The Design Builder's Blog

 

 

 

 

Guest Blogger: Judith Miller has worked with remodelers nearly 30 years; she writes for Remodeling Magazine, facilitates for Remodelers Advantage and consults with remodelers around the country with particular focus on the importance of good financials!  Visit her website at www.remodelservices.com

 

Two Ways To Predict and Measure Good Cash Flow

In his excellent blog post on cash flow, Shawn mentioned direct costs, overhead and net profit as all potentially contributing to good cash flow.  And, as he so rightly pointed out, the potential for good cash flow begins with accurate pricing for the job.  Shawn also mentioned the importance of working on ‘accrual’ accounting rather than cash.  When you’ve got these important elements of good construction accounting in place, you can lay out a couple metrics which will be useful in understanding cash flow.

First, get all your costs in the right place on the Profit/Loss:

Income = revenue from construction projects

Direct Costs = expenses, including ALL labor (even that production manager who doesn’t keep a time card) AND associated labor burden, related to jobs for which you receive the income.  Don’t include work on your own house or you Mom’s in this category because you’ll skew (and screw) the numbers.

Overhead = all costs it takes to run an office, including a construction office, but not related to jobs – those costs go into Direct.  This includes marketing expenses, rent, office supplies, professional fees, owner and admin salaries and related burden, general insurance – not liability or workers comp which go into Direct.

(List of Typical Accounting Terms and Definitions)

 

Second, establish a good system for job cost analysis

 A good system for job cost analysis lays out the true estimated cost of the job – no SWAGs or ‘guesstimates’ – and allows you to post costs against the estimate as they are incurred.  Remember that a cost is incurred WHEN THE WORK IS DONE not when the bill is received.

 

Third, reliable reports are accurate, complete and timely

Prior to calculating these metrics, be sure to review all reports for reliability. 

 

Now you’re ready to develop these two useful metrics:

1: Slippage/Grippage:  this metric calculates the difference between your estimated gross profit and the produced gross profit.  Slippage is negative, grippage is positive.    This is of critical importance because if you’ve got slippage either your estimating is wrong or your production is not working up to expected efficiency.  And if you’ve got grippage, you might be leaving money on the table from estimating too high.  Control of production allows for profits which can then be managed to ensure good cash flow.

• The calculation is: Estimated gross profit margin MINUS Produced gross profit margin
• The goal should be no more than 2 percentage points slippage – or grippage.

2: AR/AP Turnover Net: this metric calculates the difference between the number of days it takes to RECEIVE your cash from customer’s invoices (AR Turnover) and to PAY your customer’s expenses (AP Turnover).  If you receive money from your customers in 10 days and pay your expenses in 15, you’d have 5 days “float” – a good thing!  However, if the reverse is true, you might have to borrow to pay the bills.

The calculation is three part:

 

Once your accounting system is set up correctly, information is entered accurately, timely and consistently, you’ll be able to see where the money comes from, where it goes and how to control the all important cash flow!  This is a set of gears which all work together to produce profits and protects cash!

 

The Most Common Reason For Construction Business Failure

There are many reason construction businesses fail.   A read of a 2007 report by the Joint Center for Housing Studies at Harvard University titled “The Performance of Remodeling Contractors in an Era of Industry Growth and Specialization” offers an in depth analysis of the reasons for failure across a variety of residential construction industry segments.  The report is further broken down by business sizes within those segments.   One glaring observation is that smaller construction businesses fail at much higher rates than larger firms.   According to the report twenty-two percent of contractors that had payrolls of less than $30,000 in 2003 were no longer operating in 2004, a failure rate almost ten times higher than contractors with payrolls of $350,000 or more.  I think it's safe to assume the failure right is even higher these days due to the current recession.

But why do the businesses fail? 

After further analysis of the report, along with my experience and observations over many years of assessing and consulting with remodeling businesses of various sizes, one big picture fact jumps out to answer why they fail.   The most common reason is that the businesses grow faster than the business systems required to support the growth.  The fact that larger businesses have a better survival rate backs up this observation.   Simply put, the business needed efficient systems to grow and without them they never would have achieved the growth.

So what does this mean to the smaller remodeler and his or her business? 

First, if you don’t put efficient business systems in place as a small business your likelihood of failure will be very high even if your business remains small in size.   Also, even with modest growth, unless you put systems in place your business is more likely to fail.  Also consider, without efficient systems, it will be you the business owner who will have to work harder and longer to get things done due to the lack of those systems.   If that is the case then burn out and or the typical resulting health problems might lead to failure.  But remember, that burnout happened because of a lack of systems.

 

So here’s my advice if your business lacks adequate systems:

Start with your financial system first.  Here are four reasons I suggest you do so.  These suggestions assume you have and use a properly setup financial tracking software like QuickBooks or something similar.

1. First, unless you can determine the cost of being in business you won’t know what to charge for your services over and above the direct job costs of labor and materials.   If you don’t know what to charge you literally won’t know whether you are buying or selling jobs.  Plus, every contractor I have helped do a budget goes forward with confidence and success selling at the price they now know they need to get to be profitable.
2. Second, if you have predicted the costs of being in business you have established a reference (budget) against which you can measure your efforts.  This budget can then be entered into your financial software.  By measuring (budget to actual report) you will know if you are selling enough work and bringing in enough gross profit on all the jobs you complete to bring in enough gross profit to cover your overhead and planned net profit. 
3. Third, if you know whether or not your earning enough gross profit you can prioritize how and what overhead expenses you can afford.  Having that budget can also help you shop around for better pricing when and where appropriate.
4. Fourth, all other systems within your business might not matter if you don’t have the money you need to pay for them and know if you will have the money you need when you need it (cash flow)!

 

Have you used a Marvin Product in one of your projects?

• Submit your before and after project photos to the Marvin Remodelers Gallery

• If your project gets added to the gallery you can link to it from your own web site!

 

 

How Remodelers Can Make More Money; If They Have Good Cash Flow

Making more money as a remodeler

 

As a remodeling or Design/Build business grows, managing cash flow becomes extremely important, maybe even critical to continued operations. The business owner or manager soon becomes a money manager by default. As this happens, there may be opportunities for the business to earn more money by using the money it already has in a strategic way.

 

Good cash flow is an assumption of my suggestions

Many Design/Build and remodeling companies put all the money collected from sales in one checking account. The funds are then used to pay for the expenses of producing projects (direct costs) as well as the operational costs of the business (overhead). Typically businesses leave any excess of money (net profit) in the same account as well.  If this is how your business is operating, meaning you actually have excess funds to contribute to profit, you have what can be referred to as good cash flow.  If this isn’t happening already at your business I suggest you stop reading this blog and read this one first.

Accrual accounting can help you predict excess funds

If the business’ financial system includes the ability to predict income and expenses on a monthly basis, the cash flow needs for that month can be easily determined in advance. Any excess of cash that would normally remain in the account could also be anticipated and create an opportunity to earn additional profits. In order to actually qualify what is excess cash over and above monthly expenses, the accounting system should be run on an accrual basis, not a cash basis. By using the accrual method of accounting, expenses are recognized as they occur, even if the expense has not yet been paid for. Income is recognized when the customer is billed, even if payment has not yet been received.  Income and expenses are then tracked by the exact day they are to be collected or are due respectively.  By tracking the income and expenses in this way, one can easily predict the money that will be owed at a certain given time as well as how much money will be available to pay for those expenses at the time the expenses become due.

You will need a second account for your money

If your accounting system predicts you will have excess funds, consider opening a second interest-bearing account where any excess monthly funds could be deposited.  The amount of interest this second account could earn depends on how long the money will stay there. Typically, the longer the commitment to leaving the money in the account without having to access it, the higher the interest rate a bank would offer. Interest rates on these account types may seem low, especially in the current market, but over the course of a year a significant amount of money you wouldn’t otherwise earn could be added to your bottom line.

I also suggest that this second account and your primary business account are with the same bank. By working with the same bank, transferring of funds between accounts can be instantaneous. There will be no need to wait for checks to clear between banks. Also, most banks now offer electronic banking using the internet. This can eliminate the need to even leave your office or the job site when making transfers between accounts. On-line banking services can be used to be sure the money is actually available in a “just in time” fashion.

A word of caution!

Before you consider using any of my suggestions, be sure they make sense for you and you understand the legal and or tax implications for you and your business.  I suggest that you always be sure to consult with your accountant, tax adviser and or other appropriate counsel before trying any new strategies, including those described in this blog.

If you have been use this or a similar strategy, be sure to share your experiences in the comment section below.  Other remodelers and Design/Builders looking to earn more money could benefit from what you have to offer!

 

 

 

 

Guest Blogger: Melanie Hodgdon is a Certified QuickBooks ProAdvisor who has been providing financial analysis and QuickBooks training for contractors since 1994. She’s the author of A Simple Guide to Turning a Profit as a Contractor.  Melanie and Shawn often coordinate their efforts when helping remodelers develop financial systems for their businesses so they serve the contractor, not just their accountant.

Benefits of Rethinking Your Estimating and Job Costing Approach 

What functions should an estimate serve on a fixed/contract price job?

 

Pricing
The cost of the job determines the price of the job, so knowing the costs allows you to generate a sale price.

Job Costing
The estimate can function like a budget for both time and costs.

In order to price and job cost accurately, the estimate needs a lot of detail. If you (oops!) forget to include windows or a toilet, your only choices are (a) go back to the customer, admit your mistake, and hope he accepts the revised price or (b) eat the cost.

Also, sharing a highly detailed estimate with the project’s lead carpenter can help limit questions from the field back to the office.

But the same high level of detail that can save you when pricing and producing the job can get in your way if you attempt to job cost at that same level of detail. As a QuickBooks ProAdvisor working with literally hundreds of contractors, I have seen two common categories of errors:

 

Job costing at too high a level of detail can be a problem

Contractors who try to job cost inside QuickBooks at the level of 2x6’s and specific products (Kohler faucet K-13490-CP) produce three problems:

1. Your project manager and bookkeeper will waste time coding out every little line item on a vendor’s bill.
2. The more opportunity for choice, the more likelihood of misclassifying things. Highly detailed job cost reports actually have a greater chance of being inaccurate on a category-by-category basis.
3. Your job cost reports will be so lengthy and complex that you’ll lose the forest for the trees.

 

Job costing using apples and oranges?

Contractors who continually add job-specific line items in QuickBooks invoices (ex: “repair Jones front porch step”, “Replace damaged shower tile”, “Add backsplash”) produce these two problems:

1. They create a disconnect between the categories used for estimating (apples) and those use for job costing (oranges), making it virtually impossible to compare common estimated and actual categories
2. They create an ever-increasing list of job-specific categories inside QuickBooks with single-use history   

 

How to do it right

Instead, estimate at a high level of detail but create a way to subtotal these into categories that you use consistently, will be relatively simple to code, and will produce reports that allow you to perform a side-by-side comparison of estimated and actual costs.

For those using a customized spreadsheet for estimating, the process might look like this:

The summarized categories with costs can then be entered in your accounting software and job costed using the same categories. Doing this will keep your cost categories consistent and provide apples to apples comparison.

 

Harsh Realities About Retirement for Remodelers and Their Employees

The harsh reality I am pointing out in this blog post is the fact that for most remodelers and their employees a comfortable retirement is really just a fantasy. 

For these individuals, ignoring this fact so far during their careers is the reason they are lacking adequate funds to retire and my prediction is that they will continue to ignore this fact.   However, remodelers are not alone.  Most Americans are in this same predicament.   When they reach retirement what will their lives be like and who is going to pay for their living and medical expenses?   One answer; the next generation of working tax payers, assuming they have jobs.  With such a financial burden on the next generation, they too may be destine for the same harsh reality.

Business owners are obviously too busy running jobs to even think retirement.   Employees are often living and thinking day-to-day, often working for cash.  This is a huge mistake.  While you may love what you do, your body may not allow you to do it forever.   Consider the day when you will no longer be physically able to work in the field and or your declining physical abilities will result in lower productivity and therefore reduced compensation. 

 

Just the facts  

Here are some harsh facts that I hope will wake up those who are currently sleeping when it comes to retirement planning.  These facts and others can be were found in an article on the Fiscal Times web site titled “5 Shocking Predictions about Retirement in America”

• In the U.S. seventy-seven million baby boomers are slated to retire in the next 20 years, with approximately 10,000 reaching retirement age every day.  At the same time 401(k) accounts have been drained by the recession, pension systems are strained, and Social Security coffers are near a breaking point.
• According to a study by the Transamerica Center for Retirement Studies 54 percent of workers in their 60s said they haven’t saved enough to sustain themselves for the rest of their life.
• The Employee Benefit Research Institute recently found that just 14 percent of those surveyed were very confident they will have enough money to live comfortably in retirement.  Even more shocking, sixty percent of workers reported that the total value of their household’s savings and investments (not including the value of their home and any official retirement benefit plans) was less than $25,000.
• Another report from the financial industry think tank LIMRA, found that 49 percent of Americans aren’t saving for retirement at all. 
• The Employee Benefit Research Institute (EBRI) reports that for those who are 10 years away from their planned retirement age, more than a third have saved less than $25,000.  That’s $875K away from the EBRI’s suggested $900,000 that a typical person would need to live out his or her years.

 

Will your children be able to support you?

Oh, and if you are assuming that the government will be footing the bill for your retirement, that doesn’t look very good either.  The latest annual trustees’ report for Social Security predicts that the program’s trust fund will be depleted by 2033, three years earlier than they estimated last year. When the fund runs dry, the government will only be able to pay 75 percent of the promised benefits to retirees.  This of course assumes our children will have jobs and earn enough to generate the taxes the government will need to meet the 75%.

 

• Are you confident in your abilities to earn enough for your own retirement?
• Are you confident that the government will be able to finance the lifestyle you want to live when you can’t work any longer?
• Are you motivated to do something before its too late?

 

Don’t fall into the trap of running your business to the point that it runs you and your employees into the ground!

 

How to Cover the Cost of Non-Productive Time in Your Remodeling Estimates

 

As a remodeler you need to know what your labor costs are if you want to price your work properly and for profitability.  Inside estimates, your estimated labor costs for any project must include everything required to compensate and support field employees.  This labor rate is called the burdened cost of labor or your burdened labor rate.   Of course, the total estimated cost is then marked up by a predetermined factor so the selling price also covers your overhead and planned profit.

If you have been guessing at the markup you use, you might want to read this article.

 

Non-Productive time

Check out the Labor Worksheet below.  An important consideration when determining the burdened cost of labor is the difference between the hourly pay you give an employee and the hours that they actually work producing income. When you add up all of the hours for paid vacations (one week, 40 hours), holidays (five days, 40 hours), paid time while attending training programs or trade events (10 hours total), as well as attending company meetings (2 hours, every other week, or 50 hours annually), where will that money come from if you’re not charging for it in your estimated labor costs? 

 

Request a FREE copy of Shawn McCadden’s Burdened Cost of Labor Worksheet

 

How much is non-productive time costing your business?

Many remodelers I’ve worked with never even realize that they’re making this mistake. With the standard fifty-two weeks in a year and a 40-hour work week, your company pays each full time employee for 2080 hours. The time paid for non-productive hours, as listed above, totals 140 hours, or 3 ½ weeks.   Look at row 54 of the worksheet.  The wages alone to be paid to the employee total $2800.00.   That doesn't even include other related costs paid by the business like payroll taxes,  liability insurance and and workers compensation insurance!

 

No more guessing!

So, when you determine the burdened hourly rate to use in your estimates and for job costing you can't be guessing. To get the accurate rate you must divide the total annual cost to compensate and support each employee by the number of hours he or she will be working producing income. For the example above, you must collect enough money in 1940 hours of productive time so you will have enough money to pay the employee for 2080 hours.  Non-productive time and other labor related expenses are easily calculated into a burdened labor rate using a spreadsheet like the one shown above.

 

Request a FREE copy of Shawn McCadden’s Burdened Cost of Labor Worksheet

 

The Design/Build Remodeler’s 10 Step Plan For Long Term Success

 

A long time ago a remodeler in my NARI Chapter who was just starting his business asked me for advice about how he too could have a successful and profitable business.   Seeking to keep my response simple and to the point I came up with a list of nine steps.   When I was explaining my list to him he asked where he would find the time to do all these things.  He said he was already straight out trying to sell and complete work.   That’s when I added step number one to the ten step list below. 

Success won’t happen by accident.  If you are disappointed with your level of success use the list below to help identify what you need to do to get your business on the path to planned success.

 

Recharge Your Batteries!

Step ten might be the most important.  Unless you take time to recharge your batteries they will go dead.  My experience has shown me that business owners get a lot more done and can remain positive even during challenging times if they take the time to reward themselves for all their hard work and effort.

“To get to the next level in your life will require a higher level of thinking than the level of thinking that got you where you are”   Thomas Edison

 

The 10 Step Plan For Success

1. Make time to create and implement your plan.
2. Establish your criteria for personal and financial success.
3. Establish an obtainable volume of sales for the coming year.
4. Create a budget based on historic information.  Adjust as needed to achieve current goals.
5. Establish the Mark-up required to provide planned gross profit.
6. Accurately estimate project costs and mark-up as planned.
7. Find your customers and sell them projects at the price required to obtain planned gross profit.
8. Monitor production and overhead expenses.
9. Adjust business as needed to maintain path to planned net profit.
10. Enjoy planned personal and financial success.

 

Typical Accounting Terms and Definitions for Design/Builders and Remodelers

 

 Early in my career as a remodeling business owner I struggled to learn about accounting and understand accounting principles.  One big obstacle getting in the way for me was understanding the language of accounting.  All too often I didn’t know the definition of terms seminar speakers and my accountant used when explaining things to me.  Worse, sometimes I was assuming the wrong definition.  What I came to realize was that I needed to learn the terms and the definitions if I really wanted to wrap my head around small business finances.

 

That learning experience and the difference it made for me sticks with me even today.   For example, every time I start working with a new remodeler or design/builder as their business consultant or coach I make it a first priority to be sure my client knows the difference between margin and markup.  Many a remodeler has made the mistake of figuring out the margin they need to cover overhead and profit only to assume they can then use that same number as the markup for establishing their project selling prices.  When I explain the difference the light bulb goes off; shedding light as to why they are not achieving their required gross profit margin and therefore have no or even negative net profit.

 

KEY BUSINESS CONCEPTS TO LEARN AND UNDERSTAND

1. The total amount of money that can be collected during one business year for work completed by the company should be determined based on past experience and/or the capabilities of the company. (Volume)
2. Gathering known business operation expense figures for the anticipated volume of installed sales, you can create an estimate for what it will actually cost you just to be in business even if you don’t produce any work.   These are expenses that cannot be assigned to a particular project.  (Overhead)
3. By being honest with yourself, rewarding yourself for the risk of being in business, and by planning for the future growth of your business, your business can plan for financial compensation.  (Profit)
4. Overhead and Profit added together make up the total Indirect Costs of the business.
5. By knowing your overhead and what you want for planned profit, you can determine how much you need to charge over and above the estimated project cost to be successful.  (Mark-up)  Markup is determined by dividing the total Indirect Costs by the total Direct Costs.
6. Predicting the cost of labor, cost of project related equipment, as well as material and subcontractor costs, you can determine what the production related cost should be to complete the project. (Estimate)
7. By increasing the estimated cost with a predetermined mark-up amount you can establish the price your company must charge to successfully complete a project.  (Sell Price)
8. By keeping track of actual production related expenses (Direct Job Costs), and comparing the expenses against the estimated project cost you can measure the success of your production performance as well as the accuracy of the estimate that was created. (Job Costing)
9. Through the use of job costing you will know how much money is left from the sell price after paying all production related expenses.  (Gross Profit)   This is expressed as the Gross Profit Margin. (GPM)    To calculate the Gross Profit Margin, divide the gross profit for a particular project (or time period) by the total sell price of that project (or time period).
10. After paying all overhead related expenses, from the gross profit, you can determine how much money is left to compensate the business. (Net Profit)
11. It is important to know how much business your company must complete in installed sales before it actually starts making a profit. (Break Even)    This is determined by dividing the known total overhead expense by the gross profit margin.

 

Suggestion

As a suggestion, post this list somewhere near your desk so it’s in view at all times.   Next time you’re reading a blog or magazine article that uses one or more of these terms you’ll be able to quickly find or verify their meaning.  You’ll be amazed how quickly you can commit this information to memory if you do so.  

 

Click here to download and print the list as a one page poster.

 

Do You Put Your Remodeling Business At Risk By Guessing At What Markup To Use?

Markup on anything you sell needs to be based on projected overhead costs and net profit requirements for producing a specified volume of work. Be careful using someone else's markup suggestions particularly if they have not done the math to figure it out.

Fact is about 9 out of 10 contractors eventually go out of business because they don’t know the true costs of doing business.  They are either guessing at what markup to use or guessing at which contractor’s markup they should copy.  If you’re going to risk copying the markup of another contractor, make sure you get your markup info from that 1 out of 10!

Think about it, it’s like asking how much money you need for gas to drive across county. Depends on where you start, cost of the gas, how fast you drive, how many miles/gallon, summer or winter, who’s driving...

Also, many magazine articles advise contractors to apply a “professional markup” to their bids. But what, exactly, is a professional markup? Does a 50% markup make you a professional, or should you apply 67% to qualify? The simple answer is, if you don’t know what markup your company needs to use, you’re not a professional, and therefore you’re not using a professional markup. But if you know the formulas for determining margin and markup, you have a working financial tool, rather than a magic number suggested by some remodeling guru or pulled out of a hat by another remodeler.

Different Markups, Same Price

To determine your company’s markup, divide your anticipated annual indirect costs (costs of overhead and profit) by your anticipated annual direct costs (costs to produce projects):

 

Therefore, if one company considered its field employees’ health insurance a direct cost, and another company defined it as an indirect cost, those two companies would apply different markups. In theory, if both companies had all of their other costs covered somewhere within their annual budget or estimate, they’d sell their projects at the same price, even though their markups differed.

Remember this the next time you’re impressed or puzzled by what your fellow contractors claim to be using as a markup. 

 

Financial success doesn't happen by accident.  Knowing your real costs can give you the confidence to estimate and sell at the right price. Contact Shawn today if you need help!

 

Workers Comp Rates Likely To Increase; Budget Now For The Increase

 

Workers compensation insurance rates have already increased in many states and are expected to increase soon in others.   Often, increased medical costs are cited as a main cause.  Be sure to understand how rate increases will affect your overhead costs and estimating assumptions for labor costs.

 

Rate increases may be out of your control; but you do have some options to control your total cost.

• Proactively control your claims history
• Provide safety raining relevant to the work your employees perform
• Maintain a safe working environment for employees and subs
• Make sure to report and handle claims in a timely manner
• Create return-to-work programs where practical.
• Make sure your subs have their own coverage

 

The following information was found in an e-newsletter from Tom Messier at Mason and Mason Insurance.  

Many expect Workers Compensation rates to increase significantly this year. The MA Workers Comp Rating and Inspection Bureau has recently applied for an average rate increase of 19.3%. According to the Insurance Journal, Commissioner Joseph Murphy will be holding a public meeting on March 30th on this request.

Whatever rate increase is approved by the insurance commissioner will be effective September 1st, with the negotiations for the final rates continuing through most of the summer. We believe the final rate increase this year will be in excess of 10%. The rate for residential carpentry is currently 8.68. If the commissioner approves the increase of 19.3% the new rate would be $10.30. This is significant. If you have a payroll of $100,000 this will increase your cost by more than $1,500.  

You might wonder, "Is it possible to avoid these rate increases?" The answer is "yes." There are some insurance programs that are available today that will guarantee your maximum rate for three years. This program is not available to all employers in MA. It is available to the best contractors that have had good experience. So long as your losses are under control and you have premium of over $5000, you may qualify. By making the switch today, you can avoid the increased rates, at least for the next few years. You do not need to wait until your policy comes up for renewal, you can start saving now. 

Remember, Workers Comp costs are controllable, and every dollar you save in Workers Comp premium goes straight to your bottom line as profit.

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The full article can be found here

Email Tom to see if he can help you control your Workers Compensation costs.

Read more about the proposed increase here

 

Need help understanding workers comp costs and how to budget for them?  Contact Shawn to discuss how he can help