Job Costing - What is it and Why is it important?

As we work with business owners in the construction industry the idea of job costing is often brought up and met with a sense of uncertainty. What we find is that a lot of business owners and leaders don’t track the hard data on a job or project basis, but instead they utilize “feel” or past experience as a replacement for the numbers. This is cause for concern in our eyes as the costs of materials, labor, mobilization, gas, shipping, heck just about everything has increased over the past couple of years. It is more imperative than ever to be detailed and track your revenues and costs by job to have an accurate representation of performance. This allows business owners and leaders to put emotion aside and read the unbiased story of the business.

This concept in fact can be used in any project-based business. The idea of job costing is relatively simple; it’s just allocating expenses and revenues to each job performed, proportionally. In practice, there are several processes that can be implemented to keep this a manageable job. Software will help to streamline the process and ensure that you have the most data possible while still allowing you to focus on other areas of your business.

Job Costing – How and What to Track?

The calculation of job costing takes into account all of the costs of your business and allocates them to the jobs or projects that you work on. If done correctly, all expenses that are incurred during the year will be allocated to jobs. There are varying degrees of complexity when it comes to job costing and an accounting professional with experience in job costing should be consulted when setting this up.

When starting to entertain the idea of job costing try and think about it in its simplest forms. When allocating costs to jobs, we have Direct (COGS) and Indirect (Overhead) costs.

Direct Costs

Direct costs (or your cost of goods accounts) are usually fairly easy to allocate to each project. Materials are ordered specifically for a job, hours for the field labor allocated to jobs by tracking where employees were on their timesheets, and equipment mobilization or rental fees are usually billed or included in the estimates.

Carpenter Measuring Board

Indirect Costs

The tricky part comes with indirect costs (or your general overhead expenses). These costs should be coded to a job, but how do you know how much of your utility bill, or your support staff wages you should allocate to each job? The answer is to find an allocation method that suits your business.

Allocation Methods

There are many methods of allocating your indirect costs, but all of them have one thing in common. It comes down to finding an allocation factor through a calculation and using percentage to allocate costs. Typically, we use a Rate of Costs Factor when preparing estimates or bids for a job, and use Proportion of Direct Costs when allocating recognized overhead expense.

Rate of Costs

When preparing estimates or bids it is imperative that you not only have a good figure for the direct costs, but also how much of your indirect costs will be allocated to the job in question. Enter, The Rate of Costs. This allows us to determine an appropriate amount to estimate or bid on the job. To do this, use historical data if you have it and it is accurate enough for your purposes. If not, ensure that you are continually updating this number as you are starting off, typically monthly.

Total Direct Costs (For a Period) / Total Overhead Costs (For Same Period) = Rate of Costs

Example: Last fiscal year ABC Construction had Direct Job Costs of $11,000,000. They also had Indirect Costs of $1,500,000. ABC Construction is resetting their Rate of Costs for this year in their estimating system. The new rate will be:

$11,000,000 (Total Direct Costs) / $1,500,000 (Total Indirect Costs) = 7.33%

This means that when estimating, ABC Company will take the direct costs projected for the job and multiply by 7.33% to determine the amount of projected indirect costs that will be allocated with the job. This will help ensure that the estimate/bid will have an accurate cost projection to apply a markup to. Say the job has projected direct costs of $50,000 and ABC’s normal markup is 35%. The estimate or bid would be calculated as follows:

$50,000 (Projected Direct Costs) * 7.33% (Rate of Cost) = $3,665 (Projected Indirect Costs)

$50,000 + $3,665 = $53,665 Total Estimated Costs

$53,665 * 135% (Typical ABC Markup of 35%) = $72,450 Total Estimate/Bid for Job

Proportion of Direct Costs

Now, while we utilize Rate of Costs for our estimate or bid process, we can allocate indirect costs more accurately based on a Proportion of Direct Costs Method. This involves looking at the relationship between direct and indirect costs that the company incurred during the time period. Then allocating the indirect costs proportionally to the completed jobs.

Example: Last month, ABC Company performed 3 jobs and had total direct costs of $750,000. Each job had costs as follows: Job 1 - $200,000, Job 2 - $150,000 and Job 3 - $400,000. The indirect costs for the month were $100,000.

Job 1 – $200,000 / $750,000 = 26.67%

26.67% * $100,000 = $26,667 of Allocable Overhead Expense

Job 2 - $150,000 / $750,000 = 20%

20% * $100,000 = $20,000 of Allocable Overhead Expense

Job 3 - $400,000 / $750,000 = 53.33%

53.33% * $100,000 = $53,333 of Allocable Overhead Expense

Data – What can it tell you?

Keeping track of the data is just half of the job, analyzing and understanding the data is the other half. Job Costing Summary Reports, Profit and Loss by Job, Unit Productivity and Labor Analysis Reports are among a few of the important reports that you can unlock with this data. Each of them can help companies maintain better budgets, increase efficiency in the estimate and bid process, maximize the efficiency of staff in the field, understand the revenue generating activities that make the most money, and identify activities that operate at a lower profit margin to change or cut services. This data can take your business from where you are now to where you want to be in the future, while cutting the amount of time that it takes to get there.

Example: After implementing a job costing accounting model into their business, a client we worked with had the hard data to analyze their revenue streams and noticed that one of their revenue streams was running at a significant loss. There had been changes in pricing from their vendors over the past couple of years that hadn’t been passed on to their customers. The pivot that they were able to make was so significant that the company went from a pattern of cash flow pinches on payroll weeks, to being able to hire another crew to focus on their top revenue generating service. The kicker, they didn’t have to cut the low performing service or change their business model, they just needed to accurately reflect their pricing based on the direct and indirect costs of each job.

As you think about taking the next step in your business, whether the goal is to increase revenues, grow cash positions, or to gain clarity and illuminate a path through the weeds, keep us in mind. We work hard for the business that work hard for our communities and are experts in giving you the advice and data that you need in terms that you understand. Form Financial Management, Specializing in Structured Success.