45. How Much Builders Should Pay Themselves With Russ Stephens

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

Do you feel that builders pay themselves enough?

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

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

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

This is Professional Builder Secrets, the number one podcast to help you grow your building company safely and securely. Brought to you by the association of Professional Builders. 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. Hello and welcome to the Professional Builder Secrets podcast, a podcast by the association of Professional Builders for building company owners, general managers, VPs and emerging leaders. Here we discuss all things running a professional building company from sales, processes, financials, operations and marketing. I'm joined today by co founder Russ Stevens for the association of Professional Builders. Russ, it's great to have you here on the podcast again. Welcome.

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

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

Well, I think the number one problem in small business is that the owners who work in the business, they don't take a regular salary. And what that does is it distorts the fixed expenses, which then leads to them underpricing. And it doesn't matter what business you're in. You know, we're talking about construction and residential building companies, but it tends to happen generally in a lot of small businesses. But probably, you know, I've seen it affect the, the pricing in a residential building company more than any other business. 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're also the shareholder. And you've got to be paid appropriately for both of those roles. Now, as a, as a director, you need to be getting the market weight for what you're 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're invested and that ROI that's got to align with the risks that are involved with lending money to a business.

So 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?

No. Now, I know that because I ask them every month when I run a live presentation. And I mean, 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? And then think about how many hours do you work a week? And from that, you can then calculate an hourly rate figure. And once you've done that, ask yourself, is it enough? Because probably about 90 to 95% of builders that I speak to, they all tell me that it's not enough.

Right. And so, you know, 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?

Well, 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're doing that and you're not budgeting for tax. And that's the same when, if you take dividends at year end, and again, you don't budget for tax. And 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.

And you 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 sort of that hard question to ask yourself at this point, too.

Oh, 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. Now, in terms of paying yourself first, it's got to be a market salary that appears within your fixed expenses. Now, typically fixed expenses for a building company, they are around 15%. For a residential building company, when the director's salary is included as a market salary. However, when they don't include Their salary as a market salary, and the fixed expenses. You'll typically notice that the fixed expenses probably sit around about 10%. Now, when that happens, builders then think that 10% is their break even point. But no, your break Even point is 15%, because you know you've got to be paid for that work you're doing to, to run the building company. So when they start thinking in terms of 10% or, sorry, 15%, they've then got to look at generating a 10% net profit for the shareholders as well. And what that means is they need to be adding 33% to their cost of sale to actually get to that point. Because a 33% markup on the cost to sell, that's a 25% gross margin, 15% to fixed expenses, that will leave 10% for the shareholders. That's the ideal setup, really, for a residential building company. Now, most builders, they balk at the idea of charging these kind of levels until they realize just how little that they are earning in terms of an hourly rate. And 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. And 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 we're doing here, we're just charging market rates. We're not doing anything exceptional. We're charging market rates.

Right. So it's almost like a financial awareness that you're taking them through 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.

Yeah, financial awareness. Yeah, Is spot on, Bosco. That's exactly what it is. Because too much of the time, I think we get wrapped up in what we do. We're technicians in our own businesses. We get wrapped up in that role. We don't always give enough objective thought, I would say, to things outside that area of comfort, that area of expertise. And we, we tend to repeat the same things we've always done. Go with the flow. But having our eyes opened up to what is possible and what we should be doing and then taking that on board, that really is what makes a difference to a residential building company.

So let's get into designing a financial, you know, compensation plan. Where, where does one start? You know, is it, is it looking at your financial projections, working with certain professionals to help you get there? Is it working with the apb, you know, where, where do you actually put your focus when you're looking at paying yourself the right way.

Well, the first thing you've got to consider is what would it cost to replace you? Because you are a professional. As a, 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 someone in, with your level of expertise and do what you're doing. And bear this in mind as well. If you're 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. And if you're working 60 hours a week, you're not going to be able to bring someone else in and churn out that kind of productivity. It's going to be closer to two people. And also, if your partner also works in the business, how much would it cost to replace them? I mean, we, we see a lot of building companies where the husband is the, the builder and the wife comes in and typically might do a lot of the bookkeeping, but what they're really doing or 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 and that role attracts a far higher salary as well. So you need to consider that as well.

Now, obviously, we live in a world where fluctuation sort of changes with what's going on out there as well, 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?

No, it doesn't. I mean, just like staff wages really, they don't fluctuate. They're not kind of linked to any index. They go up, but they rarely go down. Unless in exceptional cases, the only fluctuation might be if you're putting in like 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 into account, always take into account, but especially these days, is inflation. So if we are not giving ourselves an annual increase, we're actually falling behind because of the effect on inflation. And even in the past 10 years, when inflation's been relatively low, that's still a couple of percent that's chipping away at Our buying power. So always need an index linked increase at the very least just to maintain our standard of living. But certainly in these times where we can see inflation is really out of the bag. Yeah, some hefty increases are going to be required just to stand still.

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

Sorry, Bosco. In terms of how I classify the two.

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

Well, I think you have to be objective and detached and you have to look at them one at a time. And certainly in terms of your role of running a building company, that really does come down to the experience, the size of the building company. That's really how you have to look at that particular role. And then when it comes to the shareholding, really it comes, it's really down to risk. There is an amount of money that you would have put into the business and there is a reasonably large risk associated with that. So you know, you can expect in the region of like 20 to 50% return on that money as a minimum being a shareholder. But I think in terms of a director of a building company, 5% is, is a pretty good rough indicator, I think, to start with. It's, 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. But you know, equally, it's, it's not a bad idea to just do a bit of research online and just look at comparable roles and see what it would cost to bring someone in.

You have a lot of builders that end up struggling with documenting or archiving these payments to themselves as well. 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?

Yeah, well, I guess it falls into one of two strategies. You are either drawing the money out as a, 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 actually deal with that in your account so that it doesn't get dropped off the fixed expenses is to record it as a journal entry. So that then gives you the ability to either draw out the cash each week, each month, or, or by doing journals, you don't necessarily have to draw out the cash out the business. You can leave the money in the business, but it's still being recorded as an expense, which means you will be pricing your jobs correctly. Now this, this can be a bit of a stumbling block, especially for new businesses who don't want market salaries coming out for the, the founders of the business in the early days because they just put all this cash in, doesn't make sense to just pull it out. But in order to get their pricing right, it's important to have those G journals inside the fixed expenses so that we understand what it's truly costing to run this business. Yeah, we don't have to draw the physical cash out and at year end the accountant can make adjustments where, yeah, we can do a drawdown and put it as a director's loan or we can just write it off altogether and not draw anything out. But the important thing is as we progress through the year, we're very, very clear, we're very much a across what it's really costing to operate this building company.

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 sort of, 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.

Yeah. And don't fall into the mistake of believing, oh well, that's okay because I know I'm not drawing a salary, but in my mind it's 5% or 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 now running a small business, especially a construction company, where the margins are tiny, it's all about accuracy. Accurate information, better 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.

It's funny you mentioned accuracy because that was one of the first lessons I learned from you when we actually talked about the WIPA calculator and about the importance of being so accurate on your numbers during tax time because you 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 about the WIPA calculator and the calculations around it. So accuracy is definitely something that I'm a big fan of, for sure.

And 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. 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?

Well, it depends because if you're expecting a lot of growth in the business in the year ahead, then like a bonus structure, like, could be. Could be good. It might sound silly, like setting yourself up with a. With a bonus structure, but, you know, you might set a base salary based on what the business has done over the past 12 months, but, you know, you're going for some serious growth over the next 12 months, you know, 50% growth. Well, reward yourself for the extra work you're going to be putting in and like, tell yourself, if we hit these levels, then I'm going to give myself a pay increase to these, you know, this amount. Or, you know, it could be like just the bonus. But yeah, that's a good way of protecting the business so that you don't just think, oh, yeah, we're going to increase by 50%, so I'm going to earn, you know, that amount based on that revenue. And if we don't hit it, well, it doesn't matter, the incentive has kind of gone. Yeah, it's good to kind of incentivize yourself in that way. Delayed gratification and self discipline is very, very important in business.

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

I think it's always good to have a conversation about these things. So if there is more than one owner, which, yeah, there generally is, even if it's a husband and wife team, sit down and talk about that. It will help you think more objectively. If you're 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, sound these things out, you know, see what's reasonable. But if there's certainly, if there's 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 maybe any incentives for exceptional performance as well. But definitely encourage everyone to speak to a third party about this rather than just attempting because it becomes emotional and we don't always make the best decisions.

Right, right. That makes sense. One of the things that really stood out when I was interviewing builders that are success stories from the APB association of Professional Builders, they always talked about how the coaches always were able to help them uncover their blind spots. It was a recurring theme from every success that I've heard so far about the awareness and learning about their blind spots. And 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?

Well, I know I've mentioned it already, but it is. Tax is probably the number one blind spot. So I would always encourage builders to look at their expected salary in the year ahead along with any other personal income, yeah, 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. So if the money is coming out through their building company as a salary, and it's coming out just like in the same way as their staff salaries do, that is being taxed at source. But if it's coming out in the form of a loan or dividends, then they need to make sure they're accounting for that tax and that money becomes untouchable, it goes into a separate bank account and just forget about it. And that way you'll never be stressed at tax time. But another blind spot, really, that builders have got to be aware of when it comes to paying themselves is the actual amount. And 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, we got two roles. So the shareholders have to be compensated realistically for the investment. So overpaying yourself as a director, it 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. And as a consequence you will leave money on the table. When you price jobs.

Right. Should you also factor a cash reserve? You know, when times when the cost of goods go 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?

Yeah, well, 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, especially these days, to be very aware of.

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, a professional lens and a personal lens too.

In a professional sense. So looking at it from their business. And that's obviously the first thing that we have to protect. Always remember, you know, my father saying to me after I had a, 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. And yeah, he looked at me and yeah, he gave me a real strong lecture. He said, your business is more important than anything and anyone. You always protect and look after that first. So, yeah, that's always kind of stuck with me. So in terms of protecting their business, the first thing builders can do is to calculate work in progress. The work in progress accounting adjustment or income in advance, whatever term might actually resonate with you. But you need to calculate that hidden liability every single month in order to protect yourself. Because, yeah, if you're, 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 they can do is, once they've calculated that number, is check their balance sheet every month to make sure they have the physical cash to cover that liability. Because for new construction, it is a liability and it's a liability that does not show up anywhere in your account or in your project management software. It's a calculation that you as a builder have to understand and have to go out your way to make sure it's done every month. So you've got to be calculating it every month. And because you're in new construction, that means it's definitely a liability. You've got to make sure you got the cash to cover that on hand. The next thing you need to do is to make sure that you've built up three months in reserves and by reserves, I'm really talking about working capital to cover your fixed expenses because that will cover any short term blips, you know, adverse weather, declines in the economy that will give you enough time to course. Correct. So whatever your three, 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've got covered in working capital, which will probably typically equate to net equity as well. Once you've achieved that, then you can start diverting excess profits into personal holdings. So in terms of protecting themselves personally, the first thing is to create a one year emergency fund. So by that I'm talking about all of your expenses. So 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 will typically recommend between 3 and 6 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, but for business owners it's got to be 12 months because the risks are so much higher. So 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 and 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. Yeah, obviously mortgage is probably the last thing that anyone gets to eliminate, but all the other debt has got to be eliminated as quickly as possible because only then can you start investing in income producing assets. Because if you have credit card debt and any other, you know, car loans etc on top of a mortgage, and then 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. And 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.

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

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

You know, everyone at the association of Professional Builders are around builders all the time. Events, coaching, interactions. When should a builder be concerned when it comes to their financial model? At what point do they have to start going, I need to pay attention to this because things are getting out of hand?

Well, the first thing I'd say here, if you are not calculating your income in advance or work in progress, work in progress, accounting adjustments, whatever the term is, that kind of 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. And the reason for that is that you don't have an accurate idea of your finances. Now, 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. So if you don't know how to calculate this number yourself, your finances, your financial reports are wrong. And 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. Knowledge is power. Just understanding where you are financially makes such a, such a difference. So yeah, 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. So I would urge anyone in that position to seek expert help urgently while you still have the opportunity to make changes. And of course, you know, 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. And if you're 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%, what are some of the trends that you're seeing with the coaching program and the mentorship? How is the association of Professional Builders helping builders become more proactive with their current financial model long term?

Well, most builders come to us looking to grow their building companies and 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, they do not scale profitably. So we help builders to understand their numbers by breaking everything down into bite sized chunks, then create a profitable business model that they can follow as they grow. And that means they can then grow their building company safely and securely.

Well, Russ, as always, this is always informative and I always learn something new when it comes to financial roadmapping and planning. It was a pleasure having you here. Should builders out there, our listeners out there, have any questions about the financial models? What's the best way for them to access the brains at the association of Professional Builders?

Well, I would say subscribe to this podcast is, you know, 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 is going to be on. And I'd probably suggest reading our book Professional Builder's Secrets. So Sky Stevens, the other co founder of the association of Professional Builders and myself, we, we wrote a book where we mapped everything out all the way from marketing, sales and financials to help builders truly understand their building companies. So I definitely recommend either reading the book or listening to it on Audible.

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.

Good stuff. Thanks so much Bosco.

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