Builderpulse: A Financial Health Check to Ensure Capacity, Quality, and Sustainable Growth in Construction

Introduction

In our previous post, we highlighted the importance of improving quality in residential construction by implementing stricter quality control measures like mandatory Inspection and Test Plans (ITPs) and a demerit point system for non-compliance. But ensuring the success of a construction project isn’t just about quality—it’s also about making sure the builder is financially capable of delivering what they promise.

Enter the Builderpulse metric, a method of financial due diligence that helps assess a builder's viability before signing a contract or transferring any money.

The Builderpulse metric empowers both builders and consumers by offering a clear financial snapshot of a builder's health and capacity. In this post, we'll show how builders can use the Builderpulse tool to assess their financial stability, demonstrate a commitment to transparency, and build consumer confidence.

We'll also provide a downloadable spreadsheet to simplify these calculations, allowing builders to evaluate different scenarios and make informed decisions about project capacity.

The Importance of Financial Literacy and Education for Sustainable Building

In the construction industry, many businesses are so focused on managing daily operations and staying afloat that they don’t take the time to fully understand their financial capacity. The mindset often becomes, "get while the getting is good," especially when demand exceeds supply, as we saw during COVID-19.

Builders took on more projects than they could handle, driven by opportunism and greed. To prevent this in the future, we believe that all builders should be required to participate in RTO-provided courses on cash flow forecasting, financial assessment, and quality management system creation and utilisation as part of keeping their licenses active.

The goal of improving financial management and quality management is to help builders deliver higher-quality homes with fewer headaches.

If we don't continue to educate ourselves, we limit our potential for growth, holding onto outdated practices at the cost of progress and a better future. Investing in financial literacy and quality management makes building easier, more efficient, and ultimately more rewarding.

Introducing Builderpulse, the second part of our "one-two punch" solution to the residential construction quality crisis. The first punch, as we detailed thoroughly in our last post (the link below), which discusses implementing quality management systems, mandatory ITPs, third-party oversight, and a demerit point system for accountability (think: a compliance enforcement mechanism).

Construction Quality Issues: When Is Enough, Enough?

Residential construction quality in Australia often falls short, leaving home owners “holding the bag”. In this post we discuss the need for stricter quality control, including mandatory ITPs and a demerit point system, to improve accountability and ensure compliance with NCC and Standards.

ConstructorAnthony Painter

The second punch is Builderpulse—a straightforward yet powerful metric that uses real-time financial reporting to assess the health and capacity of residential building companies, ensuring they can deliver quality projects without overextending. Builderpulse is the name we give to the overall metric or rating calculated using the tool. Throughout this post, we use the terms "Builderpulse" and "Builderpulse Metric" interchangeably, but they both refer to the same concept.

My Initial Attempt To Talk To The QBCC About This

The regulatory authorities in each state—the ones responsible for issuing builder’s licenses—are in the best position to administer this tool.

Last year, I contacted the Queensland Building and Construction Commission (QBCC). While they acknowledged receiving my email (included below), I haven’t heard back since. I understand they have a lot on their plate, but without meaningful engagement, how can things improve? I don’t expect large organisations to generate ideas like this—that’s exactly why I reached out to them about the BPM.

Some might say, "You're just being naive, Anthony." Well, if that’s the case, what’s your position, what ideas say you?

What are your constructive, tangible ideas—ones that aren’t self-serving — to stop customers from being left high and dry by irresponsible builders? It’s easy to spot when people are making too much money from a sector—it attracts the conmen looking for a quick buck.

Take the WA-based builder who sublet their operation to another builder. The fine they received was a joke compared to the profit they made off the customers they misled.

The Need for Real-Time Financial Reporting with Builderpulse

One of the major challenges in evaluating a builder’s financial stability is the time lag in regulatory financial reporting. Currently, financial data for private companies is reported up to 12 months in arrears, meaning that the information available to consumers is often outdated and may not reflect the builder's true financial position at the time of contract signing​. As a result, consumers face significant risk when committing to a contract with a builder whose real-time financial health is unknown.

For example, reports such as the D&B (Illion) Financial Valuation Assessment Report provide some insight into a company's payment risk and overall financial health; however, this information cannot fully replace detailed financial disclosures​.

Commercial financial assessments like an FVA (Financial Valuation Assessment) are available, but they are typically available only to businesses rather than individual consumers, and private companies are not legally required to make their financial information public (or to the credit reporting agencies such as Illion who compile FVA​.

This means that consumers are left with little more than a builder’s sales pitch, unable to validate the promises made with qualified financial information.

This is where Builderpulse comes into play. Unlike the traditional, infrequent reporting required by regulations,

Builderpulse utilises real-time data reporting, submitted and verified by the builder's financial representative—be it a CFO, accountant, or bookkeeper.

This data captures the true status of the company’s balance sheet, providing a validated snapshot of financial health and project capacity.

Accountability must be mandatory, and there should be clear repercussions for companies that fail to disclose accurate financial information. Consumers deserve transparency—they have the right to know if their builder is a financially healthy company or a "zombie" entity, barely surviving while feeding on their hard-earned money.

Builders operating as "zombies" pose a significant risk, as they continue taking on projects despite being financially unstable, ultimately leaving consumers vulnerable.

Proper disclosure ensures that these financial "zombies" are held accountable, protecting consumers from potential losses.

What is the Builderpulse Metric?

The Builderpulse metric is a financial health metric tailored specifically for residential builders. It aims to evaluate how well a builder can manage their current projects and whether they have the capacity to take on more work without risking their financial stability.

Much like a physical health check-up, the Builderpulse offers a financial "pulse" that provides insight into liquidity, profitability, and overall business resilience.

With growing concerns over builder insolvency and construction quality issues, the Builderpulse metric was designed to restore consumer confidence by adding a layer of financial transparency. By evaluating the financial viability of builders, consumers can make informed decisions, and builders can position themselves as trustworthy and reliable partners.

Key Components of the Builderpulse Metric

To properly assess a builder’s capacity, the Builderpulse metric considers several financial metrics. Below, we'll look at each component. The (%) in brackets is the weighting applied to the component in the calculation of the metric.

1. Liquidity Buffer (40%):
   • This component measures how many months of operating expenses can be covered by the builder’s available cash (Current Assets). Builders should aim for at least a 3-month liquidity buffer to ensure stability during slow periods or unexpected setbacks.
   • Why It Matters: A sufficient liquidity buffer provides a safety net to manage operating costs even if progress payments are delayed.
2. Gross Profit Margin (20%):
   • This assesses whether the builder is achieving enough profit after direct costs (materials, labour, etc.) to sustain and grow the business.
   • Target: Builders should aim for a gross profit margin of at least 23% to comfortably manage indirect costs and make a healthy profit.
   • Why It Matters: High profit margins provide builders with flexibility to handle increased costs, improve quality, and invest in future growth.
3. Operating Cash Flow Stability (20%):
   • This evaluates the cash generated from business operations over the past four quarters.
   • Why It Matters: Positive cash flow means that the business can cover its obligations without relying on external financing, which keeps the company stable and self-sufficient.
4. Stress-Tested Capacity (10%):
   • Builders are tested for their resilience against stress scenarios such as increased costs, delays in payment, or reduced supplier credit terms.
   • Why It Matters: This ensures that a builder can still operate comfortably under unexpected adverse conditions, giving both the builder and consumer peace of mind.
5. Trade Payables to Subcontractors (10%):
   • This measures how dependent the builder is on subcontractor trade credit. Lower dependence implies better cash flow management.
   • Why It Matters: Too much dependence on subcontractor credit indicates financial stress and can lead to cascading issues if payments are delayed.

How to Calculate Your Builderpulse Metric

The Builderpulse tool includes a downloadable spreadsheet where builders can input their current financial data to assess their financial health. Here’s a simple overview of the steps to follow:

1. Input Key Financial Figures: Enter values for your current assets, current liabilities, operating expenses, projected costs per house (COGS), and more.
2. Calculate Metrics:
   • The tool will automatically calculate critical metrics like the Liquidity Buffer (in months), Gross Profit Margin, and Maximum Number of Houses you can build.
3. Assess Your Metric: The spreadsheet will generate your Builderpulse metric using weighted metrics. Aim for a metric above 3.0 for a healthy status. If below 2.0, focus on building liquidity and improving profit margins before taking on additional projects.

How to Use the Builderpulse Metric for Growth and Risk Management

The Builderpulse not only helps builders understand their current capacity but also acts as a roadmap for growth:

• Managing Capacity: By knowing how many houses you can realistically build without overextending yourself, you avoid the common pitfall of over commitment. Builders often face financial duress when they take on more projects than their cash flow can handle, leading to missed payments, penalties, and, ultimately, a risk of insolvency.
• Planning for Expansion: If you're looking to grow, the Builderpulse can guide you on what conditions need to be met before expansion. For example, you might need to increase liquidity or improve profit margins before committing to more projects.

Why Continual Financial Assessment is Key to Quality Construction

As we discussed in our previous post, quality management in residential construction cannot be compromised. Quality is deeply intertwined with financial stability—if a builder is financially stretched, cutting corners on quality might be their only option. Continual financial assessments through Builderpulse can prevent this:

• Regular Evaluations: Builders should evaluate their Builderpulse monthly or before taking on new projects. This helps ensure that they have sufficient resources, are not overcommitting, and are capable of maintaining quality standards.
• Consumer Trust: For consumers, demanding a Builderpulse from builders before signing a contract provides an extra layer of due diligence, assuring them that the builder has the financial capacity to complete their project.

How to find your builderpulse!

To create the Builderpulse metric for evaluating the financial position of residential builders, we need to select key balance sheet items that reflect both the company's solvency and capacity accurately. Below are the balance sheet items used to develop this metric, along with the rationale behind each:

1. Current Assets

• Cash and Cash Equivalents: Cash is crucial for covering short-term obligations, especially progress payments to suppliers and subcontractors. A builder’s liquidity directly reflects their ability to manage ongoing projects, meet payroll, and sustain operations, especially during high-expense stages like lockup and fixing.
• Accounts Receivable: This shows outstanding progress claims to clients. A high level of overdue receivables can indicate cash flow issues, as it suggests a significant amount of cash is tied up, unavailable for operations.
• Work in Progress (WIP): WIP measures the value of ongoing projects and their costs. If WIP is significantly greater than cash or other liquid assets, it may suggest that the company is over-extended, posing a liquidity risk.

2. Current Liabilities

• Accounts Payable: This represents short-term obligations owed to suppliers and subcontractors. If accounts payable exceed current assets, it indicates potential solvency issues and difficulty in meeting short-term obligations.
• Short-Term Debt: Short-term borrowing indicates reliance on debt to finance daily operations. High short-term debt may signal cash flow constraints and a need to borrow to maintain liquidity.

3. Long-Term Liabilities

• Loans and Other Long-Term Debt: A significant amount of long-term debt creates ongoing financial obligations that require consistent cash flow. The ability to service this debt is crucial for long-term stability.
• Deferred Revenue: Deposits and prepayments from clients represent deferred revenue. While this may indicate upcoming projects, spending these funds before making sufficient progress can create cash flow issues down the line.

4. Equity

• Owner’s Equity/Retained Earnings: High retained earnings reflect accumulated profits over time, a sign of financial health. On the other hand, negative retained earnings suggest prolonged financial struggles.

5. Other Considerations

• Net Working Capital: The difference between current assets and current liabilities helps gauge liquidity. A positive working capital is essential to meet short-term obligations smoothly.
• Debt-to-Equity Ratio: This ratio indicates the company’s dependence on external debt versus internal funding. A high debt-to-equity ratio may suggest the builder is heavily leveraged, increasing the risk of overextension during economic downturns.
• WIP vs. Billing: Comparing WIP to progress billing provides insight into whether the builder is over-committed. A high WIP with low billing suggests that more work has been committed than the current financial capacity allows, indicating potential cash flow issues.

Integration into the "Builderpulse" Metric

The Builderpulse metric integrates these elements into a scoring system, with each category weighted according to its impact on solvency and capacity:

• Liquidity Score: Evaluates cash, accounts receivable, and work in progress (WIP) against current liabilities to assess the builder's ability to fund ongoing operations. A higher liquidity score indicates a strong short-term financial position.
• Solvency Score: Analyses long-term debt, equity, and the debt-to-equity ratio to determine long-term financial health. This score measures whether the builder has sustainable leverage and a stable financial structure to support ongoing projects.
• Capacity Score: Assesses WIP and deferred revenue in relation to the average progress payment cycle (based on the Residential Building Contract breakdown) to evaluate if the builder has enough capacity to complete ongoing work without overextending resources.
• Normalised Operating Cash Flow (OCF) Score: Incorporates the operating cash flow as a percentage of total revenue, capped at a maximum value of 1. This score evaluates how effectively the builder generates cash from ongoing operations, providing a measure of the builder's ability to manage cash flow. A normalised approach prevents overly large OCF values from distorting the Builderpulse Score.
• Stress-Test Score: Evaluates the builder's resilience under adverse conditions, including a 15% increase in input costs, a 30-day delay in build times, and a reduction in supplier credit terms to 15 days. This score indicates whether the builder can sustain operations without severe financial strain if unexpected challenges arise.
• Contagion Risk Score: Measures the reliance on subcontractor credit by calculating the Contagion Risk Ratio, which is the proportion of trade payables to subcontractors relative to current liabilities. A lower ratio indicates less dependence on subcontractor credit, reducing financial risk in times of market uncertainty.

Step-by-Step Builderpulse Calculation Guide

Step 1: Gather the Necessary Financial Information

You will need the following information from your balance sheet or income statement:

1. Current Assets: Cash, accounts receivable, inventory, etc.
2. Current Liabilities: Trade payables, short-term loans, and any other liabilities due within the next 12 months.
3. Average Monthly Turnover: Total revenue for the past year divided by 12.
4. Gross Profit Margin: Gross profit (total revenue minus cost of goods sold) divided by total revenue.
5. Operating Cash Flow (OCF): Cash generated from normal business operations over the last four quarters.
6. Trade Payables to Subcontractors: The portion of your current liabilities that are payments due to subcontractors.
7. Liquidity Buffer Target: How many months of operating costs you want in reserve. Typically, a minimum of 3 months is recommended.

Step 2: Calculate Each Component of the Builderpulse

1. Liquidity Score (Weight: 40%)
   • Liquidity Ratio: Measures your ability to cover short-term obligations.
     • Formula: Liquidity Ratio=Current Assets/Current Liabilities
   • Liquidity Buffer Ratio: Measures how many months of operations you have in reserve.
     • Formula: Liquidity Buffer Ratio=Current Assets/Average Monthly Turnover​
   • Scoring:
     • If your liquidity buffer is 3 months or more, use the liquidity ratio directly.
     • If the liquidity buffer is less than 3 months, deduct 0.2 points from the liquidity score.
2. Profit Margin and Cost Pressure Analysis (Weight: 20%)
   • Gross Profit Margin: Assesses your ability to absorb rising costs and maintain profitability.
     • Target: Aim for 23% or higher.
     • Formula: Gross Profit Margin=Gross Profit/Total Revenue
   • Scoring:
     • If your gross profit margin is 23% or higher, score 1.
     • If between 20-23%, score 0.8.
     • If below 20%, score 0.5.
3. Operating Cash Flow Stability (Weight: 20%)
   • Quarterly Operating Cash Flow: Assess whether your business generates enough cash each quarter.
   • Scoring:
     • Count the number of quarters with positive cash flow in the last year.
     • Score: Operating Cash Flow Score=(Number of Positive Quarters/4)×1
4. Stress-Tested Capacity Score (Weight: 10%)
   • Performance Under Stress Scenarios:
     • 15% Increase in Input Costs: Determine if you can still be profitable.
     • 30-Day Delay in Build Times: Assess how this impacts cash flow.
     • Reduction in Supplier Credit Terms: Assess how reducing credit terms to 15 days affects liquidity.
   • Scoring:
     • If you can manage all scenarios without financial distress, score 1.
     • If any scenario causes distress, deduct 0.5 points for each negative result.
5. Contagion Risk Component (Weight: 10%)
   • Trade Payables to Subcontractors: Measure your reliance on subcontractor credit.
     • Formula: Contagion Risk=Trade Payables to Subcontractors/Current Liabilities
   • Scoring:
     • If below 30%, score 1.
     • If between 30-50%, score 0.5.
     • If above 50%, score 0.2.

Step 3: Calculate the Final Builderpulse

Use the following formula to determine the final Builderpulse:

Builderpulse Score=(Liquidity Score×0.4)+(Profit Margin Score×0.2)+(OCF Score×0.2)+(Stress-Test Score×0.1)+(Contagion Risk Score×0.1)

Step 4: Interpret the Builderpulse (see below for additional discussion on this point)

• Score > 3.0: Healthy. You are in a strong financial position and can consider taking on more projects if market conditions are favourable.
• Score between 2.0 and 3.0: Moderate Risk. You are doing well but should be cautious about taking on more projects without improving liquidity or profit margins.
• Score < 2.0: High Risk. You are at significant financial risk and should avoid overcommitting. Focus on stabilising cash flow, reducing reliance on credit, and improving profit margins.

Step 5: Determine the Optimal Number of Houses to Build

1. Determine Cash Availability:
   • Available Liquidity = Current Assets - Current Liabilities.
2. Calculate Cash Requirement per House:
   • For each new house, you need 20% of the contract value in liquidity as a buffer.
   • Example: If the contract value is $325,000: Cash Requirement per House=0.20×325,000=65,000
3. Calculate Maximum Capacity:
   • Example: If Available Liquidity is $10,000,000: Maximum Number of Houses=10,000,000/65,000≈154 houses
4. Adjust for Risk Level:
   • If your Builderpulse is below 3.0, reduce the number of houses to avoid overcommitting.
   • For a BPM below 2.0, reduce the number of houses by at least 25% to prevent overextension.

Additional Discussion on Interpretation of BPM

The Builderpulse is designed as a metric that captures various aspects of a builder's financial health. The scoring range is defined to help builders assess their current position and make informed decisions about their capacity and risks. Here is the reasoning behind it:

1. Metric Above 3.0: Healthy

A metric above 3.0 is considered healthy because it indicates that the builder is in a strong financial position across multiple critical factors:

• Liquidity: A high liquidity score indicates that the builder has enough current assets to comfortably cover short-term liabilities, which means they are well-positioned to handle ongoing costs without risking insolvency.
• Profit Margins: A gross profit margin above 23% suggests that the builder has sufficient profit after covering direct costs (materials and labour). This allows the builder to cover indirect expenses, absorb cost fluctuations, and maintain profitability.
• Cash Flow Stability: Positive operating cash flows across multiple quarters indicate that the builder is generating enough cash from regular operations, which ensures business continuity and the ability to meet financial obligations.
• Stress-Test Resilience: The builder can manage adverse market conditions, such as cost increases, build delays, or reduced credit terms, without experiencing significant financial distress.
• Low Contagion Risk: Low reliance on trade credit from subcontractors minimises the risk of cascading financial trouble in case of disruptions.

A metric above 3.0 implies that the builder is not only stable but also resilient enough to handle increased workloads or adverse market conditions. This financial robustness means that expanding capacity or taking on more projects is feasible without undue risk.

2.Metric Between 2.0 and 3.0: Moderate Risk

A metric between 2.0 and 3.0 is considered moderate risk because, while the builder may be in a reasonably stable position, there are some areas of concern:

• Adequate Liquidity but with Caveats: The builder may have sufficient liquidity to cover liabilities, but the liquidity buffer may be just at or below the recommended 3 months. This leaves less margin for handling unforeseen cash needs.
• Lower Profit Margins: A gross profit margin below 23%, but still acceptable (e.g., 20-23%), suggests that the builder is somewhat vulnerable to cost increases, which could potentially erode profitability, especially if costs increase unexpectedly.
• Mixed Cash Flow Performance: If the builder has some quarters with negative operating cash flows, it indicates that there could be periods where cash flow is strained. This poses a risk of cash shortages, especially if there are delays in project payments.
• Stress-Test Challenges: Moderate risk indicates that while the builder may manage some adverse scenarios, there could be issues if multiple unfavourable conditions occur simultaneously.
• Contagion Risk: A moderate reliance on subcontractor trade credit (e.g., 30-50% of current liabilities) means that the builder could be at risk if payments to subcontractors are delayed, leading to cascading problems within the supply chain.

A metric in this range suggests that the builder should exercise caution. Expanding capacity or taking on more projects should only be done after improving financial health—such as increasing liquidity, boosting profit margins, or stabilising cash flow.

3. Metric Below 2.0: High Risk

A metric below 2.0 is considered high risk because it indicates significant vulnerabilities in the builder's financial position:

• Insufficient Liquidity: Low liquidity suggests that the builder may struggle to meet short-term obligations, leading to potential cash flow issues and an increased risk of insolvency.
• Low Profit Margins: A gross profit margin below 20% indicates insufficient profitability to cover both direct and indirect costs comfortably. This leaves very little room for absorbing cost increases, delays, or unexpected expenses, and poses a serious risk to the builder’s sustainability.
• Inconsistent or Negative Cash Flow: If the builder consistently has negative operating cash flows, it means that they are not generating enough cash from operations to sustain the business, leading to a reliance on borrowing or other financing methods to cover expenses.
• Stress-Test Failures: Inability to withstand adverse conditions (e.g., increased costs, reduced credit terms) without experiencing financial distress indicates that the builder is very vulnerable to changes in the market environment.
• High Contagion Risk: A high reliance on subcontractor trade credit (above 50% of current liabilities) increases the risk that financial trouble will spread through the supply chain, leading to further challenges in managing costs and completing projects.

A metric below 2.0 suggests that the builder is in a fragile financial state and is at significant risk of becoming insolvent if any unfavourable conditions arise. Builders in this range should avoid taking on additional projects and focus on improving financial stability—such as reducing costs, improving cash flow management, and increasing liquidity—before considering expansion.

20% contract value liquidity - why is this so?

The assumption that a builder will need 20% of the contract value in liquidity is based on several factors that reflect the needs of the residential construction industry, particularly when starting a project.

This liquidity serves as a financial buffer to ensure smooth project execution and reduce financial risk. Here are the main reasons behind this assumption:

1. Upfront Costs and Initial Expenses

• Mobilisation Costs: When a construction project begins, a builder incurs significant upfront costs before they can request progress payments from the client. These costs can include site preparation, labour mobilisation, permits, and initial material purchases.
• Early Stage Expenses: Typically, 20% of the contract value is considered a reasonable estimate to cover these initial expenses before reaching the first payment milestone. For example, a deposit (usually 5% of the contract value) is often paid by the client at contract signing, but the builder will still need to cover costs until additional progress payments are made.

2. Cash Flow Management

• Delay in Progress Payments: Residential building contracts are usually structured with a series of progress payments, tied to the completion of specific stages (e.g., base stage, frame stage, lockup). However, delays can occur due to weather, labour shortages, or other reasons, which means that builders may need sufficient liquidity to cover costs if progress payments are delayed.
• Working Capital: Builders need working capital to continue operations smoothly between payment milestones. The 20% liquidity buffer helps cover working capital requirements, ensuring that the builder can pay suppliers and subcontractors without relying on credit or incurring debt.

3. Risk Management and Unexpected Costs

• Contingencies: Construction projects are inherently risky, with many potential variables—unexpected price increases for materials, changes in labour costs, or unforeseen site conditions. Having 20% of the contract value available as liquidity provides a safety net to absorb these unexpected costs without disrupting the entire project or running into cash flow issues.
• Mitigation of Financial Stress: Without sufficient liquidity, a builder is at risk of financial stress that can lead to delays, penalties, and in extreme cases, insolvency. The 20% liquidity ensures that the builder can absorb shocks, continue building, and avoid project stoppages or contractual penalties due to financial shortfalls.

4. Progress Payment Gaps

• Stage Payment Requirements: In a standard residential building contract, the client typically pays based on project milestones (e.g., base stage, frame stage). The payment structure often follows this breakdown:
  • Deposit: 5%
  • Base Stage: 10%
  • Frame Stage: 15%
  • Lockup Stage: 35%
  • Fixing Stage: 25%
  • Completion Stage: 10%
• Before the builder reaches each milestone and is eligible for a payment, they must fund the costs to achieve that milestone. For example, to reach the base stage, the builder incurs costs for excavation, laying the slab, etc., and might need more than the initial deposit to cover all expenses. Having 20% liquidity allows the builder to finance work between these payment milestones without relying entirely on incoming client payments.

5. Supplier and Subcontractor Payments

• Credit Terms: While many builders rely on trade credit (e.g., 30-day payment terms) to manage supplier and subcontractor payments, it's not always guaranteed or sufficient. Suppliers may shorten credit terms in times of economic uncertainty, requiring builders to make payments sooner than expected. The 20% liquidity buffer provides the financial flexibility needed to maintain relationships with suppliers and subcontractors even when credit terms change.
• Subcontractor Dependence: Subcontractors are often critical to project timelines. To keep subcontractors on the job and motivated, it is important for builders to pay them on time, even if progress payments from clients are delayed.

Gross Profit & Net Profit - what's the difference?

Gross profit and net profit are two different measures of a company's profitability, and they reflect different aspects of the company's financial performance:

1. Gross Profit

• Definition: Gross profit is the profit a company makes after deducting the costs directly associated with producing and delivering its products or services. These costs are typically known as Cost of Goods Sold (COGS) and include expenses such as materials, direct labour, and subcontractor costs that are directly related to the production or construction process.
• Formula: Gross Profit=Total Revenue−Cost of Goods Sold (COGS)
• Purpose: Gross profit helps determine how efficiently a company produces its goods or services. It shows how much money is left from sales to cover operating expenses, taxes, interest, and ultimately to generate profit.
• Example: If a building company generates $1,000,000 in revenue from building homes and the direct costs of materials and labour (COGS) are $700,000, the gross profit would be: 1,000,000−700,000= $300,000
• Focus: Gross profit focuses only on the production costs, excluding other expenses such as administrative costs, marketing, or finance charges.

2. Net Profit

• Definition: Net profit, also known as net income or bottom line, is the profit that remains after all expenses have been deducted from total revenue. This includes COGS as well as operating expenses, taxes, interest, depreciation, and any other costs.
• Formula: Net Profit=Total Revenue−(COGS+Operating Expenses+Interest+Taxes+Other Expenses)
• Purpose: Net profit indicates the overall profitability of the company after considering all costs. It is an important indicator of a company’s financial health and its ability to generate profit after covering all its expenses.
• Example: Using the gross profit example above, if the company has additional operating expenses of $200,000, taxes of $30,000, and interest expenses of $20,000, the net profit would be: 300,000−(200,000+30,000+20,000)= $50,000
• Focus: Net profit provides a comprehensive view of the company's profitability and shows how much of the revenue actually becomes profit after all costs are considered.

Key Differences

1. Costs Included:
   • Gross Profit includes only the direct costs associated with production (e.g., materials, direct labour).
   • Net Profit includes all costs, both direct and indirect (e.g., administrative costs, taxes, interest).
2. Level of Profitability:
   • Gross Profit is a measure of how efficiently a company is producing its goods and services.
   • Net Profit is a measure of the overall profitability of the company after all expenses are accounted for.
3. Purpose:
   • Gross Profit helps assess production efficiency and cost management related to delivering products or services.
   • Net Profit helps assess whether the company is financially viable after considering all aspects of its operations.

Importance for Builders

• Gross Profit helps a builder understand if they are generating enough income to cover their direct costs, such as materials and labour. If gross profit margins are too low, it suggests problems with cost management or pricing strategies.
• Net Profit is crucial for determining if the business is profitable overall, after paying for all operational aspects. It indicates whether the builder is generating enough to sustain the business, cover debts, reinvest in the business, and generate returns for the owners.

Maintaining a healthy gross profit margin allows builders to cover operating expenses and remain financially stable. Without sufficient gross profit, it becomes challenging to cover overheads and make a net profit, leading to financial stress.

Example of Builderpulse

Download the BuilderPulse Tool Below and Play With The Numbers Yourself

Factors That Affect Financial Duress of A Building Company

1. Late Progress Claims

• Impact on Cash Flow: If progress claims are not paid on time, cash inflow would be significantly affected. The company must still pay suppliers, subcontractors, and overheads, increasing reliance on working capital.
• Borrowing Requirement: Late payments could force the company to use short-term borrowing, increasing interest costs and worsening the debt-to-equity ratio.

2. Extended Build Times

• Increased Costs: Extended build times mean more extended periods before achieving milestones for progress payments. The company would incur additional labour and overhead costs, directly impacting profitability.
• Delayed Revenue: Revenue from completed projects would also be delayed, causing further cash flow issues.

3. Changes in Supplier Credit Terms

• Reduced Credit Term: If suppliers reduce the credit period from 30 days to 15 days, the company would need to settle payments more quickly, reducing liquidity. The need for more immediate cash would mean fewer resources available for ongoing projects.

Other Market Factors That Could Negatively Impact Building Capacity

In addition to the above factors, several other market conditions could negatively impact the company’s ability to build:

Increase in Material Costs

• Inflation and Supply Chain Issues: Rising material costs due to inflation or supply chain disruptions can reduce profit margins, requiring more working capital to maintain the same level of production.
• Profit Margin Erosion: Increased costs without an increase in contract price could result in a loss.

Labour Shortages or Increased Labour Costs

• Wages: If labour costs increase (e.g., due to labour shortages), the staffing overhead would increase, placing pressure on cash flow and requiring adjustments to capacity.
• Availability: A lack of skilled labour would result in slower build times, increasing holding costs.

Changes in Market Demand

• Decrease in Demand: A decline in demand for new homes could leave projects partially completed, tying up capital in unsold properties and reducing liquidity.
• Increased Inventory Costs: Unsold completed houses would lead to higher inventory holding costs and increased pressure on cash flow.

Interest Rate Increases

• Higher Cost of Borrowing: If interest rates increase, the cost of using short-term debt or a financial facility will rise, increasing overall project costs.
• Impact on Buyer Financing: Higher mortgage rates could reduce buyers' purchasing power, leading to a slower sales cycle and increased inventory levels.

Regulatory Changes

• Building Codes and Compliance: Stricter building regulations or changes in compliance requirements could increase costs per house or slow down the build process, resulting in higher expenses and delayed progress payments.

Ways to improve liquidity, capacity, profit margins and risk management

Significant Increase in Working Capital and Cash Flow Management

• Additional Funding or Increased Equity:

• Equity Injection: To support an increase in output, the company would need an additional injection of capital, either through retained earnings, new investment, or a combination of both. This would provide the liquidity necessary to cover the increase in upfront costs and manage potential cash flow gaps.
• Financial Facility Expansion: Obtain a substantial credit facility to manage working capital needs. The facility would need to be flexible enough to provide cash for stages where expenses are high (e.g., Lockup and Fixing Stages).
• Increase in Net Working Capital:
  • Increase current assets significantly to maintain a liquidity ratio that ensures the company can comfortably meet its obligations. Net working capital should be sufficient to handle the ongoing expenses for the number of desired concurrent projects, considering higher requirements for materials, labour, and other costs.
• Efficient Progress Payments:
  • Implement mechanisms to accelerate progress payments from clients. This could involve offering incentives for early payments or negotiating payment schedules that align more closely with the builder’s cash flow needs.
  • Use of Escrow Accounts: Require clients to deposit funds into an escrow account at the beginning of the project. This would ensure timely payment for each stage, reducing the risk of cash flow issues. This option is not really an option given the various standardised residential building contracts used that dictate contract payments.

Risk Management for Market Changes

• Mitigate Risks of Late Payments:
  • To manage the risk of late progress claims, the company should implement strict payment monitoring and enforce late payment penalties where applicable. Establishing relationships with clients that have a strong credit history and using payment guarantees can reduce the likelihood of delayed payments.
• Buffer Against Extended Build Times:
  • Establish a contingency fund to cover the costs of extended build times. This contingency fund should be sufficient to cover labour and material cost increases in case of delays. People much wiser than I have espoused this position for quite some time now.
• Insurance and Hedging:
  • Consider insurance policies to protect against unforeseen events, such as extreme weather, that may cause project delays.
  • Price Hedging: Hedge against the price fluctuations of critical building materials to stabilise costs and reduce uncertainty.

Financial Management and Leverage

• Debt Management:
  • While leveraging debt can support growth, the builder should ensure that the debt-to-equity ratio remains manageable to avoid over-leverage. If debt increases substantially without a corresponding increase in equity, the financial risk would increase.
• Cash Flow Forecasting:
  • Implement robust cash flow forecasting to predict cash needs and ensure that sufficient liquidity is available to meet obligations at all times, particularly when managing a larger volume of projects.
• Use of Technology:
  • Adopt construction management software and Construction Project Management systems to improve project tracking, budgeting, and cash flow analysis. Improved oversight can help identify potential cash flow issues before they escalate.

Conclusion

Financial health and quality control are two sides of the same coin when it comes to successful residential construction. The Builderpulse provides a way for builders to transparently show their capacity and stability, ensuring that they are well-positioned to deliver quality work without overcommitting.

This method of continual financial assessment, combined with strong quality management systems and a demerit point system for compliance, is key to restoring consumer confidence in the industry.

By using the Builderpulse, builders can determine the optimal number of projects to take on, ensure they have sufficient liquidity, and identify areas for improvement. This post, along with our previous discussion on quality control, aims to offer a comprehensive approach to improving the construction industry—benefiting both builders and consumers.

BONUS: FINAL REPORT JUST RELEASED!

Bonus: You may not have seen this yet—the recently released Construction Integrity: Raising Standards Through Professionalism Industry Report. It’s a fascinating read, exploring the relationship between time, cost, and quality in a large construction company, with recommendations for improving the industry.

FAQs

1. What is the Builderpulse Metric (BPM)?
   1. The Builderpulse is a metric that evaluates a builder's financial health and capacity to handle projects without overcommitting. It is designed to ensure that builders have sufficient resources to complete ongoing projects.
2. Why is a Builderpulse important for consumers?
   1. It allows consumers to assess the financial stability of a builder before signing contracts, helping them avoid potential risks associated with financially unstable companies.
3. What data is needed to calculate the Builderpulse?
   1. You need information such as Current Assets, Current Liabilities, Total Revenue, Cost of Goods Sold (COGS), Average Monthly Turnover, and Contract Value per House.
4. How often should a builder calculate their Builderpulse?
   1. It is recommended that builders calculate their Builderpulse monthly or before taking on new projects to ensure they are not overcommitting.
5. How does Builderpulse help builders in managing project capacity?
   1. Builderpulse helps builders determine the maximum number of houses they can take on based on their available liquidity, allowing them to maintain quality and avoid financial strain.
6. What is the recommended gross profit margin for a healthy Builderpulse?
   1. A recommended gross profit margin is 23% or higher. This margin provides a buffer to cover costs and ensure profitability.
7. How can builders use the provided spreadsheet to calculate the Builderpulse?
   1. Builders can input their financial figures into the spreadsheet, which will automatically calculate their Builderpulse, assess liquidity, profit margins, and determine project capacity.
8. What happens if a builder's Builderpulse falls below 2.0?
   1. A metric below 2.0 indicates high financial risk. Builders should focus on improving liquidity, reducing reliance on credit, and avoiding over commitment.
9. Can new builders use the Builderpulse tool without historical data?
   1. Yes, new builders can use projections and estimated financial figures to calculate their Builderpulse and determine how many projects they can realistically handle.
10. How does the Builderpulse relate to quality management?
    1. Financial stability allows builders to focus on maintaining high-quality standards without cutting corners. A healthy Builderpulse Metric ensures that builders have enough resources to invest in quality management systems.