5 key milestones for gross margin calculation
Posted on behalf of Stuart Siegel, Cornerstone Solutions
Traditionally builders tend to calculate their gross margins in the following way:
Milestone 1 – original proforma
- Original plan designed, including cost estimates (Community XYZ, Plan 1A)
- Assumptions and values are stored in a file for historical purposes and future comparisons.
- Calculate expected margins and returns for the Community at large and the plans to be built.
However, if you extract data at certain milestones during the build, you can quickly see where your gross margin is eroding and make real time adjustments to your processes. Milestones 2, 3 and 5 show the additional intervals where builders should also be calculating their margins.
Milestone 2 – Initial Release for Construction (Issue POs)
You decide to build a Plan 1A and issue Purchase Orders to your suppliers and vendors. When you release your Purchase Orders you may find your revised estimate is greater than your proforma. .
This milestone provides the builder with the opportunity to generate a revised gross margin calculation which can be compared against the original proforma. At this point the builder should have a better understanding of anticipated revenue and costs.
This updated data can be applied to future projects immediately.
Milestone 3 – Sales Contract with Options
Once your buyer is on board, they can purchase structural and designer options. These buyer decisions have an impact on the bottom line which is reflected in the revised gross margin at the time of sale.
So, now you have a base house, land, indirect costs, and options pricing. You have a revenue figure and a cost to build.
At this milestone, we recommend that the builder calculates a revised gross margin which includes options and incentives. It should be compared to the previous calculations in Milestones 1 and 2. . It should also be stored and easily accessible for further analysis.
Milestone 4 – Hand Over
The house has been built and you’ve handed the keys over to the new owners. This is what most builders consider to be the close out for the home and the final gross margin calculation to determine their profit. In my experience, homebulders record costs after a home has been “closed” due to Variance POs, late invoices, and unrecognized price increases.
Here, you should calculate your gross margin again to compute the cost of sales for the closed home. This margin should be compared to the previous milestones. Builders should include narratives to provide explanations for the increased costs, unforeseen incentives, and sales price adjustments. This information should be used in real time for other homes.
Milestone 5 – Hard Close
This one is crucial and is so often overlooked. Six months after the keys have been handed to the buyer, all bills should now have been paid and reconciled. You have a true reflection of the cost of sales – including the invoices the superintendent had in his vehicle for 3 months after the handover occurred.
We recommend a final margin calculation to determine the true profit for a home. In my experience, many builders find that their margins have eroded by 5 – 8% in the six months following the handover due to poor processes and inefficiencies.
NEXT: So now that you know how to check that your gross margin is accurate, what other factors do you need to consider for continued profitability?