan without strapping yourself personally."

The time to establish a credit line, Hann says, is when you don't need it. "Exercise it every year — even if you turn around and pay it back in 30 days, just so the line stays active," he says. "You want as much liquidity as possible so you can negotiate better deals with the trades than your competition. And you want to be able to stand out as the golden boy or golden girl when the market turns around."

Even if it's just 90 minutes a week, every builder should schedule a regular day and time to review his or her finances, says Hann. "As you start going into the process, you'll learn more about what to look for."

And eventually, you'll have time for the things that matter most. As DiBenedetto puts it, "When you don't have to worry about the financial structure of your company, you can concentrate on the job and your family, which is the whole point of being in business."