Minimum Bottom Line Profit Should Average 9.4%!
For Trades & Subcontractors, at Least 11%
After Income Taxes Are Paid!
A construction draw schedule is a financial tool used by contractors with identifying percentage of completion points in the project for the bank to advance proceeds to the contractor. The construction draw schedule is instrumental in keeping the project moving along. Without good points in the schedule to draw funds, the contractor can run out of funding and the project could grind to a halt. It is essential to negotiate with the buyer and the bank for proper release points in the construction draw schedule.
This article identifies some common points of draws, issues and concerns a contractor should identify to obtain an appropriate construction draw schedule.
Points of Draw
A typical draw schedule for new construction (residential and light commercial) breaks at 20% increments. The bank’s goal is to create a reasonable set of completion points in order to minimize the paperwork. A higher frequency of construction completion points generates more draws and exaggerates the documentation process. Furthermore, it increases the fees associated with a project. Typically, a bank uses an outside inspector to identify the respective completed elements of the contract (trades, materials, subcontractor work etc.). The inspector will charge between $75 and $200 for an inspection. Then the bank charges a deposit fee of $35 to wire the funds to your account. The contractor pays these fees. Some residential contracts for construction have the fee passed to the buyer thereby avoiding a reduction in the draw from the bank for the fees. As a contractor, you want to keep the total number of draws to a minimum in order to reduce your cost of construction.
Goal: Get a draw deposit on the following Thursday to pay subcontractors and material providers.
* Friday a week before draw – contractor tries to reach an allowed percentage of completion point authorized by the bank.
* Monday (3 Days to Go) – A phone call is made to the banker requesting a draw. Local government inspectors requested.
*Tuesday (2 Days to Go) – Inspectors pass the items and the draw inspector reviews the status and faxes a completed itemized list.
*Wednesday (1 Day to Go) – Bank documents, authorizes, and the buyer signs the documents.
*Thursday – Deposit is made into the contractor’s account.
The above works in the perfect world, however, your subcontractors, the material suppliers or the local inspectors don’t have mental telepathy and therefore it never unfolds as desired. Usually the construction project is at some point whereby four subs are working the project at the same time. One of them doesn’t have money to buy the materials needed or didn’t do his paperwork and isn’t authorized to call in an inspection from the local codes and compliance department. Or a subcontractor decided to not complete his portion of the work on the project for some oddball reason. I once saw the mechanical guy not complete his step because the electrician had not run the wiring to the junction box to feed the HVAC system. The electrician told me he couldn’t run the wires because the HVAC guy didn’t mount the box for the feed. It is as if these guys didn’t have a clue to work together to get this done. It took another week before the draw was issued holding up funds for about 10 other subcontractors and material suppliers.
A typical draw schedule follows a % of completion as follows:
- 20% – site development, septic, water feed (main installed), footer and foundation laid, garage concrete pad completed.
- 20% – house framed, roof on, windows installed, exterior doors installed.
- 20% – trades have completed the rough ins, exterior siding completed, insulation, sheetrock, trim installed, hardwood floors laid, base coat of paint inside, exterior paint completed.
- 20% – kitchen cabinets and countertops installed, plumbing fixtures installed, interior painting done, trades have trimmed out the house, exterior building completed, driveway installed, drainage completed, hand rails installed.
- Final 20% – flooring completed, tile work done, house fully trimmed out, appliances installed, garage doors and lifts completed, landscaping done, Certificate of Occupancy issued.
Issues and Concerns
As the contractor, your job is to organize and coordinate the communication between the subcontractors to achieve incremental steps towards completion of the project. An example of a significant step in the percentage of completion process is the ‘drying in’ section of the home. Typically banks consider this a very important step towards creating value in a home. Drying in means the house is framed, roof is on, doors and windows installed. Well, in order to have the roof shingled, it is wise to have the plumber do the cuts through the roof for the venting of the sewage lines. Thus, the plumber needs to get into the home too before the house is considered ‘dried in’. Generally, the trades go into the house once the house is dried in and then begins the next draw phase on the home. Thus, there is a little bleed over from one draw phase to another.
Another example is the facial board along the roof line. It is so much easier for the carpenter to have completed this step prior to having the overhang from the shingles in his way. You can see there is a lot of coordination required to get the house completed and obtain draws in reasonable steps.
When negotiating the draw schedule focus on the most expensive steps in the construction of the project. In new home construction, the most expensive step is the materials and labor cost associated with the framing of the home. These two items run over 16% of the entire project. Add in the windows and roof shingles and you can easily top 27% of the project costs. Because these are so closely tied together in the timeline, it is best to request a draw once the house is ‘dried in’. This way the funds are used to replenish your used funds to cover these costs. A proper tool is for you to advance these costs from your capital and then be reimbursed for expended capital.
Almost every contractor I have provided services to in the past did not use their own capital to fund the project. They relied on the draws to pay the bills. This is not the proper way to handle the financial affairs of your company. This is why it is important to have plenty of cash available to fund the project as you proceed. It eliminates subcontractor pay issues, allows for greater confidence from the bank that you have the available equity to handle construction and the best part, cash allows for discounts from subcontractors and suppliers thereby saving you money.
Reduce your costs of handling the affairs of the project by drawing in accordance with the expensive phases of construction. Draw less frequently and fund the project with your own capital. The benefits far outweigh the frustration and heartache you have to deal with from suppliers and subcontractors. In addition, your overall stress will be less if you do not have to rush to get a draw in order to pay the subcontractors. Use the construction draw schedule to your advantage. Act on Knowledge.