On the floor of the Senate, Finance Committee Chairman Max Baucus (D-Mont.) said that, “It’s important that this tax credit does not become a permanent fixture in the tax code. Our amendment would end the credit on April 30 of next year. This extension would get us through the winter – traditionally the worst season for real estate. Our amendment would jump-start the housing market as it enters the summer months of 2010.”  Baucus added that the seven-month extension of the tax credit would be “long enough to encourage home buyers to buy homes, but it’s short enough to remain fiscally responsible.”

This article first appeared in NAHB's Eye on the Economy. [return to top]

Balancing your company’s books is not like balancing your company’s checkbook.

You balance your checkbook using the cash-basis accounting method, which is simply totaling all the deposits, subtracting the payments, and — voilà! — that’s how much money you have in the checking account.

But you can’t report company books balanced that way (which measures cash flow) to either your bank or the IRS. According to generally accepted accounting principles (GAAP), you get a truer picture of your profit with the accrual accounting method.

As a manager, you must understand why profit doesn’t equal cash flow. Both measures, while very different, are important to your financial health.

Accrual Accounting

There are a couple problems with using cash flow to measure your company’s financial performance. Both have to do with the timing of economic events. Consider the following:

• Payment doesn’t always occur at the same time goods and services are provided.
• Revenues and expenses don’t occur at the same time.

Cash flow is, by nature, very volatile. The goal of accrual accounting is to remove some of that volatility so that your financial performance doesn’t depend on when you look at your books.

For example, when a trade contractor finishes his work he mails you an invoice. At that point in time you owe him money. The cash-basis accounting method inaccurately claims that you haven’t incurred an expense because you haven’t paid him yet.

As another example, some builders require deposits from their customers upfront before construction begins. Under the cash-basis method, if you examined your books just after receiving this deposit, it would appear that you’ve turned a huge profit (because you’ve recorded the revenue without any accompanying expenses).

Accrual accounting corrects for these timing issues in two important ways:

• First, revenues are recorded when they are earned, not when payment is received.
• Second, expenses are recorded at the same time as the revenue they help generate.

In the home building business, this means waiting to record revenue and expenses until construction is finished and the home is sold. Expenses that cannot be matched to a specific home, such as advertising, are recorded as soon as they are incurred.

Equity vs. Cash

When you turn a profit, it adds to the equity portion of your balance sheet. Equity is the amount of investment you have in the business. But profit isn’t always cash. To keep your books balanced, the accrual method adds several accounts to your balance sheet:

Payables and Receivables. Say you finish construction on a pre-sold home, but haven’t received payment yet. Because you have earned the revenue, your equity has increased. But there hasn’t been any increase in cash, so what asset does that equity refer to?

To maintain balance, the price of the home is added to a placeholder asset called accounts receivable. When you receive payment, you shift the price of the home out of accounts receivable and into the cash account.

Similarly, when you expense something that has yet to be paid for, equity has decreased without a corresponding decrease in cash. Accounts payable keep your books in balance between expense recognition and payment.

Inventory. You incur many costs and expenses during construction of a home. But they are not recognized on your income statement until closing. How do your books stay balanced with a decrease in cash but not a corresponding decrease in equity?

The costs and expenses are added to the placeholder asset inventory, which offsets the decrease in cash. The inventory is written off when the house is closed.

Liabilities. When a customer deposits cash with you before the home is finished, there is no increase in your equity because you haven’t earned that revenue. To keep your books balanced, the deposit is classified as a liability.

In general, liabilities refer to the amount of borrowed money invested in your business. Although borrowed money increases your cash flow — and you are free to purchase anything you want with it — it is certainly not profit.

Maximizing Your Profit

The goal of your business is to earn you cash. The best measure of this goal is profit because profit takes into account the cash that belongs to you and the cash that belongs to someone else.

For example, part of your profit consists of accounts receivable. Although accounts receivable aren’t cash, they increase your wealth because you have gained the legal right to receive cash in the future.

Moreover, using only cash flow to measure financial performance is inaccurate because it doesn’t take into account investment. Investing your cash in fixed assets doesn’t decrease your wealth, because those assets can be sold for cash in the future.

For example, construction costs and expenses don’t decrease your wealth. Assuming you haven’t made a poor business decision, they should be fully recouped when the house closes. Accrual accounting correctly recognizes these costs and expenses as an investment in inventory.

Profit vs. Owner Compensation

The profit of your business is not the same as your compensation. When you compensate yourself, you take money out of the business and put it in your pocket. That money in your pocket doesn’t bring you any return.

Remember that equity (whether it’s cash, receivables, inventory or something else) is your investment in the business. An investment is putting cash away today for profit in the future. When you compensate yourself, you reduce your equity and are trading larger profits in the future for profits today.

Determining how much to compensate yourself depends on your personal financial situation. Unless you have other, more lucrative business opportunities, you should leave excess cash in the business where it will bring you a return.

Reserving Enough Cash

Although profit is a better measure of financial performance, it’s still very important to monitor cash flow. When your bills come due, you won’t be able to pay for them with accounts receivable or inventory.

The size of your cash reserves determines the risk level of your business. Fixed expenses like loan interest must be paid or you’ll go bankrupt. Maintaining adequate liquidity is one of the most important aspects of financial management.

It’s often tempting to let your cash reserves get too low, because fixed assets offer a higher return on investment. Under accrual accounting, investments are capitalized and therefore show no effect on your bottom line. But profit means nothing if you go out of business to obtain it.

Jordan B. Zimbelman served as NAHB’s Business Management Department as an intern in 2006. [return to top]

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The EPA comments are due Nov. 27.

“Anyone compensated for working inside homes built before 1978 will be affected by this rule,” says Bob Hanbury, CGR, a remodeler from Newington, Conn. “NAHB members need to have their say before EPA makes this rule stricter and burdens contractors with greater requirements.”

Members who wish to send comments to the EPA can download and complete a letter template created by NAHB. The link is available to NAHB members only.

Members who have noticed an impact on their business from the new lead paint regulation and wish to submit information for the NAHB comment letter are urged to e-mail Matt Watkins at NAHB with details; or call him at 800-368-5242 x8327

The proposal, a result of the EPA’s recent settlement with environmental advocates, would remove the “opt-out” provision in the Lead: Renovation, Repair and Painting rule governing remodeling activities in homes and child-occupied facilities built before 1978 that are more likely to contain lead.

As the rule currently stands remodelers and other contractors (such as carpenters, plumbers, roofers, window and siding contractors, HVAC, and electronic installers) doing work in homes affected by the lead paint regulation must pay a $300 fee to certify their firms, have a trained and certified lead renovator on staff, educate home owners, contain and clean up dust, conduct a final dust wipe to confirm cleaning, and maintain records of all the work done. The rule goes into effect in April 2010.

The rule also currently allows an “opt-out” provision for homes without children under six and pregnant women as residents. If the proposal to remove the provision is accepted, all pre-1978 homes will be subject to the rule.

The EPA is also collecting cost estimates on how the rule will affect remodelers and contractors, including specific examples and suggestions for reducing the costs of the rule.

Additional proposed changes to the rule include a requirement for contractors to give the home owner a compliance checklist document to add to their home records that can be passed on to future owners. The checklist would describe the sections of the home renovated and details on rule compliance.

NAHB is submitting comments to EPA with concerns about EPA’s proposing changes to a rule not yet in force, the lacking number of trainers to train contractors by April 2010, and the great increase in costs to the contractor because of the rule. NAHB members are encouraged to use the template letter and tailor with any additional comments, including:

• Estimates of costs to your business (including labor, record keeping requirements, insurance, tools, materials, and more)
• Concerns about home owners hiring unscrupulous contractors to avoid greater costs due to the rule
• Lack of training providers for obtaining certification by April 2010
• EPA’s lack of outreach to builders, remodelers, trades, and other affected contractors
• EPA’s lack of outreach to homeowners about the rule and how it may cost them more in contracting and remodeling expenses
• EPA’s creating confusion by proposing changes to a rule that has not been fully implemented

The full proposed amendment was published in the Federal Register and can be downloaded in PDF format.

For more information on the current rule, including obtaining training and certification, visit www.nahb.org/leadpaint. [return to top]

Participants can attend the course in person or watch it during the live webcast by registering on the NAHB Web site at www.nahb.org/Customer.

Several local home builders associations also will be showing the live webcast, and participants can contact the participating HBA to register. A complete list of participating HBAs is available here.  

About the Course

The Customer Service course teaches participants how to manage every phase of customer interaction — from initial contact through construction, the warranty period and beyond.

Graduates of the course will be able to:

• Understand customer expectations and behaviors
• Set appropriate service criteria
• Etablish and communicate their quality standards
• Administer the customer service process
• Understand and fulfill their obligations for warranty service
• Enhance their repeat and referral sales

Designation credit is available for CGA, CGB, CGR  and Master CSP. Continuing education credit is available for CAPS, CGA, CGB, CGR, GMB, CSP, Master CSP, CMP and MIRM.

Beverly Koehn, CAPS, CGA, CGB, CSP, GMB, MIRM, of Beverly Koehn and Associates, based in San Antonio, a sought-after consultant and speaker with more than 20 years of experience in sales and customer care in the real estate industry, is the instructor.

For more information, e-mail Maria Nande at NAHB, or call her at 800-368-5242 x8435.

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It will be an evening to remember and a fitting accolade for the 2009 Designees of the Year, who will be announced at the event. Come prepared to enjoy light hors d’oeuvres and libations and a rare chance to connect with industry stars from every area of the building industry. Emcee Tim Sullivan will keep things lively as he recognizes the 2009 graduates.

This year’s celebration brings together designees from all over the housing galaxy — builders, remodelers, sales and marketing professionals and more — so you’ll see new faces and make contacts you may have missed otherwise.

Register now at www.nahb.org/designationreception. You may also complete your registration by fax with this form. The deadline to register is Tuesday, Dec. 29. The 2009 graduates receive complimentary entry to the event if they register by Dec. 29.

For more information about the Designation Achievement Reception, contact The Professional Designation Helpline at 800-368-5242 x8154 or designations@nahb.com. [return to top]