Market and margin – how a failure to understand can be “catastrophic”

To further cut into the abstraction of finances, he provided an all-too-real scenario of the pitfalls of not understanding margins: “Although the benchmark, what the big companies are on, it’s all 33.3% for new construction, which is 25% margin. That’s pretty standard. But in small business, they don’t understand the margins are that high and because someone down the bar told them they should add 20% on their jobs, that’s what they do – without any proper research or understanding of their financials.

“A lot of builders are adding 20% to their cost of labor and materials. So, if they’re turning over, say, $3 million a year every month, that’s $250,000. So they look at that $250,000 and they think ‘I’m working on 20%, that’s $50,000 profit.’ But they’re not because the 20% was a markup, which was 16.6% margin. So this is really dangerous because when they don’t understand their financials properly, they think they’ve made $50,000 but they’ve really made about $40,000 in reality. And when they start spending that extra $10,000 they haven’t made – because it’s sitting cash flow positive in the bank account – this is where, over time, they get into trouble. So it’s a very important concept for them to understand.”

A slowing housing market, challenging supply chain and labor shortage issues have combined to erode builders’ profit margins, Stephens told MPA. Moreover, APB’s own State of the Residencial Construction Industry report finds that smaller residential building companies are failing to charge the correct margin because they lack demand.

More sobering stats come from the US Bureau of the Census, which reports that the start of construction on new residential homes fell to 1.45 million in July – a 9.6% decline from the previous month. Consequently, homebuilders have an ever-important task ahead of ensuring they are pricing for profit by carefully calculating their net profit margins, Stephens said.