Episode 45: How Much Builders Should Pay Themselves With Russ Stephens

In episode 45 of the Professional Builders Secrets podcast, we’re joined by Co-founder of the Association of Professional Builders Russ Stephens. Throughout this episode, we go over exactly how much building company owners should be paying themselves.

 

Inside episode 45 you will discover

• How much the owner of a building company should pay themselves, and if they’re actually paying themselves enough
• The key measurments an owner needs to consider when allocating their salary
• How to calculate your true fixed expenses
• When you should start to become concerned about your finances
• How to become more proactive with your finances
• And much, much more.

Listen to the full episode to find out exactly how you can take control over your finances and pay yourself a salary you deserve, while not letting anything else slip.

 

Russ Stephens - Co-founder

Russ Stephens is a Co-founder of the Association of Professional Builders, a business coaching company dedicated to improving the residential construction industry for both builders and consumers. Russ is a data analysis expert who has introduced data-driven decision making to the residential construction industry. Russ is also a proud member of the Forbes Business Development Council.

Connect with Russ

 

Timeline

1:48 Builders don’t take a regular salary

3:10 Do builders pay themselves enough – and why not?

4:59 Should owners pay themselves first?

8:10 Designing a financial compensation plan

9:59 Why wages don’t fluctuate

11:26 Salary allocation, net profit and shareholder returns

13:13 Documenting owner’s salary payments

15:14 Factoring in true expenses

16:10 Accuracy and the WIPAA calculator

17:06 Key measurements to consider when paying the owner

18:19 Including incentives for the owner

19:47 How APB helps identify builders’ blind spots

22:04 Factoring in cash reserves

27:57 When to be concerned about your financial model

30:33 Becoming proactive with your finances

 

Links, Resources & More

Professional Builders Secrets Book

APB Website
APB on Instagram
APB on Facebook
APB on YouTube

Join the Professional Builders Secrets Facebook group for builders & connect with professional builders world-wide.

Russ Stephens:

The number one problem in small business is that the owners don't take a regular salary.

Bosco Anthony:

Do you feel that builders pay themselves enough?

Russ Stephens:

No. It's very important to pay yourself first. What would it cost to replace you?

Bosco Anthony:

I'm sure this answer is going to disturb a lot of builders out there.

Russ Stephens:

No one else is going to work as hard or as fast as you do in your own business.

Bosco Anthony:

Hello and welcome to the Professional Builders Secrets podcast, a podcast by the Association of Professional Builders (APB) for building company owners, general managers, VPs and emerging leaders. Here, we discuss all things running a professional building company, from sales processes to financials, operations and marketing. I'm joined today by Co-founder Russ Stephens for APB. Russ, it's great to have you here on the podcast again. Welcome.

Russ Stephens:

Thanks so much, Bosco. Great to be joining you again.

Bosco Anthony:

I'm really loving this topic today about how much builders should be paid. It's such a hot topic with everything that's going on, but before we get into it, I just want to know, why is it so important to create a financial compensation model for the residential building company owners out there?

Russ Stephens:

Well, I think the number one problem in small business is that the owners who work in the business don't take a regular salary. What that does is distort the fixed expenses, which then leads to them underpricing. It doesn't matter what business you're in. We're talking about construction and residential building companies, and it tends to happen generally in a lot of small businesses, but I've seen it affect the pricing in a residential building company more than any other business.

Russ Stephens:

Now, I think the theory is that it's tax efficient to just let your accountant figure things out at the end of the year. But here's the thing: as the owner of a residential building company, you've effectively got two roles. You are the director, and you are also the shareholder and you've got to be paid appropriately for both of those roles. Now, as a director, you need to be getting a market wage for what you are doing performing that role in the business. But as a shareholder, you need an ROI, a return on investment, from all the money that you are invested, and that ROI has got to align with the risks that are involved with lending money to a business.

Bosco Anthony:

Here’s a controversial question and I’m sure this answer is going to disturb a lot of builders out there, but do you feel that builders pay themselves enough?

Russ Stephens:

No. Now I know that, because I ask them every month when I run a live presentation. If you’re a builder listening to this podcast right now, think about this: how much do you earn, not including the net profit that’s retained in your company, but how much do you earn as a salary from running your building company? Then think about how many hours you work in a week. From that, you can then calculate an hourly rate figure. Once you’ve done that, ask yourself, is it enough? Because probably about 90 to 95% of builders I speak to tell me that it’s not enough.

Bosco Anthony:

If you had to look back, what are some of the more common struggles when it comes to this remuneration model and why are people struggling with paying themselves enough?

Russ Stephens:

I think one of the most common problems is taking drawings for your role as a director, drawing it down as a loan. Now that’s a problem in itself because it doesn’t get picked up in the fixed expense ratio; therefore, you end up underpricing your jobs. But it’s an even bigger problem if you are doing that and you’re not budgeting for tax. That’s the same if you take dividends at year end, and again you don’t budget for tax. Again, that’s simply because if you do it through dividends or a loan, it’s not included in the fixed expenses, so your margins get compromised, but it’s a double whammy when you don’t have enough money to pay your tax either.

Bosco Anthony:

You’re probably asked this question quite a bit as well, working with so many owners out there. Do you pay yourself first as an owner? Should you pay yourself first? It’s a hard question to ask yourself at this point too.

Russ Stephens:

Absolutely. It’s very, very important to pay yourself first because when you do, it becomes very clear what you need to charge your clients. In terms of paying yourself first, it’s got to be a market salary that appears within your fixed expenses. Typically, fixed expenses for a building company are around 15% for a residential building company when the director’s salary is included as a market salary. 

Russ Stephens:

However, when you don’t include your salary as a market salary in the fixed expenses, you’ll typically notice that the fixed expenses probably sit around about 10%. When that happens, builders then think that 10% is their break-even point, but no, your break-even point is 15% because you’ve got to be paid for that work you are doing to run the building company. When you start thinking in terms of 15%, you've then got to look at generating the 10% net profit for the shareholders as well.

Russ Stephens:

What that means is you need to be adding 33% to your cost of sale to actually get to that point, because a 33% markup on the cost of sale, that's a 25% gross margin, 15% to fixed expenses that will leave 10% for the shareholders. That's the ideal set-up, really, for a residential building company. Now, most builders baulk at the idea of charging these kinds of levels until they realise just how little they are earning in terms of an hourly rate. When they start to calculate it and look at what they're earning as an hourly rate, they get annoyed and then they start charging more. It's always the same. They're always surprised at just how easy it is to charge more. And it should be easy because all you're doing here is just charging market rates. You're not doing anything exceptional, you're charging market rates.

Bosco Anthony:

Right, so it's almost like financial awareness that you're taking them through with this process, because it sounds like a lot of builders out there are scared to ask for more or ask for what's already in the market when it comes to pricing.

Russ Stephens:

Yeah. Financial awareness is spot on, Bosco. That's exactly what it is because too much of the time, builders get wrapped up in what they do. They’re technicians in their own businesses. Builders get wrapped up in that role and don't always give enough objective thought to things outside their area of comfort, their area of expertise. They tend to repeat the same things they've always done, go with the flow, but they need to have their eyes opened up to what is possible and what they should be doing. When they take that on board, that really is what makes a difference to a residential building company.

Bosco Anthony:

Let's get into designing a financial compensation plan: where does one start? Is it looking at your financial projections? Is it working with certain professionals to help you get there? Is it working with APB? Where do you actually put your focus when you're looking at paying yourself the right way?

Russ Stephens:

Well, the first thing you've got to consider is what it would cost to replace you, because you are a professional. As the owner of a residential building company, you are a professional, you're an engineer, a project manager, an expert in construction, plus all the other things you do. Think about that, what would it cost to bring someone in with your level of expertise and do what you are doing? Bear this in mind as well: if you are working 60 hours a week, whatever it might cost to bring someone in on a regular salary, you can think about doubling that as well, because no one else is going to work as hard or as fast as you do in your own business. If you are working 60 hours a week, you're not going to be able to bring someone else in and churn out that kind of productivity.

Russ Stephens:

It's going to be closer to two people. If your partner also works in the business, how much would it cost to replace them? We see a lot of building companies where the husband is the builder and the wife comes in and typically might do a lot of the bookkeeping, but what they're really doing, the role that they're really performing is that of a financial controller, rather than a bookkeeper, and a financial controller has a lot more responsibility. That role attracts a far higher salary, so you need to consider that as well.

Bosco Anthony:

Now, obviously we live in a world where fluctuation occurs with what's going on with cost of living increases and everything else out there. But do you notice a fluctuation of the amount that you'd be paying yourself over time as well? Is that something that is in line?

Russ Stephens:

No, it isn't. Just like staff wages, really, they don't fluctuate. They're not linked to any index. They go up, but they rarely go down unless in exceptional cases. The only fluctuation might be if you are putting in a bonus structure, which can be a bit of fun, but not typically necessary, but it is a gradual increase. And you do raise a very good point, Bosco, because one thing that we must take always take into account, especially these days, is inflation. 

Russ Stephens:

If you are not giving yourself an annual increase, you're actually falling behind because of the effect of inflation. Even in the past 10 years when inflation's been relatively low, that's still a couple of percent that's chipping away at your buying power. So, you always need an index-linked increase at the very least just to maintain your standard of living. But certainly, in these times where we can see inflation is really out of the bag, some hefty increases are going to be required just to stand still.

Bosco Anthony:

Russ, what are your thoughts about the salary allocation, as well as the net profit and shareholder returns? You've talked a little bit about that at the start of the conversation, but how would you classify the two?

Russ Stephens:

Sorry, Bosco, in terms of how I classify the two, in what way?

Bosco Anthony:

How does the salary differ from the net profit and the shareholder returns? When you look at how someone pays themself, how do you view those two streams of income?

Russ Stephens:

Well, I think you have to be objective and detached and you have to look at them one at a time. Certainly, in terms of your role of running a building company, that really does come down to the experience and the size of the building company; that's really how you have to look at that particular role.

Russ Stephens:

When it comes to the shareholding, it's really down to risk. There is an amount of money that you would've put into the business, and there is a reasonably large risk associated with that. So, you can expect in the region of 20 to 50% return on that money as a minimum, being a shareholder. But I think in terms of being a director of a building company, 5% is a pretty good rough indicator, to start with. It's not perfect, but if you're running a residential building company and it's got annual revenue somewhere between $3 million and $10 million, then I think looking at 5% of revenue is a pretty good starting point. Equally, it's not a bad idea to do a bit of research online and just look at comparable roles and see what it would cost to bring someone in.

Bosco Anthony:

You have a lot of builders who end up struggling with documenting or archiving these payments to themselves. I'm just curious if there's a tool or system that allows them to do this seamlessly, with little to no effect when it comes to the actual recording of payments as well?

Russ Stephens:

It falls into one of two strategies. You are either drawing the money out as a salary, and it's going to appear in your fixed expenses, or if for any reason you are drawing it down as a director's loan or a dividend, the way you can deal with that in your accounts so that it doesn't get dropped off the fixed expenses is to record it as a journal entry. That then gives you the ability to either draw out the cash each week, each month, or by doing journals, you don't necessarily have to draw the cash out of the business. 

Russ Stephens:

You can leave the money in the business, but it's still being recorded as an expense, which means you'll be pricing your jobs correctly. Now this can be a bit of a stumbling block, especially for new businesses that don't want market salaries coming out for the founders of the business in the early days, because they just put all this cash in.

Russ Stephens:

It doesn't make sense to just pull it out, but in order to get their pricing right, it's important to have those journals inside the fixed expenses so that you understand what it's truly costing to run this business. You don't have to draw the physical cash out and at year end the accountant can make adjustments where you can do a drawdown and put it as a director's loan, or you can just write it off altogether and not draw anything out. But the important thing is, as you progress through the year, you're very, very clear. You’re very much across what it's really costing to operate this building company.

Bosco Anthony:

Yeah. I suppose if you're not really going to record that, you can't really factor in your true cost, essentially, because it's not giving you the true numbers, right? So there has to be a way of you actually factoring in all true expenditure, inclusive of paying your owners out too.

Russ Stephens:

Yeah, and don't fall into the mistake of believing, “Ah, well, that's okay because I know I'm not drawing a salary, but in my mind it's 5% or it's this amount,” that never works. That is a bit like doing an estimate for a job and putting in 5% contingency for no good reason and thinking, “Yeah, that's where my net profit is.” Running a small business, especially a construction company where the margins are tiny, is all about accuracy. Better information, accurate information, leads to better decisions. So don't hold anything in your head like that. Record the actuals and you'll make way better decisions.

Bosco Anthony:

It's funny you mentioned accuracy because that was one of the first lessons I learnt from you when we talked about the WIPAA [Work in Progress Accounting Adjustment] calculator and about the importance of being so accurate on your numbers during tax time, because you don’t want to wake up with this surprising amount that you've got to pay back. So, I still resonate, and my mind goes back to our early conversations when I first started to learn about the concept of the WIPAA calculator and the calculations around it. So, accuracy is definitely something that I'm a big fan of, for sure.

Russ Stephens:

The interesting thing is, with a building company, you can calculate your exact gross and net profit right down to the very last cent every single month. It can be done. You just need to know the right calculations to do in order to make that possible. But unfortunately, a lot of builders don't understand what those calculations are, and they simply look at cash in the bank, which is a terrible indicator of where the business is at.

Bosco Anthony:

Yeah. And Russ, what are some of those key measurements that builders should be paying attention to when it comes to this process of paying yourself up?

Russ Stephens:

Well, it depends, because if you are expecting a lot of growth in the business in the year ahead, then a bonus structure could be good. It might sound silly, setting yourself up with a bonus structure, but you might set a base salary based on what the business has done over the past 12 months, but say you're going for some serious growth over the next 12 months, say 50% growth.

Russ Stephens:

Reward yourself for the extra work you're going to be putting in and tell yourself, “If we hit these levels, then I'm going to give myself a pay increase to this amount,” or it could be just a bonus. That's a good way of protecting the business so that you don't just think, “Ah, yeah, we're going to increase by 50%. So, I'm going to earn that amount based on that revenue. And if we don't hit it, well, that doesn't matter.” The incentive has gone. It's good to incentivise yourself in that way. Delayed gratification and self-discipline are very important in business.

Bosco Anthony:

I resonate with the delayed gratification. You talked a little bit about incentives – how does an owner factor a pay rise or bonus not only for himself, but also for the people who work for him as well? Where do you go to draw up those numbers?

Russ Stephens:

I think it's always good to have a conversation about these things. If there is more than one owner, which there generally is, even if it's a husband and a wife team, sit down and talk about that. It will help you think more objectively if you are just sounding it out with someone else. Maybe you've got an experienced friend in business. Your business coach, for instance, is a good sounding board. So, sound these things out, see what's reasonable. 

Russ Stephens:

If there are two partners within a building company, two business partners, then I'd certainly recommend doing six monthly appraisals. They should be taking place where you appraise each other, assess each other, discuss realistic remuneration for the roles being performed along with any incentives for exceptional performance as well. But definitely encourage everyone to speak to a third party about this rather than just attempting it on your own, because it becomes emotional, and then you don't always make the best decisions.

Bosco Anthony:

Right, right. That makes sense. One of the things that really stood out when I was interviewing builders who are success stories from APB is that they always talk about how the coaches were able to help them uncover their blind spots. It was a recurring theme from every success story that I've heard so far about their awareness and learning about their blind spots. I'm just curious, because I was thinking about this and I was wondering, what is the most common blind spot that builders should be aware of when it comes to paying themselves?

Russ Stephens:

Well, I know I've mentioned it already, but tax is probably the number one blind spot. So, I'd always encourage builders to look at their expected salary in the year ahead, along with any other personal income, bank interest, dividends, et cetera, from any personal investments they might have and then just make sure they're budgeting for any tax that isn't being deducted at source. If the money is coming out through your building company as a salary and it's coming out in just the same way as your staff salaries do, that is being taxed at source. But if it's coming out in the form of a loan or dividends, then you need to make sure you’re accounting for that tax, and that money becomes untouchable. It goes into a separate bank account, and you just forget about it. That way, you'll never be stressed at tax time. 

Russ Stephens:

Another blind spot really that builders have got to be aware of when it comes to paying themselves is the actual amount. It's very important not to pay yourself too much or too little, and that's because if you pay yourself too much, then you are stealing from the shareholders. Now that might be yourself as a shareholder, but don't forget, you’ve got two roles. So, the shareholders have to be compensated realistically for the investment. So, overpaying yourself as a director simply robs from the shareholders. And if you pay yourself too little, then you are kidding yourself how much it costs to operate this building company. As a consequence, you will leave money on the table when you price jobs.

Bosco Anthony:

Right. Should you also factor in a cash reserve? When the cost of goods goes up or there's a price increase in certain products and everything else, should builders be also be paying attention to what's happening in the geographical trends as far as cost of goods and supply chain?

Russ Stephens:

I think that probably comes more into the estimating and job costing, rather than how it affects the salaries and the net profits there. But it certainly is an important thing to be very aware of, especially these days.

Bosco Anthony:

Yeah, you definitely want to consider that too. So, what can a builder do to protect themselves financially long term, looking at it from both a professional lens and a personal lens too?

Russ Stephens:

In a professional sense, that’s looking at it from their business, that's obviously the first thing that you have to protect. I always remember my father saying to me after I had a wild weekend out, when I hadn't done what I was supposed to do in business, and I started blaming it on friends, “Oh, well, I had to do this and that.” He looked at me and he gave me a really strong lecture. He said, “Your business is more important than anything and anyone. You always protect and look after that first.” That's always stuck with me. So, in terms of protecting your business, the first thing you can do is calculate the WIPAA, or income in advance, or whatever term might actually resonate with you, but you need to calculate that hidden liability every single month in order to protect yourself.

Russ Stephens:

If you're not calculating that every month, if you're not in trouble now you will be at some point in the future. The second thing you can do, once you’ve calculated that number, is check your balance sheet every month to make sure you have the physical cash to cover that liability. For new construction, it is a liability and it's a liability that does not show up anywhere in your accounts or in your project management software. It's a calculation that you as a builder have to understand and you have to go out of your way to make sure it's done every month.

Russ Stephens:

You’ve got to be calculating it every month. Because you're in new construction, that means it's definitely a liability. You’ve got to make sure you’ve got the cash on hand to cover that. The next thing you need to do is to make sure that you've built up three months of reserves. By reserves, I'm really talking about working capital to cover your fixed expenses, because that will cover any short-term blips, adverse weather, declines in the economy; that will give you enough time to course correct.

Russ Stephens:

Whatever your fixed expenses are, including your salary at market rate, of course times that by three, that's what you want to be building up to and making sure you got covered in working capital, which will typically equate to net equity as well. Once you've achieved that, then you can start diverting excess profits into personal holdings. In terms of protecting yourself personally, the first thing is to create a one-year emergency fund, and by that I'm talking about all of your expenses. 

Russ Stephens:

Whatever your outgoings are, whatever that figure is for the year, you want to hold that in cash. Now you'll probably hear a lot of financial experts typically recommend between three and six months as being the size of an emergency fund. However, that is typical for employees, and the reason they set that number is because it takes between three and six months to find another job, on average. However, for business owners, it's got to be 12 months because the risks are so much higher. 

Russ Stephens:

As the owner of a residential building company, build up one-year emergency fund in cash, and that can be quite difficult to do. It can take a lot of commitment and it also can be quite frustrating because that's a lot of money that's not really earning anything in interest. You're obviously not able to invest it either, because it's got to be liquid cash on hand. So don't think of it as an investment, think of it as insurance. Once you've done that, the next thing is to eliminate all debt. 

Russ Stephens:

Obviously, your mortgage is probably the last thing that you get to eliminate, but all the other debts have got to be eliminated as quickly as possible because only then can you start investing in income producing assets. If you have credit card debt and any other debt, such as car loans et cetera, on top of a mortgage, and you want to start investing as well, all you're effectively doing is borrowing to invest. It doesn't make sense. You're much better off clearing your debt rather than going for investments. The goal then is to create enough passive income from your investments to exceed your salary. Because when you do that, that means you have financial freedom and you have succeeded in protecting yourself financially for the never-ending future.

Bosco Anthony:

Yeah. It's an interesting personal roadmap too, of getting to different milestones as you start to see the progress out there.

Russ Stephens:

Yeah, and you're not going to get there instantly. It's all about having a plan and chipping away. It might take a lot longer than you initially think when you plan it out, but you'll start making headway a lot more quickly than you think as well. I think a lot of people are surprised in five years or six years just how much progress they've made.

Bosco Anthony:

I know that everyone at APB is around builders all the time at events and coaching interactions. When should a builder be concerned when it comes to their financial model, at what point do they have to start saying, “I need to pay attention to this because things are getting out of hand”?

Russ Stephens:

The first thing I'd say here is, if you are not calculating your income in advance or work in progress, or WIPAA, or whatever the term is that resonates with you, if you are not calculating this figure every month, you should be very concerned about your financial model. That's the first thing I'd say. The reason for that is that you don't have an accurate idea of your finances.

Russ Stephens:

If you think your accountant will take care of your accounts and produce accurate accounts for you, then the simple answer is they can't because they go by what builders tell them. So, they won't know this number. They can't calculate it themselves. They rely on the builder providing it. So, if you don't know how to calculate this number yourself, your financial reports are wrong. Most likely, if you're in new construction, you're paying way too much tax. You're paying tax on profits you didn't make, and you don't have the level of equity in your business that you'd probably like to think you have, either.

Russ Stephens:

Knowledge is power. Just understanding where you are financially makes such a difference. So, you've got to be concerned if you're not calculating that number. But that aside, I would say in new construction, a builder should be concerned when they can't pay their suppliers and subcontractors on time, and that is because new construction is cash flow positive. So, if you don't have enough cash to pay someone their invoice, when it's submitted and it's due and payable, that is a sure sign that your business model is not working as it should.

Russ Stephens:

I would urge anyone in that position to seek expert help urgently while you still have the opportunity to make changes. Of course, these things are slightly reactive. In order to be proactive and spot a problem well before it happens, a time to be concerned is if you're not making at least 3% net profit, because the goal for a residential building company is 10% plus net profit. If you are 3% or below, that is a very dangerous place to be. So, I would have a concern there if your net profit is less than 3%.

Bosco Anthony:

What are some of the trends that you're seeing with the coaching program and the mentorship? How is APB helping builders become more proactive with their current financial model in the long term?

Russ Stephens:

Well, most builders come to us looking to grow their building companies. Typically, they're looking for more leads and that's because if they can get more leads that will lead to more sales and that will lead to more profit. However, building companies, residential building companies below $10 million a year in annual sales, do not scale profitably. We help builders to understand their numbers. By breaking everything down into bite sized chunks, we then create a profitable business model that they can follow as they grow. That means they can then grow their building companies safely and securely.

Bosco Anthony:

Well, Russ as always, this is always informative, and I always learn something new when it comes to financial road mapping and planning. It was a pleasure having you here. For builders out there, or listeners out there who have any questions about the financial models, what's the best way for them to access the brains at APB?

Russ Stephens:

Well, I would say subscribing to this podcast is a pretty good start. We also run a webinar, a live webinar once a month. So, if you go to our website, Association of Professional Builders, you can always find when the next webinar's going to be on. I'd also probably suggest reading our book, Professional Builders Secrets. So, Sky Stephens, the other Co-founder of APB and I wrote a book where we mapped everything out all the way from marketing to sales and financials to help builders truly understand their building companies. I definitely recommend either reading the book or listening to it on Audible.

Bosco Anthony:

Well, we'll have to link all the books and the references and the webinars to the show notes. As always, thank you for being here today. We really appreciate your time.

Russ Stephens:

Good stuff. Thanks so much, Bosco.

Bosco Anthony:

Cheers.

Bosco Anthony:

Thank you for listening. Remember to subscribe to Professional Builders Secrets on your favourite podcast platform and leave a review. To learn more about how the systems at APB can help you grow your building company, visit AssociationofProfessionalBuilders.com. See you next time.