Building and remodeling homes is complex business – the variables are countless. The business of building requires much more than technical expertise. It requires financial expertise! Success is in the numbers, and without a commitment to know, and own the numbers, business owners in the construction industry have little hope of ever attaining lasting financial success. Financial struggles (chasing cash and juggling payables) are the biggest single roadblock for most building businesses, leading to much unnecessary stress, frustration and sleepless nights. This is the first in a 4-part series to dispel financial myths and build your financial future.
The first step to financial success; know (and own) your annual overhead expense budget. It’s not a mystery that a business must spend money to make money. Those ‘expenses’ are referred to as “overhead”. But the term ‘expense’ is somewhat of a misnomer, because overhead is really not an expense in the truest sense. In reality it’s an investment! Overhead is the investment that you, the owner, decide to make in your business, in order to produce the outcomes you want, which are ultimately happy customers and great profit.
Every dollar spent on your annual overhead should be invested to make a difference on the bottom line. That should be your expense budget spending criteria. If there is even one dollar invested that is not achieving that goal, it needs to be cut – period! Otherwise you are simply taking away valuable net profit dollars in exchange for nothing. And that shouldn’t be a mystery either. So, to accurately redefine Overhead, think of it as the least amount of cash required to produce the most optimal results!
Starting with your own salary, add together all of the expenses not directly related to producing jobs to create a budget for the coming 12 month period. These include things like rent, insurance, fuel, vehicle maintenance, administrative wages, software etc. For a simple chart of accounts to help clarify what an ‘expense’ is vs. cost of goods sold, click here and review the “expenses” column to be sure you’re not missing anything. For a more complex chart of accounts, see the NAHB website. Or, just use your most recent tax return to compare and update for the coming year. Whatever you do, get this step completed first. And remember, major in progress, minor in perfection in this exercise. There is no ‘perfect’ when it comes to calculating an overhead budget. Things will change and costs will fluctuate throughout the year, so just get it close and be sure to allow for unknowns.
Overhead is the first ‘nut’ you need to crack to achieve financial success over any given period of time. Knowing your overhead number for the next 12 months is like knowing how much fuel you will need to have in your car to travel a specific distance – no more, no less. No fuel, no results. But a lack of cash does not necessarily mean that overhead is the problem. A chronic shortage of cash is a symptom that could be due (at least in part) to excessive overhead spending. Or it could be a combination of issues needing addressed such as poor or inaccurate estimating or incorrect gross profit percentages.
Here’s how important knowing your annual overhead budget is; that number, when added to your annual net profit goal (you do have that goal determined right?), equals your total gross profit goal for 12 months, and becomes the pivot point for financial budgeting success. Once you have your overhead number, try entering it, along with your average cost of goods sold percentage, in our Profit Predictor spreadsheet to predict the revenue you will need to succeed financially in the coming year. Also, check out this SlideShare for tips to calculate and cut overhead expenses!
In part 2 of Success in the Numbers, gross profit as a percentage of sales will be discussed along with a powerful calculation to set realistic revenue goals and determine break-even sales goals. In the meantime, Legacy Business Leaders is here to answer your most challenging questions in the construction industry. Feel free to call or email anytime. Wishing you the best success this year and beyond!