Smart Decisions vs. Short-Sighted Accounting

As a business owner and former CPA, I know how important good bookkeeping is to running a business. However, it is frustrating to see some of my clients make short-sighted decisions because of project-based accounting. Here are some examples that I hope will help you change your business for the better:

1. Spending Now to Benefit the Future: The large builders usually spend the money necessary to improve their floor plans and processes. Personally, I don't think they do it because they are smarter than small builders, but they do it because they don't have a project-specific construction lender or equity partner to answer to. Do your banks, joint venture partners or CFO allow you to conduct useful research on a community for use on your next community, or must all dollars be spent only for the benefit of each community? For example, do you survey the prospects on your interest list for design knowledge that you can use on future projects in that market?

2. Unadjusted Risk: You don't expect the same return on your personal investments in stocks as you do on Treasury bills, so why would you treat your communities or divisions the same way? Do you have a sliding scale of target profit margins or returns based on the risk associated with each land acquisition, price point or market, or do all deals need to meet a certain criteria established by accounting-types (including bankers and equity partners)? Here are four situations I came across recently:

1. Uniform Cost of Capital: I recently discovered that a large builder charges the same cost of capital to all divisions, regardless of the risk that division is taking. Does that make sense?

    

2. Corporate Comparisons: I have a client who was criticized by corporate for achieving excellent, but below average, returns in comparison to another division - yet the other division had booked more than 50% of their profit from land development risk. Does that make sense?

    

3. Equity Partner Returns: One of my clients' equity partners has a target return on equity they expect to achieve, and they underwrite each deal based on the target return, regardless of the risk associated with each deal. Therefore, my client shoots for the highest risk deals because they have the greatest upside. Does that make sense?

    

4. Target Profit Margins: Several of my clients paid huge bonuses to division executives who were lucky enough to be in high-risk, high appreciation markets. Did they perform better than their peers? Were they subjecting the company to greater risk?

Although the very large builders spend a small fortune on accounting systems, their "pooled capital" approach to each project often allows them to make some smarter long-term decisions. Their uniform approach to capital allocation, however, encourages risk-taking. Please take risk into consideration in all that you do.

Smaller builders are subject to the short-sighted accounting of their banks and equity partners. Those builders who take a long-term view to running their business and treat each dollar like it is their own usually end up with the greatest success. If you're lucky, you can convince your banks and equity partners to help fund your future success - and their future success.

John Burns publishes three free Building Market Intelligence e-mails each month: U.S., Local and Strategic. He helps real estate executives develop and execute strategic plans, conduct market research and maximize profitability.