Cash flow for house builders

By - , Build 170

Keeping a healthy cash flow is vital for home builders. Those who don’t, even in busy times like these, can go under. What should you look at?

A HOUSING boom that’s tough on the residential building sector reads like an oxymoron, but high competition, price volatility, large overheads and lower margins make it tough going for many companies.

With builders booked out for months in advance and a major housing shortage, we can be forgiven for assuming the building industry won’t slow down for some time. However, that doesn’t mean the industry is flush with cash. Cash flow issues are rife, and remaining cash positive is more vital than ever.

Smaller margins causing issues

In our experience, the three key factors that keep builders in the black are billing structure, margin and break-even point.

The Kiwi way is to get three quotes for any major renovation or build and generally opt for the cheapest. This has led to a very competitive market and a resulting drop in margin for many companies.

The main residential home build sector is dominated by large housing companies, and the business model for many of these companies is high sales volume and low to mid-margins.

Often they have high overheads to cover, including management salaries, marketing spend, construction managers and finance costs, and the high-volume turnover is necessary to cover these costs. If sales volumes drop for an extended period of time, the company can soon run into issues covering these overheads, and we have seen examples recently of housing companies collapsing.

Risk with fluctuating prices

Another issue facing the housing industry is fluctuations in costs – both in land and materials. The latest QV costbuilder 6-monthly report shows the average cost of building a new home has risen by 30.7% since 2007. Often these cost increases can not be passed on to customers quickly enough due to existing fixed-price contracts.

The companies that offer houses and land packages take on a calculated risk when it comes to the price of land. Companies that turn houses over quickly do well. However, often sections in sub-divisions are sold 1–2 years before the houses are sold.

An agreement to purchase 10 lots at $300,000 with an on-sell value of $320,000 makes sense, but if the land value drops to $280,000, the price of the house and land package needs to increase significantly or you’re faced with absorbing the loss. On the flip side, if the land value increases, those 10 lots become very profitable.

Regular cash flow is needed

In the building industry, cash is king. Any successful company relies on a steady stream of cash coming in to cover the outgoings. The construction of a house generally has certain billing points, such as the ready-to-roof stage. This means companies will incur material and labour costs they need to cover before a billing point is reached. Sometimes, any upfront deposit may be sufficient to cover this.

At any one point you could have multiple jobs that haven’t reached a billing point. Combine this with the fixed overheads, and you’ve got a large cash outflow and high working capital requirements. Managing the billing points on multiple jobs to keep cash flow regular becomes key.

Invest in a quality job-costing system

The timeline for a house to be built can range from 4 to 12 months. With multiple builds on the go, you need a system that allows you to review how much profit you are making each month.

Each house that is built needs to be carefully planned and priced, so you also need the ability to track how the job is progressing and whether you are meeting budget. A quality job-costing system is a key tool for monitoring progress.

Key lessons

Successful housing companies remain cash positive by focusing on key items such as billing structure, margin and break-even point and volume requirements.

  • Review your target margin and stick to it. Avoid negotiating below this point. Five quality jobs with a good margin can be better than 10 jobs won by negotiating down on price and making poor margins.
  • Know your break-even point. How many houses do you need to build over a period to cover your fixed overheads before you are making a profit in that period?
  • Aim to be cash flow positive on every job by reviewing your billing structure. If a build has four billing points, consider the optimum spread of these billing points to keep working capital requirements down and therefore save on costs of capital.
  • Track your costs by maintaining a quality job-costing system that can record costs on a job-by-job basis and allow you to monitor multiple jobs on the go.

For more

This is intended for general advice only. For specific advice, contact your advisor or local Staples Rodway office.

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