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Be Specific When Determining Your Target Operating Profit
By Steve Maltzman, SMA Consulting
 Profit is the lubricant that makes the machinery of business run smoothly.
Profit provides a cash cushion that allows builders to weather the inevitable ups and downs of the industry. It provides the operating capital to fuel growth and deal with emergencies. And it provides the psychological incentive to improve productivity and competitiveness.
With profit so important during these difficult times in the industry, builders can no longer afford to answer, “It depends,” as so many so typically do when asked what their mark-up percentage should be.
As a home builder, your profit margin depends on your market’s demand for new homes, your competition and your management efficiency. Establishing a target operating profit could mean the difference between riding our the downturn or not.
The following is a step-by-step guide to help you establish a workable target for profit. The best time to perform this analysis is when you set up your company’s operating budget for the year:
- Establish a Target Profit
The first step is to determine how much money you would like to make as profit. Calculate this amount after paying yourself a reasonable salary for the work that you do for the company.
For example, suppose you anticipate building and selling five homes this year for an average sales price of $240,000. Your anticipated sales would be $1.2 million and you want the company to make a net profit of $60,000 this year. Keep in mind that this net profit would be in addition to your annual salary, which is included in operating expenses.
The $60,000 net profit is 5% of sales, which is probably on the low side.
- Establish a Marketing Budget
The next step is to budget what you need to spend on marketing to create name recognition and increase sales. Most builders don’t spend enough.
When creating a marketing budget and plan, remember that it’s more important for marketing to be effective than for it to be plentiful. Ineffective marketing can actually hurt you.
For the purposes of this article, let’s budget $40,000 for marketing.
- Identify Overhead Expenses
Go through your chart of accounts and establish a budget for each of your detailed operating expense items. Overhead includes salaries ― yours as well as your employees’ — office rent, office supplies, phones, vehicles and similar items.
Again, for demonstration purposes, let’s set the annual operating budget at $120,000.
- Compute Your Projected Gross Profit
Gross profit is sales revenue minus the direct costs of building your homes. Gross profit must cover your entire overhead and operating expenses and your net profit.
Using the figures from above, the gross profit for the year should be $220,000 ― $60,000 net profit plus $40,000 for marketing plus $120,000 in overhead expenses.
Since you plan on building five homes this year, each home must generate $44,000 in gross profit.
- Calculate Your Mark-Up
Rather than adding a fixed amount for each home you build, it’s usually better to find a mark-up percentage that generates the profit you want without pricing yourself out of the market.
Again, suppose that you plan to build a spec home with land and direct construction costs of $200,000. If your gross profit per home is $44,000, your mark-up is 22% ― $44,000 divided by $200,000.
Don't confuse mark-up with gross profit. A 22% mark-up gives you an 18% gross profit, which is $44,000 divided by $244,000.
- Analyze the Construction Budget
If you want to make 18% gross profit, hard construction costs cannot exceed 82% of the sales price.
To make the profit numbers work, you need to ask two very hard questions — Can I build a home for $200,000 or less? Can I sell it for $244,000 or more?
If the answer to either of these questions is no, then you need to go back and find a way to either lower the cost or increase the perceived market value of the home. Do that now — in the planning stage — rather than later at the selling stage.
- Determine Your Break-Even Point
Before you make one dime of profit, you must cover not only your direct construction costs but also your fixed operating costs. This is your break-even point.
Suppose you have fixed operating costs of $160,000 per year. That includes marketing, salaries and overhead, but not net profit.
If you build a home for $200,000 and sell it for $244,000, you have a net contribution margin to profit and overhead of $44,000.
To cover your operating costs for the year, you have to sell 3.6 houses ― your break even point. Since you really can’t sell a fraction of a house, your break even point is really four houses.
Once you have sold your first four houses, the additional contribution margin goes into your profit.
- Develop a System to Monitor Results
Once you have determined a targeted operating profit, it is important to have a job cost control system in place to track how you are doing on each job in relation to your targeted gross profit.
In addition, it is important to develop regular financial reports to help you monitor your overall gross profit and overhead expenses.
Steve Maltzman is founder and president of SMA Consulting, LLS with offices in Redlands, Calif. and Orlando. For more information, e-mail Maltzman in the Redlands office, call him at 909-335-9100 or visit the SMA Consulting Web site at http://smaconsulting.net.
 NAHB Has Nearly 300 Resources to Help You Run Your Business More Profitably
Go to NAHB's Business Management Tools Web pages (available to members only) for instant access to nearly 300 timesaving, moneymaking and cost-cutting business resources to help you run your business more profitably. Get guidance on accounting and financial management, business strategy, computers and information technology, customer service, human resources and more.
Resources are added weekly, so bookmark www.nahb.org/biztools to go directly to these vital business management resources.
Local and state home builders associations can link directly to www.nahb.org/biztools from their Web site and give their members instant access to these resources. It will make your HBA's Web site the place to go for the information and guidance that members need to succeed.
 Add Success to Your Schedule
Missing a deadline can seriously damage your bottom line. The "Scheduling" course from The NAHB University of Housing shows building professionals how to set workable schedules and use various time-management tools.
The course teaches the benefits of scheduling and integrating scheduling with other management activities and will help builders, remodelers and site managers deal with those days when nothing goes according to plan.
Find upcoming Scheduling courses here, or call 800-368-5242 x8154 for more information.
 Improve Business Operations With ‘Cost of Doing Business Study’
The “Cost of Doing Business Study, 2008 Edition,” available through BuilderBooks.com, enables home builders to compare their business operations with like-sized builders across the country so they can fine-tune their businesses and boost profits.
The study analyzes several operational business categories ― including volume, operation type and land vs. no land costs ― and enables builders to identify their strengths and weaknesses, increase efficiency, set realistic budget targets and improve business practices.
The categories have been analyzed, where applicable, by average and by the top and bottom 25% of performers by net profitability.
Builders can use the the study to develop proven strategies to succeed in an increasingly competitive market.
To view or order the “Cost of Doing Business Study” online, click here, or call 800-223-2665.
 Free NAHB Kit Gives Builders Back-to-Basics Tips to Navigate the Slowdown
What was once expected to be a relatively mild housing slump following three years of record new home construction and sales has given way to a significant downturn.
To help members navigate the uncharted waters of this slowdown, NAHB has compiled a comprehensive “Back to Basics” online toolkit — the best of the basics, the tried and true and the truly new. To access the toolkit, click here.
To access the “Back to Basics” toolkit, you must be an NAHB member and have a login to www.nahb.org. To create a login, go to www.nahb.org/login or click on the log-in button on the main menu bar.
For assistance, call the NAHB Member Service Center at 800-368-5242.
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