Have you ever gone on a trip with children when just as you pull out of the driveway you hear that infamous saying: “Are we there yet?” At this mid-point of the year, you should be asking yourself this question—not about a summer road trip but about the state of your custom building business.
Where your business is going should be set by the budget and business plan you laid out at the beginning of the year. In the budgeting process you established the amount of money you wanted to make during the year over and above your salary. You also defined your company’s overhead—how much money will be spent on a month-by-month basis for operating expenses. You also defined how many jobs you planned on selling, starting, and closing during the year.
So… are you there yet? How well are you following your company’s roadmap? Is the company on target to hit its net income goal? Is overhead running according to plan? Have you sold the volume of homes anticipated?
If you are like most builders, your best-laid plans may not work out exactly the way you expect them to. When this happens you are dealing with variances—the difference between what was expected and what actually occurred.
Variances come in all shapes and sizes: the difference between the planned and actual sales price, more lumber needed for a house than estimated, slippage in the schedule, spending more money on office supplies than you budgeted for. Sometimes variances can be positive, but usually they are negative. Sometimes, your positive variances may offset your negative ones.
One of the keys to success for a custom builder is having a reporting system that identifies these bumps in the road. Such a system includes timely reports that raise a red flag when things are not going according to plan. This enables the custom builder to quickly spot variances and ask three critical questions:
- What went wrong?
- Why did it go wrong?
- What am I going to do about it?
In investigating a potential variance, first check the income statement (sometimes called a statement of profit and loss). Many builders I work with use a nine-column income statement that includes three sets of columns for month-to-date, year-to-date, and percentage of sales. Within each section the income statement includes columns for actual, budget, and variance. (For a copy of a sample income statement visit my Web site at www.builderbt.com.)
Examine your income statement carefully and compare budget to actual results. Where is there a difference? When the difference is significant, follow the trail to the detail to spot what went wrong. Use this information to gain an understanding of why the variance occurred. The next step is to close the loop: Take the time to make a change to a procedure or policy. Explain what happened to the people involved and discuss how to avoid the problem in the future. Better yet, have them explain what happened and how they think it’s best to solve the problem.
Depending on your accounting system you should be able to run a number of job cost reports that will assist you in evaluating variances. The best report is one that highlights variances from purchase orders. This report identifies variances from plan and can even be coded with a variance reason. Builders with less sophisticated systems should always be able to obtain a report that compares estimated to actual costs by line item as well as by detail.
For example, what should you do if in reviewing a job cost report you notice that framing appears to be going over budget? First, ask yourself what is causing the variance. With a variance purchase order system you should be able to get a report that will pinpoint the reason for your slippage. If your job cost system does not provide for variance purchase orders you may have to dig deeper to identify the cause of the variance.
Was the variance caused because the framer cut the 2x4s differently than you planned, which required more lumber? Or did you need additional material because the lumber that was dropped on the job “had legs,” was damaged by weather, or was necessary because the owner decided to make changes to the plans? Did your lumber supplier charge more for the 2x4s than the unit price in your estimating database? Did the framer charge you more for his labor? Did the additional charge relate to poor supervision, extra time spent on the job waiting for material, or not getting a firm price from the framer up front?
In dealing with builders over the years I have heard many different reasons for variances occurring, but what is frustrating is hearing the same reason for the variance over and over. Once you identify the variance it is critical to ask the next question: What can I do about it?
First off, look at the way you do business. Can anything be done to modify the system so you won’t have the same problem next time? If you find that the framer cut the 2x4s differently than planned either discuss this issue with the framer or add a waste factor into your estimate. If you have a theft problem on a job, develop better security procedures. If you were charged a different price for your material than what is in your database, make sure to update your database pricing so you won’t make the same mistake next time.
After identifying your job variances, it is time to dig deeper into variances in your operating expenses. Even if total operating expenses are relatively close to budget, the review should not stop here. It is necessary to investigate the individual over- and under-budget items. Maybe advertising was under budget, but cellular phone charges exceeded budget. If the cause of the advertising variance was a timing difference, the budgeted amount will still be spent but in a later month. Maybe the superintendent exceeded the allotted number of minutes on his calling plan. This is a variance that probably can’t be made up in the future, but something can be done to stop it from occurring again.
Unfortunately, things do not always go according to plan, but if you strive to find out what caused a variance and take corrective action your home-building journey will be that much smoother.
Steve Maltzman, CPA, is president of SMA Consulting in Colton, Calif. He can be reached at smaltzman@smaconsulting.net.
