What is your ratio?

Purchasing is at the center of any home building business. As a purchasing professional, you are expected to possess a high degree of business acumen and know your operation’s costs so you can be a good steward of the company’s financial resources. But how do you really know if you’ve made a good deal? Certainly, the competitive bid process is an indicator, but you can more precisely determine if your costs are in line by knowing your purchasing ratios—a deeper and more accurate dive into what you typically pay for specific materials and labor. There are many types of purchasing ratios. The two most common are trade cost as a percentage of vertical construction costs and commodity cost drivers as a percentage of the finished materials you use to build your homes.

THE TRADE CODE RATIO

A purchasing ratio based on trade codes is one I use a lot. Trade codes are the aggregate costs for each trade category (foundations, framing, electrical, etc.), ideally broken down into four buckets:

? Material quantity at a SKU level

? Material cost at a SKU level

? Labor rates

? Standard labor hours to perform the scope of work for each labor rate.

That level of detail isn’t always possible, so do the best you can. Obviously, if you haven’t already mapped your cost codes to their designated trade codes, you’ll want to do that before you run this report. Here’s a step-by-step process to determine a meaningful and useful trade code purchasing ratio.

STEP ONE: Run a trade code report for all of your floor plans and their elevations, as well as all of the communities within each market you serve.

STEP TWO: Sort the trade code report information by product type (single story, two story, attached, detached, etc.) and specification level (first-time buyer, move-up, luxury, active adult). This step is critical to compare costs across similar product. The cost per square foot for a condo unit will be very different from that of a large, luxury, single-family detached home. Simply knowing the difference is of little value; the real value comes when you compare multiples of each product type and across communities and markets at a trade-code level.

STEP THREE: Set up a separate worksheet for each product type. In a perfect world, you will have several communities of comparable specification levels for each type, as the simplification and standardization (or not) of your specifications will come to light. How many different specifications do you really need for each product type and buyer profile? I know builders that use different specification levels for each of their communities, as if they’re building those houses for the first time. In reality, they’re throwing all of the knowledge from a previous project of the same type out the window and starting over with each new community. That’s inefficient ... and dumb. For those of you with the discipline to standardize your specifications across each of your product lines, your purchasing ratios will be both easier to calculate and more meaningful

STEP FOUR: In each product type worksheet, divide each trade code cost by the square footage of each plan. Use the rows in the spreadsheet to designate the trade code. For example, electrical labor in one row and electrical material in another (if you don’t have your costs broken down into that level of detail, just use your turnkey cost). All of your vertical construction costs should be categorized to a trade code. Purchasing ratios shouldn’t include land. The amount of land on a lot will affect your landscaping, final grade, flat work, and other costs, so try and group similar size lots together under the same specification.

STEP FIVE: Within each worksheet, calculate your average cost per trade-code row. Also, calculate your minimum and your maximum costs in each row. You can use conditional formatting within Excel to highlight the cell that’s the highest cost or the lowest cost in a given row. You now know your cost range from least to most (or vice versa), as well as the average cost at a trade-code level for each product and specification.

STEP SIX: Analyze the results. There will surely be some aha moments where you can’t easily explain why a cost is particularly high or low, exemplifying the limits of a competitive bid process. Sure, you went with the lowest qualified bid, but did you still pay too much? Knowing and referring to your purchasing ratios would have been a good start to evaluating future bids.

See the rest of the article in Professional Builder magazine.