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Targeting Financial Ratios

Simplify the route to double-digit builder profitability with a set of financial ratios that target cost control

Bill Lurz, Senior Editor
August 22, 2006
HousingZone

Target   Typical Sale price 100.0%   100.0% Cost of sales 70.0%   78.0-85.0% Gross margin 30.0%   15.0-22.0% Indirect construction costs 3.5%   5.0-6.0% Financing expense 4.0%   3.0-7.0% Marketing expense 6.0%   5.0-10.0% General administrative expense 4.5%   4.0-7.0% Total operating expense 18.0%   16.0-22.0% Net profit 12.0%   3.5-5.0%

Colorado-based management consultant Chuck Shinn simplifies the route to double-digit builder profitability with a set of financial ratios that target cost control. In this space over the next six months, we'll detail each ratio - and Shinn's pointed advice about how to hit the target.

"Step one is to stop blaming your lack of profitability on the market, and focus instead on home and option pricing, reducing construction costs and maintaining balance between sales volume and operating costs," Shinn says. "By setting the right price to reach targeted sales velocity, controlling the cost of sales (land and construction) and keeping operating costs proportionate to sales volume, you can reach our target of 12% net profit. Many builders, in fact, far exceed that target."

Shinn cautions that builders who develop land should treat that as a separate business, capturing land profit separate from home building, so they don't unknowingly subsidize inefficient building operations with land profits. This table shows how Shinn's target financial ratios compare to the range he says typical builders actually achieve.

Next month, we'll break down the cost of sales into targets for land and direct construction costs.
See: Price to Hit Your Velocity Targets

© 2008, Reed Business Information, a division of Reed Elsevier Inc. All Rights Reserved.

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