Use Phase Accounting in Construction – Part I
Minimum Bottom Line Profit Should Average 9.4%!
For Trades & Subcontractors, at Least 11%
After Income Taxes Are Paid!
The most effective form of a financial feedback loop in residential construction is phase accounting. Phase accounting is a subset of cost accounting and generates accurate information in the world of new home and residential additions for small contractors building up to 20 houses per year.
A financial feedback loop is a method used in business to identify areas of poor or under performing production. In construction, it usually identifies a mismatch of the estimated cost to produce the addition or a new home to the actual cost it takes. It utilizes nine phases of construction and allows the owner to pinpoint problem areas or a failure to properly estimate or control the cost in that phase. The nine phases are as follows:
1. Project Management (paperwork)
2. Site Development and Landscaping
6. Walls (insulation, sheetrock, trim, interior doors, painting)
8. Cabinets (Kitchen cabinets, countertops, bathroom cabinets, appliances, tile work)
9. Extras (Decking, railings, sound system, exterior buildings, change-orders)
Each bill received is coded to one of the nine areas above and as the project progresses, a detail journal of costs associated with that phase helps the contractor identify if he incorrectly estimated or received an inappropriate charge. This information provides both pros and cons of that phase so that future projects with similar circumstances can be estimated more accurately. What goes into each phase to help the contractor? Well, let’s explore each phase and identify the associated costs.
The key to this phase is that it is purely paperwork related and costs that will never appear as physical item in the home. From day one working with the client these include:
· Estimating costs and architectural work
· Contractual, closing, and permitting fees
· Banking fees including interest on loans
· Insurance, bonding, and compliance fees (proctor, community compliance, etc.)
· Deposits (even though you may receive them back)
· Operational compliance, from posting the signage, port-a-johns, waste removal, inspection fees, & penalties
· Termite pretreatment and post treatment
Note that only costs that will not physically remain as a part of the home/addition are categorized in this phase. As a contractor looking at the report, you can key in on those external costs that you did not anticipate and use that for future reference.
Site Development and Landscaping
From the moment you set the environmental fence and dig the front ditch to set the drainage culvert, those costs associated with the land are included in site development and landscaping. These costs include the following items:
· Site purchase, (closing costs are including in project management)
· Lot clearing, from the temporary driveway to the debris removal, it is all included here
· Concrete work, including the garage pad, driveway, walkways, swells, and drainage
· Landscaping work including all shrubs, bushes, trees and specialty items
· Sewage and drainage lines installed
· Septic tanks and wells
This section covers those costs associated with the lot and not the house directly. Some costs are lot costs but should be charged to project management including land surveying fees (except the cost associated with marking the footing which are a part of the foundation phase) and homeowner association preservation fee (where the committee comes out to mark which trees to preserve). Any cost associated with physically preserving the trees such as pruning, splitting, or root removal are included in this phase.
This phase is pretty much the easiest of the nine to formulate the costs. It consists of the surveyor’s setting of the corner points, the costs of the digging the footer and the engineering costs. You should also include the following items:
· Crush and run for the foundation footer
· Metal wire and rebar for the foundation
· Concrete for the foundation
· Block and interior posts, include any forms built for the pouring of concrete
· Slab costs should be included here, you may include the garage slab here as long as you consistently record the garage slab here or in site development, but be consistent in where you record that element of construction
· Basement exterior walls, center posts if they are tied to a foundation such as a pier
· Include the access panel or exterior door to the basement
The goal of this section is for the contractor to examine the costs prior to the actual house framing. I would not include the support beams or foundation beams in this area as they are really a part of the house itself. However, the anchor bolts are usually concreted into the foundation and therefore are a part of the foundation. Any termite barrier mounted on the foundation prior to construction should be included in the cost of the foundation. Oftentimes I’ve been asked where to put the cost of the moisture barrier in the crawl space. To me this is not a foundation cost but one of those extras in Phase Nine. But if your termite guy is including this in his function and the termite bill is in Phase One, leave it there. The key is for you as the owner to understand what is included in each of the respective phases.
This phase is the heart of the whole operation, from framing the floor to covering the roof, many items are included in this section. Here is what I would include:
· Actual frame of the house, from the floor construction to the roof’s frame
· Windows and exterior doors, include the garage doors when they are installed, I would also include the garage door lifts and or spring system here
· Roof including water drainage systems (gutters, downspouts, splash blocks, spreaders, vent caps etc.
· Exterior brick work including the foundation fascia, any exterior siding
· Exterior trim including fascia boards, soffits, and venting items (roof vents, soffit vents etc.)
· Chimney and flu work including any type of framing required for ductwork, or framing for the exhaust of the heating system
· Front porch construction from the concrete work to the framing aspect
Often this is referred to as ‘drying the house in’, but the drying in process is truly limited to roof on, windows and doors installed. ‘Drying in’ is a draw concept for funding the project. It does not refer to the siding or chimney type work. However for the purposes of phase accounting, you want to include these other elements of construction because they are aspects of framing.
Remember, overall the key is to be consistent in where you place your costs. If you call the sand you have hauled to the site for the crawl space moisture control as a framing cost then, in the future, make sure that is where it is always posted or entered in the books. Don’t change the location; it becomes difficult to compare costs from prior projects if you keep moving them around.
The goal here is to be able to compare a historic project to one you are about to estimate. In your job set-up, describe the house in detail, the lay of the land, the amenities the buyer desires. These are all critical in helping you in two years when you have to estimate a similar project. This is the goal of phase accounting; it provides a feedback to you so you can GET BETTER at estimating projects and eliminating unforeseen costs.
Part II of this series will cover the trades and Part III, the remaining four phases of construction. From there, I’ll use a spreadsheet to illustrate the value in dollars a phase accounting program brings to the builder. Act on Knowledge.
Do you want to learn how to get returns like this?
Then learn about Value Investing. Value investing in the simplest of terms means to buy low and sell high. Value investing is defined as a systematic process of buying high quality stock at an undervalued market price quantified by intrinsic value and justified via financial analysis; then selling the stock in a timely manner upon market price recovery.
There are four key principles used with value investing. Each is required. They are:
- Risk Reduction – Buy only high quality stocks;
- Intrinsic Value – The underlying assets and operations are of good quality and performance;
- Financial Analysis – Use core financial information, business ratios and key performance indicators to create a high level of confidence that recovery is just a matter of time;
- Patience – Allow time to work for the investor.
If you are interested in learning more, go to the Membership Program page under Value Investing section in the header above.
Join the value investing club and learn about value investing and how you can easily acquire similar results with your investment fund. Upon joining, you’ll receive the book Value Investing with Business Ratios, a reference guide used with all the decision models you build. Each member goes through three distinct phases:
- Education – Introduction to value investing along with terminology used are explained. Key principles of value investing are covered via a series of lessons and tutorials.
- Development – Members are taught how pools of investments are developed by first learning about financial metrics and how to read financial statements. The member then uses existing models to grasp the core understanding of developing buy/sell triggers for high quality stocks.
- Sophistication – Most members reach this phase of understanding after about six months. Many members create their own pools of investments and share with others their knowledge. Members are introduced to more sophisticated types of investments and how to use them to reduce risk and improve, via leverage, overall returns for their value investment pools.
Each week, you receive an e-mail with a full update on the pools. Follow along as the Investment Fund grows. Start investing with confidence from what you learn. Create your own fund and over time, accumulate wealth. Joining entitles you to the following:
- Lessons about value investing and the principles involved;
- Free webinars from the author following up the lessons;
- Charts, graphs, tutorials, templates and resources to use when you create your own pool;
- Access to existing pools and their respective data models along with buy/sell triggers;
- Follow along with the investment fund and its weekly updates;
- White papers addressing financial principles and proper interpretation methods; AND
- Some simple good advice.