Episode 3: The One Figure That Could Destroy Your Building Company with Russ, Sky & Andy

In this episode of the Professional Builders Secrets podcast, our host, Bosco Anthony is joined by Co-founders of the Association of Professional Builders Russ Stephens and Sky Stephens, along with APB’s Head Coach, Andy Skarda. Throughout this episode, the trio reveal the one figure that could destroy your building company. 

The Association of Professional Builders is a business coaching company that helps residential home builders across the globe systemise their building companies. Specialised coaching on sales, marketing, financials, business operations and even personal development in order to operate a true professional building company.

During episode three of the Professional Builders Secrets podcast, Russ, Sky and Andy reveal the shocking truth behind why so many building companies fail due to not understanding the true state of their finances. 

Unfortunately, too many builders leave it up to their accountants who often miscalculate the most important number in a builders financial reporting, leaving a cancer growing inside their building company.

Tune into the full episode to hear the APB trio uncover the secrets behind Work in Progress and the accounting adjustment figure that could save your building company. 

Russ Stephens - Co-founder

Co-founder of the Association of Professional Builders, 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

Sky Stephens - Co-founder

Co-founder of the Association of Professional Builders, Sky specialises in taking complex business strategies and converting them into actionable step-by-step guides for building company owners. Sky is also a proud member of The National Association of Women in Construction and the Top 100 Women in the broader construction sector.

Connect with Sky

Andy Skarda - Head Coach 

Head Coach at the Association of Professional Builders, Andy specialises in helping business owners in the building industry identify and implement the skills and systems they need to be successful, without needing to go back to school. Or more importantly, without going bust.

Connect with Andy

Timeline

1:00 The biggest financial problem facing builders.

4:00 The role of accountants.

6:10 Why do accountants miscalculate the work in progress (WIP) figure?

9:20 Builder’s reactions after learning about WIP.

14:00 The Work In Progress Accounting Adjustment (WIPAA) figure explained.

15:20 Why most building companies go bust.

21:00 Where did the knowledge gap originate from?

28:20 Key areas of focus in implementation of WIPAA as a head coach.

31:00 The difference between WIP and WIPAA.

34:00 The biggest single change in a builder’s life.

44:00 The industry benchmarks for markup vs margin.

Links, Resources & More

Free Download: How To Calculate Work In Progress
APB Website
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APB on Facebook
APB on YouTube

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

Bosco Anthony:

This is Professional Builders Secrets, the number one podcast to help you grow your building company safely and securely, brought to you by the Association of Professional Builders (APB). Join us every week as we talk to industry experts and your fellow professional builders on everything you need to know to generate more leads, more sales and higher margins while improving the building experience for your clients.

Bosco Anthony:

Hello and welcome to the Professional Builders Secrets podcast, a podcast by APB for building company owners, General Managers, Vice Presidents and emerging leaders.

Here, we discuss all things running a professional building company from sales processes, financials, operations and marketing. Today I'm joined by Co-founders Sky and Russ Stephens, as well as Andy Skarda, the Head Coach for APB. Welcome everyone; I’m excited to be speaking to all of you today.

Sky Stephens:

Awesome.

Russ Stephens:

Thanks so much, Bosco.

Andy Skarda:

Hello, Bosco.

Bosco Anthony:

Well, let's get into it, shall we? In today's episode, let's really talk about the most critical problem that builders face. Russ, I know you're dying to answer this.

Russ Stephens:

Yeah. The biggest problem facing builders at any time is profitability. But more specifically, it's their accounts and understanding their financial position, because when a builder looks at their accounts, they never make any sense. Not at month end, not at year end. They look at the profit and loss statement, the balance sheet, but nothing seems to add up. So, what do they do? They look at the bank balance. This is the biggest issue I feel is facing the industry.

Bosco Anthony:

That's an interesting topic. Andy, when you're coaching people as well, what are builders telling you when they look at their bank balance? What are they commonly struggling with when it comes to their financials?

Andy Skarda:

The biggest problem is they confuse the bank balance with profitability. So, they live in this world of, “If there's enough money to pay the bills, then I've got to be making profit.”

Andy Skarda:

But unfortunately, because of the nature of the industry, there is no direct connection in most cases between the amount of money in the bank and the profitability that they're actually experiencing in their business. So, it's getting them to understand that those two are not an indication of each other at all. And profitability is the one that they've got to be focusing on.

Bosco Anthony:

Right. So, is there a secret to bring them to this sort of acceptance when it comes to really knowing that this is something that they have to pay attention to? Because I can see this becoming a cancer that ends up growing bigger and bigger if they're not paying attention to it.

Andy Skarda:

Absolutely. The big problem is, as we always point out to everybody, that the busier they are, the worse the problem gets. So, the critical thing here, and Russ touched on it already, is knowing accurately what your profit position is every single month. That's really where we focus on – making sure that we've got accurate numbers every single month.

Bosco Anthony:

Sky, do you see this as being one of the big reasons why builders end up folding in the first few years as well? From what I'm hearing from Andy and Russ here, if we don't pay attention to this and it starts to escalate, I can see a lot of builders going out of business pretty quickly.

Sky Stephens:

Oh, definitely. We have to be able to understand our exact financial position. So, exactly what Russ and Andy have been talking about, it's understanding profit is not cash. Cash is not profit. And so, we need a way of actually understanding, “Well, what is this? What is this in my accounts? How can I understand this?”

Sky Stephens:

That's exactly what Russ was talking about, because there's a lack of understanding of financial reports; it gets like a blind eye because it goes into the too hard basket. And so, it's actually leaning all the way in and understanding there's actually one figure you need to calculate every single month to make these financial reports make sense.

Bosco Anthony:

We start to look at this from a different holistic view. Shouldn't this be the responsibility of the accountants? This seems to be the unspoken dialogue. Shouldn't the accountants be paying attention to this, Sky? Why aren't accountants talking about this as a problem?

Sky Stephens:

It's a really good question. It's not necessarily anything malicious. It's mainly because the majority of accountants we've come into contact with just don't quite understand it. So, what figure we are alluding to this entire time? We're talking about the work in progress figure that a building company has to calculate and insert into their building company accounts for them to make sense. Unfortunately, most accountants will speak about work in progress in the form of manufacturing, and that's really where it all started.

Bosco Anthony:

So, Russ, where do we aid the businesses? Is it the builder's responsibility to be paying attention to this? Should we be re-educating the accounting system moving forward? Is there a gap in between? What does this look like, moving forward?

Russ Stephens:

It'd be nice to educate accountants on this, but really builders have got to take full responsibility. This calculation is so important. You can't pass the buck. You can't rely on anyone else to get it right for you. You've got to understand it and you've got to calculate it yourself and you've got to insert it into your accounts.

Russ Stephens:

The problem we've seen, like Sky just mentioned, was that in our research, 95% of accountants do not understand how to do this calculation correctly. That's simply because they misunderstand what the calculation is in the first place, because the term comes from manufacturing. It was a way of valuing raw materials as they went through the manufacturing process.

Russ Stephens:

Accountants think that's exactly the same with building, but it's not. Building is very different. Contracts are front loaded. Supplier invoices simply don't come in for weeks, or in the case of concreters, sometimes months. So, jobs end up, especially on new homes, they end up cash flow positive. And while that's good in some respects, it's a real danger in others.

Bosco Anthony:

Andy, let's define the term a little bit more. This is a new world for me as well. Define the term, and the differences between the common misconceptions – and why accountants don't get this right the first time.

Andy Skarda:

I think that we end up in most cases in this problem, that words create worlds. And when an accountant is referring to what they believe is work in progress, they're actually referring to what we would define as workflow. So, if we start there, workflow is the un-invoiced portion of all of the building contracts that are currently being built.

Andy Skarda:

So, in other words, it's the remaining work that you still have to do on all of the contracts that you've signed. In our case, when we talk about work in progress, we are talking about the fact that because of the nature of the way the building industry works, and Russ has alluded to this, often subcontractors and suppliers are not as administratively adept as we'd like them to be.

Andy Skarda:

What that means is that often we are being paid progress claims at different stages through the build, ahead of being invoiced for the work that made up part of that particular process. The net result is that a lot of the money that's in the bank is not actually ours to spend. It's already committed to work that's been done and completed, but not yet invoiced.

Bosco Anthony:

The builders know that this is money that they have spent?

Andy Skarda:

That's where the problem comes in, because at the end of the day, if they are not taking it into account, they will literally look at their bank balance and go, "I've got a bunch of profit here." And it gets worse, unfortunately. Most accounting systems and most accountants, if you were to ask them to unpack the arithmetic formula that's used to calculate profit, they would tell you that it's income minus expenditure, which is correct arithmetically.

Andy Skarda:

But the problem in a builder's world is if he hasn't yet been invoiced for part of the income, he's got income minus zero equals profit, and the accountant is going to be totally comfortable that that profit is accurate, when in fact, 70% to 80% of that amount is actually owed to suppliers and subcontractors who've made up part of that invoice.

Bosco Anthony:

If they're not aware of it, then they're misspending it. And that's where the shortfall is?

Andy Skarda:

Yeah.

Bosco Anthony:

Wow.

Sky Stephens:

To compound the problem more, this is exactly why our builders’ accounts do not make sense because their gross margin is going to be bouncing up and down. This is where you see you are killing it one month. You've got very high gross margin and the next month when all your bills come, it's very low. And so that's when it's like, you know what, if your accounts don't make sense from that perspective, you stop looking. And that is how the problem just gets worse and worse and worse.

Russ Stephens:

And to compound it, they're then paying tax on profits that they haven't made, because the profits are being artificially inflated and submitted. Now there's even more cash going out of the building company, paying tax that wasn't due. We have a lot of builders scratching their heads, saying, "I can't afford to pay my tax bill. I'm still paying off the tax bill from last year. Where's the money gone?"

Bosco Anthony:

So, Russ, when you bring them through your process and you educate them on this, what is the most common reaction you get on these calls? I would assume that builders are pretty shocked at this point when they start to realise that what they've been standing on is a false narrative.

Russ Stephens:

Yeah. I'll tell you if you’ve got your finger on the bleeper.

Bosco Anthony:

Fair enough.

Russ Stephens:

It's disbelief, to be honest. In most cases, it is disbelief. In some cases where they do have a good business and it's reasonably profitable and they're just scratching their head with the cash situation in terms of tax, it kind of starts to make sense. But in most cases, builders are not making any real profit in their business.

Russ Stephens:

They cannot comprehend how far underwater their business really is. They argue, they deny it. It takes a bit of time, and Andy can probably answer this a lot better than I can, because he's dealing with these guys first-hand. But it's a difficult challenge for us, because it's not easy to explain to a builder that his company is $200,000, $300,000 under water.

Bosco Anthony:

It's a growing problem if it's not addressed. Andy, let's talk about the risks. It sounds like the residential construction space is the final frontier, but it comes with a lot of risks and challenges as well. Let's get into that a little bit.

Andy Skarda:

This one in particular is really the fact that we've got to get builders to a place where they are comfortable with critical numbers. So, I don't want this to sound like we’re sort of pitting a builder against his accountant. That's not what we're doing here at all. What we're saying is, and Sky made this point, I think, very clearly, that accountants aren't deliberately misleading builders.

Andy Skarda:

It's just that because of the way they are trained, they are not necessarily aware of the implications of what's happening in this particular industry. So, the reality is, as Russ has said, it starts with education. To be honest, what generally follows the bleep filled conversation when we first show them what their company actually looks like is a very tense conversation with their accountants.

Andy Skarda:

I've had a number of them where accountants have come onto the beginning of that call, very, very aggressive. They're the ones wearing the tie in the conversation and therefore they need to be listened to. I've actually watched the lights come on. I've watched those aha moments, where they start to understand the reality of the building industry, they start to see how this works.

Andy Skarda:

To date, I think certainly in my experience, we've never, ever ended up with an accountant who by the time it's been explained, didn't get it and was therefore prepared to get involved and make the necessary adjustments. So, it's really an education situation more than anything else.

Bosco Anthony:

As head coach, you've worked with clients around the world. Any secret stories or confessions that you want to share with us? Really some experiences that you've encountered where you've had a client realise this problem either on their own or with the accountant with them?

Andy Skarda:

Regularly. The negative part is that they hate me/us for 10 minutes. They literally pull out an Andy doll and start sticking pins in it, because almost, in the stroke of one spreadsheet or one calculation, we've taken what they thought was a profitable business and showed them that in fact, it isn't.

Andy Skarda:

But what is really fantastic is three, four, five months down the line where they are now aware of it, and they are making the necessary adjustments in the business, so that they know actually where that business is. They're then able to bring into play the other activities that need to be done in order to turn the situation around.

Andy Skarda:

Now of course, they get the double positive, because now not only do they know that the business appears to be profitable, but it actually is, because they're now taking the work in progress into account.

Sky Stephens:

I think Andy's being super diplomatic here. We've got stories for days about this. I can even think of a handful of clients that immediately had a straight up argument. This went on for a couple of months as well. "No, this is wrong. This is not how it is." It's because of exactly what Russ said. It's really hard to admit what you've been doing isn't the best thing possible.

Sky Stephens:

But we did get there in the end, and it's not always a very quick 10 minute conversation. It can really, really challenge quite a few people in not the best way. Unfortunately, we do make it worse, because we then thoroughly explain the problem. Like, to paint a picture for everyone, so they can really understand work in progress. 

Sky Stephens:

We call this figure work in progress, exactly what Andy just explained, but think of it like a pile of dirt that just gets bigger and bigger and bigger as the revenue of a building company grows. So, as building companies scale, their revenue gets bigger and bigger, but so does this pile of dirt. So, as you're growing and growing and growing, as your revenue grows, the pile of dirt grows, but you never get to see it because the mat is so big.

Sky Stephens:

And so, especially when we're dealing with much bigger evolved building companies that haven't been calculating this figure, this figure becomes massive. Like we've had to tell building companies that they've got a million dollar liability on their hands. That's scary. But if they look at their bank account, they've got cash over here; they're paying everyone; things are fine and it doesn't resonate as a real problem.

Sky Stephens:

That is what I would say is the biggest problem when we're coaching relatively successful building company owners, because they're paying people, they've got a big team, they've scaled to be quite large. Unfortunately, that pile of dirt under the mat is pretty massive as well. We are so passionate about this because when the new work stops and revenue declines, that mat starts shrinking and it exposes the big pile of dirt.

Sky Stephens:

The big pile of dirt doesn't shrink as the revenue shrinks. That is still a massive pile of dirt, that liability. We call that other people's money. It was never yours to begin with. It was always owed. Then that is why building companies go bust for millions of dollars. In most cases, it’s because they never made a cent of profit in years. We are just trying to save as many building companies from experiencing that.

Andy Skarda:

It happens so quickly that most of them cannot believe how quickly it turns.

Russ Stephens:

The work in progress is the pile of dirt growing, and the mat is the revenue. The reason it covers it is because in a growing company, the revenue keeps growing as well. We see this all the time. We see so many large building companies, when all of a sudden there's a hint of recession coming, and they go under owing millions, and there's no way they lost millions of dollars.

Russ Stephens:

There was one just recently, at the beginning of the year, that went down owing $1.7 million on a $5,000,000 turnover. It wasn't even a particularly large company. But you cannot lose $1.7 million in 12 months. But that's exactly what the liquidators’ report alluded to. They alluded to the fact this company was going well until 12 months ago, when they suddenly became unprofitable. It's absolute nonsense. It just shows that these forensic accountants don't really understand construction financials at all.

Sky Stephens:

I think the owners of the building company as well, they’re just drunk on cash at that point because it looks fine. It looked fine this whole time. But unless you're calculating it, you just can't see.

Andy Skarda:

And your accountant told you that you were profitable.

Sky Stephens:

Yes.

Andy Skarda:

He's the one with the tie. So come on, who's going to know? Of course, he knows.

Bosco Anthony:

How many times have we been told, "Well, we're just going to have to agree to differ on this one?”

Andy Skarda:

I think, Bosco, the other thing that's important just to get clear here is, this is a global problem. We work with clients all over the world. So, this is not unique to a particular part of the world or a particular part of the industry. This is a genuinely global problem that affects every builder everywhere in the world.

Bosco Anthony:

That's really interesting to observe. I think someone very famous once said, "More money, more problems," which really, really references to where we're going. Russ, how did you come about discovering this problem? Because this is a problem that's probably been in the making for years, by the sounds of it.

Russ Stephens:

Yeah. I came from a background and industry that was high revenue, tiny margins, even smaller margins than the building industry, so you had to be all across your numbers. You had to be right across everything, not just monthly, but literally weekly, because it was just so fine.

Russ Stephens:

When I came into the construction industry, straight away, I could see that the accounts weren't right. You couldn't put in a claim for $100,000 or $200,000 into the accounts, not have the corresponding supplier invoices in there and then go by what your accounts were telling you. It was obviously wrong. But I couldn't find anyone that could give me the solution or how to fix it. So, it kind of made no sense.

Russ Stephens:

I found the solution buried in some construction accounting software back in 2007, and it was the work in progress calculation, yet still no one I spoke to in the industry could explain it to me. When I talked about work in progress, they gave me the explanation for manufacturing.

Russ Stephens:

I did more research and I found an article online. I then came across an accountant in Melbourne, Victoria, who had been talking about this problem as well. I actually called him up to speak to him, and he was a broken man by this point; he'd given up. He'd given up trying to explain it to builders, to other accountants, to associations, because he said no one wanted to hear the truth.

Russ Stephens:

In the end, he pretty much just washed his hands of it and was just carrying on, because no one really seemed to want to know what he had to say. But you can't unlearn this stuff. Once you know the truth, you have to try and share it with as many people as you possibly can. That's really what we've been trying to do for these past seven years now.

Bosco Anthony:

So, you discovered this concept that no one's really talking about. How do you bring it to the market? Did you fear bringing a foreign concept to builders? What was going through your thoughts when you're like, "Okay, we're going to adopt this and bring this to people that are not ready to hear about this"? That's a pretty bold move.

Russ Stephens:

Yeah. That's spot on. We've got this great solution. No one wants it. No one wants to hear about it. So, the first thing we had to do was to make this really simple, because it can sound a little complicated trying to work out what this figure is. So, we developed a very simple calculator that works it out for the builder, along with step-by-step instructions for their bookkeepers on how to put two very simple journal entries into their account, which corrected their accounts at month end.

Russ Stephens:

But that was only half the battle, because the real battle came down to education. Again, it was educating builders on why this was such a big problem and why it was critical that they adopted this calculator that no one else was using or even talking about. That's really where we focused our energy – making builders problem aware.

Bosco Anthony:

Sky, curriculums and content are things that I've always been impressed by when it comes to APB. You really, really pride yourselves in what you put out there. How is it that builders don't know about these concepts? I really want to dig into this problem a little bit more to know – is this something that they don't teach in schools? Is this something that builders aren't equipped to learn? Where is the problem? Where does it lie?

Sky Stephens:

Look, builders and owners of building companies are doing some of the most complex jobs on the planet. Let's be honest here. This is very detailed, very complex work that those guys are doing. And so, with the concept of work in progress, they have some sense that this was the case. It's like that scene in ‘The Matrix’ of how you're trying to explain the matrix. You know it's there, but you can't explain it. It's exactly the same with work in progress.

Sky Stephens:

When you first start a building company and you’ve got one job running at a time, it's very, very easy to see, exactly as Russ said. You get a progress payment of $200,000 that month, but you only paid $30,000 in costs. You know you didn't just make the $170,000, so you do the mental calculation. That, I think, is where the problem lies, because it's a mental calculation, and doing it all in your head, it becomes so much harder the second you do multiple projects at any one time.

Sky Stephens:

That's where the complexity comes in. You get it, you understand it when you're just doing one project at a time. Add a few more, it adds another layer of complexity. It gets a little bit murky. It gets a little bit foggy. Then it slowly creeps into that too hard basket. You know that it's not 100% accurate, but you know what? Your accounts are probably close enough.

Sky Stephens:

Then before you know it, your revenue's increasing. So that's the mat that we were talking about. And then also the dirt is getting bigger under that mat, because just like we said, you're drunk on cash. You can't truly see the bigger problem until, just like Andy said, it's too late, unfortunately. So, you're aware it's there. You know it's there. You just can't quite describe it or put your finger on it.

Russ Stephens:

To give a bit of insight, a typical building company that's doing maybe $5 million or $6 million a year will typically have a work in progress liability. So, this is a liability that is not showing up in the creditors in their accounts possibly in the region of $500,000.

Russ Stephens:

This is how serious the problem is, which means they’ve got to be carrying well in excess of $500,000 in cash in their building company to make sure they can cover that liability. What happens there, accountants, financial advisors tell them, "That's a risk. Let's get that money invested." They pull it out of the company. And of course, they pay tax on that as well.

Sky Stephens:

That's the worst part, isn't it? Because it's not even their money. That's the problem. You are holding a $500,000 liability. It's not exactly like it's your cash. You're literally looking after other people's money and that's the scary part.

Bosco Anthony:

So, this is a nightmare as well when it comes to the end of the financial year. It sounds like you're carrying the liability over to the next year as well.

Russ Stephens:

Yeah 100%. And at best, this is when work in progress does get calculated or purported to be calculated at least. But invariably, because it is misunderstood, it gets guessed. It goes in builders’ accounts as an asset when really, it's a liability, and that just makes the situation even worse. So, now we had a $500,000 liability in that typical building company, but it ends up as a $250[K]…..$3[00K], or even $400,000 asset.

Russ Stephens:

Now we've got an $800,000 or $900,000 swing going on in the accounts. This is where building companies come unstuck big time, because when that mat can no longer cover the dirt, which is work in progress, and the building company goes into liquidation, all of a sudden, it's a big reveal, how much money they're underwater for.

Sky Stephens:

It might be actually really interesting to explain – because we're talking about it being a liability so frequently. It's most commonly going to be a liability, and it's because of the way a building company is actually set up. A work in progress figure, it can be an asset. So, when you go through the calculator, here's the most interesting thing.

Sky Stephens:

As you go through the calculator that we've ended up producing to actually establish what your work in progress figure is, you can do the calculation. What will usually happen is it's going to spit out and actually equal a liability, and that's exactly what Russ was saying, inserted into your accounts. But sometimes, it can actually come out as an asset.

Sky Stephens:

There are two reasons for that. It's usually because of how your building company is set up. You're either doing new homes or renovations, like remodellers typically have a work in progress figure that is an asset. The reason for that, if we actually just describe the main difference between the two, it's basically because of the way the building company is set up. New home builders typically subcontract everything. So, there’s naturally going to be a delay from when they invoice out their work and then they get their invoices from their subcontractors.

Sky Stephens:

Remodellers, again typically – these are generalised statements – employ most of their workers. So, you’re already front loading and prepaying for all of that work before you get your progress payments. So, you can see how there’s already an immediate difference. But we’ve actually come into instances, and Andy will be able to talk about this a lot more, when we’re working with builders, even new home builders and suddenly you see some positive Work in Progress Accounting Adjustment (WIPAA) figures. It’s actually a bigger problem.

Andy Skarda:

Yeah, and I think that’s critical because if you go back to what we were saying at the beginning of this discussion, what we are really striving for is accuracy. At the end of the day, it could swing one way or the other way, but it doesn’t matter which way it swings, it’s wrong. So, it's really getting to the place where we get it right first, that's the primary thing.

Andy Skarda:

Then once we know which way it’s swung, we can then take the necessary steps to run the business differently or make provisions for that. I find most builders, when we show them that asset side, when I explain it to them on the basis of they've just given their clients an interest free loan, their eyebrows go up.

Andy Skarda:

But essentially, that's what they've done because they've effectively paid for materials or possibly a subcontractor prior to being paid by the client, which essentially means they just invested in their client's home.

Russ Stephens:

I'm sure, Andy, when you jump on a coaching call with a builder each month and you start digging into their numbers, you might look at the work in progress calculator, and those positive ones – we know we have them – they highlight in red, don't they, automatically?

Andy Skarda:

Yeah.

Russ Stephens:

You can go straight to the job or you can name one of those jobs and say, "What's the problem with this job?" And it's like, "How did you know there was a problem with that job?"

Andy Skarda:

They think that we've got a camera installed in their office somewhere, watching that we've got this inside track. But exactly as Russ said, the beauty of that calculator is it highlights immediately there's a problem on the job. As soon as you mention that and those clients start to think about that job, they realise that there's a red flag waving; they need to do something to get that back in line.

Bosco Anthony:

It sounds like an accounting crime scene, too. It's sounds like you're looking for the blood splatter to see whether it's a problem or a bigger problem as well when you talk about looking at the numbers. Andy, talk me through the coaching concept when it comes to this whole WIPAA figure as well. You hear about this discovery from Russ, who's taking a big risk and says, “This is something we need to talk about.”

Bosco Anthony:

Sky and Russ have worked on this curriculum with you to take this to the market as well. What's your thought process as a Head Coach? How are you thinking that this is going to be something that people are going to have to start paying attention to? What are some of the barriers that you have to break when you're doing these coaching calls?

Andy Skarda:

I think as Russ and Sky have both spoken about, there's this immediate disbelief. When I've got the Amarok parked in the driveway next to my stainless steel boat trailer and my top of the range boat sitting on it, it doesn't feel like my business isn't profitable. What I've got to understand is I bought the Amarok with the money that I owe the painter. I bought the trailer with the money that I owe the tiler. And I bought the boat with the money that I owe my carpentry crew.

Andy Skarda:

All of a sudden, when people start to understand that that's the actual manifestation of what's going on in their business, that realisation hits. To be totally honest, this is part of a slightly bigger problem in that, and I think Russ has alluded to this already, most builders don't realise that their businesses are not profitable to start with.

Andy Skarda:

Really, this is the first step in getting to the point of understanding what's actually going on so that we can then start to look at margins as a whole. I have a huge advantage coming into this, because over the years, Russ and Sky have not only brought this concept out, but taught it so incredibly well, that we've got a proven track record of the fact that we know we are correct, and we know what the outcome is when this gets addressed.

Andy Skarda:

Our coaching team has an immense amount of confidence because of the runs we already have on the board in terms of helping businesses all over the world fix this problem on the way to becoming profitable businesses, that you can then trust the numbers that you're looking at on a monthly basis.

Bosco Anthony:

Russ and Sky, how did you both go about systemising this? Obviously, you had to get some success stories to take this to the market and really test this when it was in its grassroots. But how did you both go about building a solution for builders?

Russ Stephens:

Fundamentally, the calculation is reasonably straightforward. You've just got to put the data in there to get the numbers and then get the will, really. It's having the will and the discipline to put the numbers in, which all comes from understanding the importance of it, really.

Sky Stephens:

Yeah. That's a good point. We talked about work in progress a lot. And suddenly, some of us so slowly slip in this word WIPAA. So, if we just explain that, there are two parts to this. So, we are talking about work in progress, work in progress, work in progress. This is the liability typically, if not an asset in a building company. But then you've got something that we've just alluded to constantly through this whole show, and it's WIPAA.

Sky Stephens:

That's the Work in Progress Accounting Adjustment. Step one is calculating your Work in Progress (WIP) using the calculator, exactly like Russ just said. So, you calculate your WIP. It's, "Okay. Now I know I've got a $730,000 liability in my building company. Now what?” Nothing changes if nothing changes; your accounts still don't make sense.

Sky Stephens:

Then they need to do part two, and that's doing the accounting adjustments. This is why we always talk about builders doing their WIPAA every single month. It's basically a very simple adjustment inside your accounts in two places like journal entries, like Russ just mentioned, that you can insert into your accounts so that your balance sheet and your profit and loss report make sense.

Russ Stephens:

We had to create this term, really. Builders kind of questioned what we were talking about, because I think for years, we were talking about work in progress. We might ask a builder, "Do you know what your work in progress is?" They'd say, "Yeah, mate. I've got plenty of work in progress. All good."

Russ Stephens:

I always wondered what on earth did that mean? Then I realised what they were talking about was workflow. In their mind, they just wanted to move on in the conversation. So, when you talk about WIPAA, they ask, "So, just remind me, what is that?" And we have that conversation.

Sky Stephens:

Yeah. So true. For years, because we were calling it work in progress, there wasn't as much traction, because it was sort of a miscommunication between terms, but then to really roll it out and get the traction, that's really happening lately. I think it's the proof like you're saying, the runs on the board and the coaching team sees this every single day. Knowing how many building companies we have saved is making them fully aware of that liability. Andy, you can speak to that a lot more than me, I'm sure.

Andy Skarda:

It is without doubt this single process that we do that illuminates where the problem is. The beauty of it is that once it's working, it identifies this problem. You just spoke about forensic investigation earlier – it not only identifies where the problem is, but because the builder understands the concept now, he's able to get his head around its implication in the rest of his business.

Andy Skarda:

It solves the accuracy problem, and it potentially solves the cash flow and the cash reserve problem. It definitely solves the taxable liability problem, but it also then puts him in a place where he can now start to work positively on making the business profitable as a whole, because he's actually got accurate data that he can now work from. That's probably the biggest single change that happens in the builder's life is that he's now able to trust his numbers.

Russ Stephens:

Yeah, and the builders who do this well, they understand their margins down to a couple of decimal points, and they don't move each month by more than a couple of decimal points. They really do understand, not just their building company, but their individual projects at a very, very deep level that not many builders get to see.

Bosco Anthony:

Andy, are there any benchmarks or percentages that builders should be paying attention to? Are there any statistics that define a healthy adjustment number? I'm just curious; we talk about the successful builders leaving a blueprint, but I’m just curious if there’s any industry benchmarks that builders should be paying attention to, or does it vary?

Andy Skarda:

It’s going to vary according to, and Sky has pointed this out, what kind of building business they have, number one. And number two, where in every single build they are at any particular point in time. I think that’s the other thing that we’ve got to kind of mention here, is that the accounting adjustment is a photograph. It’s a moment in time. It’s not a video.

Andy Skarda:

Literally, what we are doing is we are saying, “At the time of the month when you are calculating your profitability, this needs to be taken into account.” In fact, the way that we process that journal entry is within 24 hours, we reverse it, because to go back to generally accepted accounting principles, it needs to go the other way for the business to keep running until the next time we take that snapshot.

Andy Skarda:

If we were going to try and give a builder a rule of thumb to work to, they need to think back to when they costed their job, and any job that’s showing them significantly more profitability than they costed when they did the estimates, the flag should start to wave. The reality there is, although I got paid $100,000, I know that my markup on this job is only 15%, which is a 12% margin out of that $100,000.

Andy Skarda:

When you say this to builders, you see the lights come on. Out of $100,000 with a 12% margin, $88,000 is not mine, because when I costed the job, I knew out of every $100, I was only going to get $12. But where it gets complicated for them is income minus expenditure, 100 minus zero equals 100. Then their accountant tells them they just made $100,000 profit. And that’s where the Amarok and the trailer and the boat come from.

Bosco Anthony:

It’s a really good analogy. Speaking of analogies, Sky, you talked about this mass pile of dirt that just keeps getting bigger and bigger. It sounds like this problem goes beyond the calculation. It sounds like this is more a business vision or mindset, whatever you want to call it, problem, outside of the calculator as well.

Sky Stephens:

I think so. Mainly because, we talked about how you know it’s there, exactly as Andy just said. You know how you costed that project. If you’re running one job, you get a progress payment and your costs don’t equal that. You know that it’s not all your profit. You’re just maybe not sure how much, if you haven’t done any calculations and then multiple jobs get added. It’s all a bit confusing.

Sky Stephens:

But maybe it is a mindset thing. We kind of kid ourselves. “It can’t be that bad. I’m still making some money. I’ve got quite a bit of cash over here. I know my accounts aren’t 100% accurate, but I must be okay.” Unfortunately, it’s like burying your head in the sand, I suppose.

Andy Skarda:

Yeah. It’s that ostrich syndrome. We’ve spoken about this already today. Most of the people who we work with are fantastic at building homes or renovating or remodelling. We work with some of the most highly awarded builders in the industry, worldwide. But the reality is for most builders, nobody teaches them this financial stuff. They can make a wall absolutely plumb. They can make a home environmentally sound and air proof, and they can do all of those things.

Andy Skarda:

But nowhere in that process does somebody sit down with them and explain the implication of these kinds of things on the profitability of the business. That’s really where we’ve stepped in, in terms of being that additional education element that helps them to get their head around the bits of the business, that until now, either haven’t been important because they were only building one job anyway, and they could keep a track of it. Or alternatively, they’ve grown to that level where they now do want to scale and they want to do that safely and securely.

Sky Stephens:

One hundred percent. I think you can win all the awards in the world. You can be the most amazing building company. We talk about this so passionately, because we want you to keep winning all the awards in the world. Keep going, keep being the best. Unfortunately, if you don’t do this, you’re not going to be around for much longer.

Sky Stephens:

It’s very solemn. It’s quite sad, the topic I suppose, that we’re talking about, but there is a positive to it, because when you know it and you really know it, it’s exactly what Russ said. You are all over your margins and you know how much you are worth and you know your financials and you will last much longer. You will last a very long time.

Russ Stephens:

The sooner builders get onto this calculation though, the better, because all the time they don’t understand it and they’re putting it off, they can’t course correct. We’ve been able to save so many building companies, because at least even when they’re not profitable, they still have cash flow. When the building company has cash flow, you can work with them to turn it around. But when they leave it too late and the cash flow’s drying up and they’re in arrears, there’s really no hope at that point.

Andy Skarda:

As Sky’s just said, that’s when the conversation gets very sombre. It is the difficult conversation for all of our coaches, is that when we realise it is too late. If they’d only got to us six months earlier, we would’ve been able to help them work their way through it. That’s when it gets dark.

Sky Stephens:

I remember years ago now, Russ, you did an event. You got invited to speak about this at a big conference – and what a topic to be invited to talk about! By the end of the presentation, oh, the number of people in the audience who had their heads in their hands. I think you were doing a live exercise trying to get people to calculate it on the spot. It was really quite sombre at the end. I think a couple of people ended up coming up to talk to you.

Russ Stephens:

Yeah. This was a Master Builders’ conference I was invited to speak at. As I was going through this calculation and why it’s a problem, I looked around the audience and there were builders with their heads in their hands. It was quite unnerving.

Russ Stephens:

Then in the bar afterwards, there was a group of builders chatting and they invited me over, and they said, “Mate, can you just give us the yellow pill?” Because I used this example from ‘The Matrix’: “Do you want the red pill or the blue pill?” You can carry on. Ignorance is bliss. You can carry on or you can find out the truth. They’re saying, “Mate, have you just got like a yellow pill we can take?”

Bosco Anthony:

The in-between pill. It sounds like it’s a major blind spot that is impacting builders even today with everything that’s going on in the world. I’m just curious what everyone’s thoughts are when it comes to blind spots. What are some of the key blind spots that are impacting this problem and making it bigger today?

Andy Skarda:

It really is that fundamental understanding that business is different to building. It’s really getting to that place of understanding that no matter what an incredible home I can build, if I don’t get the business side of what I’m doing correct, as Sky has said, I’m not going to be able to keep doing this for very long.

Andy Skarda:

So, really, the blind spot is thinking that purely because I win awards, and unfortunately, even in some cases purely because I’ve got a lot of work on my books, that doesn’t necessarily mean that you are profitable or successful. It may just mean that you’re busy. That’s one of the things that we’ve got to really deal with on a daily basis.

Sky Stephens:

A hundred percent. We’ve done this calculation with smaller builders, for sure, husband and wife teams, but then some pretty big building companies as well. They’re doing dozens and dozens of homes every single year. If they weren’t 100% calculating this, or they had a makeshift sort of way of calculating it, it's always a shock. It always is. So, it's like when you talk about blind spots, you’ve got to train your weakest muscle.

Sky Stephens:

If it is financials, you’ve just got to be honest, like what is your weakest muscle? We need to start training that. Often we’ve found it is financials. It's leaning all the way into it and really training it. And you know what, if you're very comfortable with your financials, you still have to train that muscle as well.

Sky Stephens:

We talk about this quite a bit in our coaching and training programs. There are really two main phases. You've got implementation. But once it's implemented, it's optimisation. So, if you are quite comfortable that it's been implemented, let's just recap it and go back over and focus on some optimisation at this point. There's always room to improve.

Russ Stephens:

Yeah. Invariably, what this always leads to is a revision of their pricing model, particularly margins. In terms of blind spots, what I'd say is one of the biggest blind spots that we see in builders is the fundamental understanding that marketing is linked to margins, or margins are linked to marketing. Putting your prices up, your margins up, is a great start for most building companies.

Russ Stephens:

They need to put their margins up and get to the industry benchmarks, which are 25% margin for new homes, 35% for remodelling, which by the way, is a 33.3% markup for new homes. Now, a lot of builders probably fell off their chair just hearing that, saying, “That's rubbish.” But we've got the data to prove this.

Russ Stephens:

We know these are the benchmarks, but in order to get there, you are not going to get there by simply putting your prices up. You've got to develop a marketing strategy that supports your business model. That is where you're going to reach the industry benchmarks.

Bosco Anthony:

Wow. This has been a really insightful interview, and it's a really good way to start our series. I look forward to picking your brains a lot more in the future on different, various hot seat topics.

Bosco Anthony:

But before we close up, I just wanted to see if anyone had any final words for the listeners out there for someone that might be in denial, putting their head in the sand or for someone who needs to come to terms with the fact that this is a pile of dirt that's growing if they don't attend to it? What are some final sage words from all three of you today?

Russ Stephens:

Take action. Don't delay; take action. Every day, every week you put it off, the problem is only getting worse in the background. So, just take that first step right now.

Sky Stephens:

Totally. Nothing changes if nothing changes. Plain and simple.

Andy Skarda:

Associationofprofessionalbuilders.com, that would be my recommendation. We've got some incredible resources that speak specifically to this problem. That would be the start of a journey. As Russ says, you've got to do something about it. You literally cannot ignore this. It will eventually remove that boat and that trailer and that Amarok. You'll be back to driving a Ford.

Bosco Anthony:

Sky, Russ, Andy, thank you so much for your time. I really appreciate the insights, and we look forward to having more future conversations with you all.

Sky Stephens:

Thanks, Bosco. 

Andy Skarda:

Thanks, Bosco. 

Russ Stephens:

Great chatting with you.

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.