Minimum Bottom Line Profit Should Be > 7%!
After Income Taxes Are Paid!
During my 23 years of doing accounting work, I’ve had the privilege of providing temporary controller duties for a new home contractor. He built custom homes in an upper middle class area. The homes ranged between $450,000 to $900,000 depending on the square footage, style, and amenities. I learned a lot about home construction from him. I’m going to call him Jim in this article. Jim started out as a framer and then built a small home on the side for another contractor; in effect, he ran the project. He ultimately acquired his contractor’s license and got a contract to build a nicer home. Well, Jim was able to get through the framing aspect without much of an issue. But as the project proceeded, he made his errors and when it was all said and done, he lost money. He learned some valuable lessons and wanted to get better. As he built more homes, his efficiency and ability to deliver a great product got him plenty of customers.
He calls me in to help because this was the mid 2000’s prior to the real estate market crash. He was building nine homes a year and didn’t have any money to show for his work. Jim was at a loss.
I decided to look into the details, specifically the contract details to the actual costs involved. Well, I explained to Jim that his contracts were a bit lacking. Here he is building a $500,000 home and the contract was not even 3 pages long. But I still couldn’t quite put my finger on the core issue. Then one day while in the office, the phone rang. It was the wife of one of the couples that had signed a new home contract. She was wondering when the modified countertop was due to arrive. Of course, I didn’t have a clue, I’m an accountant, but I told her I would look into the situation and get back to her. To my surprise, Jim had agreed to have a bullnose cut into the marble. I was shocked to find out that this feature added about $1,200 to the cost of the countertop. My first thought was, “Where is the ‘change order?’. It was in the contract for change orders but there wasn’t one signed. Jim had become so busy, he promised items, delivered them, but never billed for them. Thus, when a project was completed, we would end up losing between $12,000 and $35,000 depending on the requested changes. This is a lot of money!
Well after some discussions and disagreements, Jim agreed to a model of practice whereby a change order form was in his truck. If the customer wanted any change to the contract, even moving a stud, there had to be a signed change order with a dollar value attached. It didn’t take long before more money started coming in and less money going out for additional costs. Even the section dealing with allowances was modified to include a change order for any item exceeding the allowance dollar value for that construction item. Jim got into the pattern of having one of these forms in his pocket. He knew the homeowner was going to make a request every time they met. He had the pen ready.
As time went on, we modified the contract to include how change orders were to be processed. In addition, we included how any verbal agreement was to be handled in case no documented change order was signed. The contract went from three pages to over nine pages in length and the font size went down two levels.
By using a concept of feedback and making changes to the business operation, a model of excellence can be achieved. This model allows the contractor to not get nickeled and dimed to the point of going out of business. Often times the customer would ask why so many documents, I would explain that without a profit, Jim was not going to be around in five years when you need him to add an addition or repair any issue in the house. A profit ensures the long term access to the man that built your home. Act on Knowledge.