2023 Financial Study Results: Gross Profit Determines Success in Today's Market
2023 was a year of anticipation and uncertainties, requiring a watchful eye and continued adjustments to sales, construction and operational strategies. The builders in our sample group remained vigilant, responding timely to the multiple changes occurring during the year. As a result, profitability was unchanged from 2022 to 2023, remaining at 14.6%, even though there were some interesting changes in the cost and expense categories.
Although the forecasted increased demand for the decade of the 2020s allows room for price increases, affordability as threatened by mortgage rate increases will limit the ability to raise sales prices.
Because construction cost is the main contributor to gross profit or margin, it needs to be monitored on all fronts, starting with design, specifications, selections, purchasing processes, negotiations, and construction efficiencies. The spectrum is much wider than simply negotiating prices with suppliers and trades. It is important to first understand the buyers, including their wants and what they are willing to pay for or can afford.
Carefully managing design, selection of materials, negotiations, processes, waste control, and speed of construction, as well as other operational elements, can help decrease direct construction cost. It is a team effort within each company including every department: sales, design, back office, field management, accounting, warranty. In other words, every employee in the company plays a role in this effort and must contribute to the common goal.
2020, 2021, and 2022 turned out to be great years with small gains in the control of direct construction costs. 2023 maintained the direct construction cost decreases achieved in 2022. However, the decreases in the direct construction cost ratios are more due to increases in sales prices versus actual cost reduction and control. Moving forward in 2024, potential increases in interest rates continue to present a real danger to sales volume and profitability. The market will not tolerate large price increases; thus, design, efficiency, and cost containment will continue to be the areas to focus on to maintain and increase profits.
It is essential to recognize that superior gross profit provides the necessary flexibility to respond to changing market conditions. During the last few years, builders have strengthened their balance sheets with averages for the current ratio at 2.0 versus the expected 1.5 target. The debt to equity ratio has also significantly improved showing an average of 1.3 in 2022 and 1.2 in 2023 against the target of 3.0. Several of the production builders are self-financing their construction costs or borrowing at a much lower percentage than the traditional 75% of sales price. They are maintaining higher cash balances with 26% of builders not having to sign personally on their construction loans.
The stronger financial position attained by private builders allows them to be more on par with public builders, making them more competitive as they achieve greater financial options and flexibility. The universal conclusion year after year is that in order to achieve superior net profits (before taxes), the company needs to achieve superior gross profits (sales less lot cost and direct construction cost). However, superior gross profits do not guarantee superior net profits. The volume, the area of the country, nor the average price of homes appear to have any bearing on achieving superior profits. The analysis by size, regions, and price point presented in the study support our conclusion.
Our observations indicate the prevalent reason of all superior builders to maintain superior profits year after year is excellence in operational processes and procedures and discipline during execution, making them not only profitable, but also consistent and reliable. For an in-depth look at the results of the study,
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