How to keep your residential construction business profitable despite material shortages and price increases

The effects of COVID have been felt across all industries including the construction industry, and it has never been more critical for builders like you to focus on your long-term financial viability. 

Buildxact hosted a webinar with The Association of Professional Builders (APB) co-founder, Russ Stephens, who outlined some vital, but straightforward, steps you must take immediately. He warned that failing to do so would risk you becoming caught up in what he described as the “tsunami of building company failures” bearing down on the Australian construction industry. 

During the webinar, Russ explained how you can remain profitable and even grow your businesses despite unprecedented challenges, such as labor and supply shortages and rising material costs.  

Below are the three key steps he recommended for all Australian home builders. Russ based these necessary actions on his extensive industry experience and the first-hand experience and accounts of builders in the US, Canada and New Zealand.

1. Lawyer up

Seek legal advice on residential building contracts

While the pandemic has sent the building industry booming, increased demand has driven up material and labor costs. As Russ explained, such rapid construction cost inflation quickly consumes any net profit you may have projected in a fixed-price project. Additionally, the resulting lag time waiting for available workers and required supplies inevitably leads to expensive delays that you, the builder, must absorb. 

With the current environment changing so rapidly, in many cases, you will know you will be losing money on a signed and contracted build before you begin. 

Think long-term

Let’s say your build has not started–circumstances then change. You now surmise plowing forward makes no financial sense in the end. The right move is to stop, said Russ during the webinar. 

“In fact, as the director of a company, a builder has a legal obligation not to continue, because this contract will clearly lead to a situation where the building company will be forced to trade insolvently. It’s very unlikely that a court will order a builder to start a contract that they cannot complete before having to place the company into receivership because they can’t pay their bills when they become due and payable,” he said. 

Because contract laws vary significantly across Australian jurisdictions, your legal obligations in Victoria may be vastly different from those in Queensland or Western Australia. Russ said he recommends seeking professional legal advice from a firm not connected to the company that may have supplied your original fixed-price contract. 

Also, most contracts have enough ambiguity to allow “plenty of leeway for interpretation when it comes to ‘acts of God’ and force majeure,” he said.  

In other words, there may still be several legal opportunities to terminate or significantly revise signed contracts to prevent you from losing money. It is critical to seek legal advice before you commence work to know exactly where you stand and your options. 

Stop, review, survive

“You can work yourself silly for the next 12 to 18 months, make no money and potentially face personal bankruptcy – or you can take a step back,” advised Russ. “You can re-evaluate your current situation, and then only proceed with the jobs that are definitely going to return you a profit. 

“So, stop right now, before you go any further. Review and re-estimate every contract that has not yet been started and include provisions to cover the expected continuing price increases.  

“It’s important to include special conditions that protect your building company from bearing the brunt of the cost escalations.” 

2. Keep your clients happy while protecting your margins

With all the proper legal and financial safeguards in place to help keep the project in the black, you’ll now need to manage your relationship with the homeowner. 

Delays, unforeseen problems and unplanned costs are all par for the course on any building project – so clear strategic communication with your client is paramount.

Russ outlined three key techniques to use: 

  • Over-communication
    One key reason builders have a terrible reputation as communicators is their tendency to put off the tough conversations they need to have with their clients. They often wait until the problem has grown from minor and annoying to significant and potentially catastrophic to both the project and their client relationship. Over-communicating means addressing the elephant in the room as early as possible – ideally as soon as a problem is likely to significantly impact the budget and schedule. By being on the front foot about the issues that pop up, you’re helping manage the client’s expectations. Don’t sugarcoat the problem and resist the urge to lean towards predicting a best-case outcome.Homeowners want to know they can trust you to act in their best interests. And when things go wrong, you’re the natural person they’ll be looking to blame – but also for help. So, they’ll be doubly angry if they ultimately end up footing higher costs and inconveniences because you failed to warn them. While they may still be frustrated at having to create additional space in their budget or timeline, they’ll appreciate your honesty and be grateful you acted quickly to nip their problems in the bud. 
  • Anchoring
    As Russ puts it, ‘anchoring’ is about “bending” your clients’ perceptions and expectations from the beginning by dictating their emotional starting point. A key example might be providing an estimated cost range for something that includes an extreme figure at one end so that the actual amount ends up feeling far more reasonable and less scary to the client.
    Anchoring might seem simplistic and obvious, but there’s a reason sales and marketing campaigns do it: it works. “The real value of anything depends on the vantage point that you’re looking at it from – it’s all about perspective,” Russ explained. By controlling the context and position from which your client is viewing the situation, you’re able to help them make the choices that are right for themselves and the build.  
  • Labeling
    Labeling is especially useful when it’s time for tough conversations. Building a home is stressful enough already for your clients. And when things aren’t going well, this anxiety will only be heightened. So, before you approach the client to discuss a significant delay or high added cost that might have popped up, Russ recommends doing an “accusation audit.”Take a moment to consider all the worst-case scenarios the client may bring up to you: How and why will they blame you? What labels might they throw at you? Untrustworthy? Dishonest? Shonky?
    Start the conversation by anticipating these negative dynamics – saying these labels out loud makes them seem more exaggerated than they are and helps prevent the client from over-reacting to the situation. For example, you may begin by saying something as simple as “you’re going to think I’m ripping you off,” or “I should have predicted these astronomical material price hikes.”
    Speaking these anticipated criticisms and negative dynamics out loud will often prompt the client to spring to your defense – they’ll end up telling you that the opposite is true. Now they see things from your side.  Russ then suggests following this up by offering positive labels the client would want to have attached to themselves to encourage positive, reasonable behavior on their part. By telling them how smart, reasonable and understanding they’re being, they’ll be encouraged to act that way. 

3. Watch the correct numbers now to cover your future cash flow needs

When looking at the financial position of a construction business, builders, their accountants, bookkeepers and even business coaches too often fail to see the bigger, more accurate picture. 

And this has never been more important than during lockdowns, where a potential building industry shutdown could smash cash flow and all but wipe out any remaining margins. 

As Russ explained during the webinar: 

“I would say there is a 95% chance that your accountant is not producing accurate year-end financial statements for your building company and, as a consequence, if you are a new-home builder, then you’ve probably been paying too much in taxes.”  

Your bank balance might look great, but it’s important to remember that home building is generally a cash flow positive activity for builders and the bulk of that cash is OPM: Other People’s Money. 

Understand the numbers the underpin your construction business

It can be hard to see an accurate picture of the financials when you’re still yet to receive invoices from a concreter for the slab he poured six weeks back. Another factor could be if the initial client invoices were heavily front-ended – specifically to help with cash flow at the beginning of a project.  

 According to research carried out by The APB, 81.5% of building companies owe far more than they realise, meaning they’re likely paying more tax than they should. Remember, the healthy-looking incoming revenue amounts appearing in the credit column are still waiting to cover costs, and debts are yet to appear on the spreadsheet. And paying too much tax, of course, reduces the cash reserve on hand to pay the invoices when they do eventually come in. So, just like that, your problems are compounding. 

“You need to know exactly where you are right now financially before you can then look ahead and plan to the future, because better information leads to better decisions,” explained Russ. 

“Once you know where you are financially, you can start planning your future. And that means creating a business plan that covers your key performance indicators.” 

The key numbers to watch like a hawk, are: 

– Sales revenue 

– Profit and gross margin percentage 

– Fixed expenses and fixed expenses as a percentage of revenue 

– Net margin and net margin percentage 

– Equity 

– Cash on hand 

Work-in-progress figure 

A small building company with annual revenue of $6 million will typically have an actual work-in-progress figure between $500,000 and $1 million. Knowing this number is vital in ensuring you manage how much cash you have on hand to cover the ebb and flow of your debts and expenses. 

And if your equity figure is not growing month-on-month, then you’re losing money. 

Following the money

Monitoring these and the other numbers in Russ’ list lets you identify inefficiencies and red flags and allows you to take swift action when you see things going in the wrong direction. Making improvements might mean better allocation of resources, planning and managing future revenue, and tightening things up to remain profitable. 

“Normally this would be done monthly, but right now, with things changing so quickly, it’s a really good idea to keep an eye on them weekly,” Russ advised. “And it’s not hard to do when you’re using advanced software like Buildxact, that enables you to record your budget and your actuals – software like that has never become more important.” 

“I would urge you to be using all the features that Buildxact has to offer you guys, because you need it now more than ever.” 

For more on this and why these figures are so essential to understand and monitor, watch this informative webinar section here.

Take action now

Hundreds of APB member builders around the world have already benefited from the above techniques and strategies and helped ward off the financial consequences of the ongoing pandemic. 

And while Australia has been luckier in some ways compared to other nations in how COVID-19 has directly impacted the building sector, you must start taking steps now to ensure a profitable and prosperous future for your construction business. 

Buildxact’s comprehensive and easy-to-use software can help you get on top of your figures, so you know where your business stands. From there, you can make the right choices for your business now and for many years to come. 

To learn more about Buildxact, sign up for a 14-day risk-free trial. Or, if you’d prefer to talk with one of our team members, book a 1:1 demo. 

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