Five numbers you need to know
By Steven W. Hays Sr., CPA
The long recovery for the home building industry is finally over and builders need to take advantage of the positive economic opportunities. To be able to do that while the market is strong, it is important to have a firm knowledge of these five key numbers in running and measure the success of your business.
In order of importance, they are:
1. Net Income (Profit) Percentage
This is a measure of net income dollars generated by each dollar of sales. Often referred to as the bottom line, it is typically the first number an owner, lender, or investor looks to for the overall health of the company. Certain cost savings are said to “drop straight to the bottom line” and a dollar savings in certain cost areas increases your net income by that same dollar. While a strong sales line is very important, the net income generated is of greater importance.
2. Direct Construction Costs Percentage
Direct Construction Costs
This is a measure of direct construction cost dollars spent for each dollar of sales generated. Direct construction costs are the biggest cost a home builder incurs by far, yet some builders do little to control these costs. Managing this number – the “sticks and bricks” that go into a house – is critical to achieving profit goals. A common characteristic of the best builders is their ability to monitor and manage their direct construction costs.
Substantial time and effort should be applied to estimating, evaluation, and budgeting your direct construction cost expenses. Even a small reduction in direct construction costs as a percentage of sales price can significantly increase a builder’s bottom line. Any costs that can be removed or decreased from a house and multiplied with direct construction cost savings from other units to be built can provide substantial income improvement.
3. Gross Profit Percentage
This is a measure of gross profit dollars generated by each dollar of sales. Gross profit is sales minus developed lot costs, direct construction costs, and indirect construction costs. The difference between gross margin and gross profit is the inclusion of indirect construction costs.
Gross profit is a key financial measure representing a home builder’s ability to cover or absorb other operating expenses. If a home builder cannot maintain an adequate gross profit percentage, it’s unlikely they can obtain an acceptable net income percentage. Maintaining an acceptable gross profit percentage is essential to long-term economic viability.
4. Break-even (in Sales Dollars)
1 - Variable Cost %
Break-even determines the number of units in sales dollars that must be closed to cover all costs and expenses of the company. Variable unit costs include developed lots cost, direct construction costs, sales commission, and certain indirect construction costs. While this calculation assumes zero profit, it is often advisable to include a desired profit amount.
Break-even analysis is a tool to calculate at which sales volume the variable and fixed costs of producing a home will be recovered. The break-even point is the point at which your homes stop costing you money to produce and sell, and start to generate a profit for your company.
5. Debt to Equity
Total debt includes all liabilities of an entity and measures a company’s reliance on lender or creditor financing, as well as the business’s indebtedness compared to the amount invested by its owners.
The debt-to-equity ratio indicates the ratio of the dollars of liabilities the company has for every dollar of stockholders’ equity. This ratio is a good indicator of a company’s capacity to repay its lenders and creditors. Since the recession, this ratio is being monitored very closely.
Steven Hays is the partner-in-charge of the Home Builders Services Group of RubinBrown LLP, Certified Public Accountants, in St. Louis, Missouri. He is also a member of the NAHB Business Management and Information Technology Committee. Contact him at (314) 290‑3336 or at firstname.lastname@example.org.