The key to a successful financial reporting system is to have a budget to which you can compare your actual operating results. An operating budget is one of the key elements in the planning process. It provides the custom builder with a basis for determining the appropriate mark-up percentage as well as targeting the amount of gross profit needed in the upcoming year to cover overhead and provide for a reasonable profit.
Before starting to develop an operating budget, it is important that you understand your current business and have an idea how it will look in the year ahead. Both internal and external factors affect your business. Study the jobs you sold and produced in the last few years to see what type of work provided the greatest gross profit, which part of town or subdivision you were most successful in, and what kind of customer was easiest to work with. Evaluate the economic outlook for your current market. Examine the effect of political, demographic, and social factors within your marketplace.
Take time to examine your internal resources and systems to determine if you are getting the most out of your systems and people. Review your successes and failures during the year to find where you can capitalize on successes and take corrective action to avoid future problems.
Before starting to detail your operating expenses, set some basic goals on the number of houses and/or dollar volume you would like to produce in the year ahead. Establish a target net profit you would like your company to make. I suggest custom builders strive for a net profit between 7.5 percent and 10 percent of anticipated sales volume. That net profit should be after paying yourself a reasonable salary for the work you perform for the company.
The best way to start your budget is to review your current year’s activity on a month-by-month basis. Identify your fixed expenses (those that won’t change with volume) and plan for possible increases. Examine your variable expenses (expenses that will vary with changes in volume) and link these expenses to your targeted sales goals.
After you have taken a first cut through your operating budget, examine the overall numbers. Add your targeted net profit to your operating expenses to determine the amount of gross profit you need for the year. Once you know the dollars of gross profit needed, you can determine the markup that will allow you to reach your goals.
For example, suppose you expect to produce five houses next year with an average sales price of $300,000 for total anticipated sales of $1,500,000. If you want to achieve a 10 percent net return, your targeted net profit is $150,000. If you estimate your overhead for the year will be $300,000, you will need $450,000 of gross profit (sales less direct construction costs) to hit your goal.
To determine the markup you’ll need, estimate your cost of sales by subtracting targeted gross profit ($450,000) from anticipated sales ($1,500,000). In this example, cost of sales is $1,050,000. Then you can divide anticipated sales by the cost of sales ($1,500,000/$1,050,000), which produces a markup of 1.42.
If the markup needed to meet your goals is unreasonably high, go back and challenge your operating expenses. Have you built in capacity that will be able to handle more volume? Will the market allow you to sell more than the five homes in your original plan?
Make the necessary changes to your budget so that you can realistically meet your net income goal.
Here’s a short test to rate your company’s process for developing and monitoring its operating budget:
For each of the items in this checklist, give your company a score of 0, 1, or 2 as follows:
0 = System not in existence
1 = System in existence but not consistently adhered to
2 = System consistently adhered to
0 1 2 My company prepares an annual operating budget.
0 1 2 The budget includes annual targets for sales, cost of sales, and all operating expenses.
0 1 2 The monthly operating budget is obtained by dividing the total annual budget by 12.
0 1 2 The expense budget is broken out monthly with specific items identified in the month anticipated.
0 1 2 The budget is broken into categories that match my company’s chart of accounts.
0 1 2 The budget includes monthly targets for home sales, starts, and closings.
0 1 2 When developing the budget, my company does a detailed review of our prior year and year-to-date operating expenses.
0 1 2 When budgeting for payroll, the gross wages and related taxes are included within the actual month they will be made (i.e., for weekly payrolls you will have some months with four weeks and some with five weeks).
0 1 2 The budget for payroll taxes takes into account the time when employees go over the tax limits (i.e., federal unemployment taxes are only paid on the first $8,000 of wages).
0 1 2 The budget is used to evaluate the target markup or margin being used for pricing our homes.
0 1 2 The budget for the balance of the year is re-forecast a minimum of once each quarter.
0 1 2 The budgeting process includes input from all departments.
0 1 2 The budget for the next fiscal year is completed prior to the start of the fourth quarter of the current fiscal year.
0 1 2 In addition to an operating expense budget, my company prepares an annual capital budget.
0 1 2 In addition to an annual operating budget, my company prepares an annual cash flow forecast broken out by month.
After the evaluation, add up your total scores; the highest total score possible is 30 points. If you receive a score of 27 or better, give your budgeting system an A; a score of 24 to 26 rates a B; 21 to 25 rates a C; and 18 to 20 rates a D on your report card. If you scored under 18 points, your budgeting system probably needs an overhaul.
Steve Maltzman, CPA, is president of SMA Consulting in Colton, Calif. Visit him at www.smaconsulting.net.
