By Ken Boyd –
If you can’t identify and accurately estimate all of your project costs, how can you determine the profitability of the job? It’s simple, you can’t.
Business owners who conduct business on a project or job basis may have a difficult time tracking each individual cost associated with each individual job. However, owners who cannot track total project costs accurately may find themselves taking on work that is not profitable or pricing their work too low. The solution lies in accurate job costing. Estimating the total cost of a job can be easier said than done. We've got a few tips to help you manage and track your job costs for more accurate estimates. Click To Tweet But first, let’s take a look at the difference between job costing and process costing.
Job costing vs. process costing
If you run a construction business or service business, or you work with clients on unique projects, you probably deal with job costing all the time. On the flip side, if you’re a manufacturer, or you deal with mass produced goods, you may be more familiar with process costing.
Job costing and process costing rely on similar principles, but there are a few important differences. Before we dive in, you need to understand which type of cost accounting applies to your business.
What is job costing?
Job costing assumes that you complete work on a project-by-project basis and that the total costs required for each job are different. People who work in specific trades, such as carpenters, plumbers, and tree services companies use job costing. They provide each customer with a job estimate before the job begins.
If you need a tree removed, for example, the tree service company will estimate the direct labor costs, equipment costs, and direct material costs required for the project. From there, they’ll add a profit margin and provide you with an estimate for the job. Each job is different, given the size and location of the tree, and the distance required to drive to the job site.
Using a job costing system, a project manager or accountant tracks the true cost of each job. The true cost of the job is the actual cost. If the actual cost is higher than the estimated cost, it means the company lost money. The purpose of job costing is to accurately predict job costs from the start to avoid losing profits.
What is process costing?
Process costing, on the other hand, is used when the products or services you provide are mass produced.
Imagine a company that manufactures plastic combs, for example. Making the combs is a process that requires material and labor costs. Costs are incurred as the product moves from one department to another. Plastic material is formed into the proper shape, each comb is painted, and the combs are packaged for shipment.
In many ways, process costing is easier for business owners because the costs are consistent or fixed. The cost of materials may fluctuate slightly, but for the most part the labor costs and materials costs are easily predetermined. This type of business process management can also be improved at scale, saving you money in the long run.
Unlike process costing, job costing requires the project manager to manage dozens or even hundreds of individual projects with varying costs. To accurately estimate job costs, you need a reliable job costing system. Let’s take a look at a job costing system in action.
Job costing in action
Emma owns and operates Lakeside Tree Services, a business that provides tree trimming, tree removal and landscaping services. She visits each customer location, discusses the project with the client and provides a written job estimate. The job estimate includes estimated labor costs, materials costs and profit margins. If the customer agrees to have the work performed, Emma’s office manager schedules a work crew for the job.
A typical tree removal job requires a crew of three people, along with a large truck, equipment, and machinery to grind the tree limbs and the stump. Lakeside’s largest cost is labor, but the company also incurs mileage costs, costs to repair and maintain assets, and overhead costs to operate the office.
Emma and her accountant decide that an efficient way to charge customers for vehicle, equipment and home office costs is to use direct labor hours worked. Jobs that require more labor hours should be assigned more of Lakeside’s costs. This is a common method used in job costing.
Here is Emma’s job estimate to remove the Johnsons’ 40-foot oak tree:
Johnson Job Estimate
Vehicles and equipment $30
Home office costs $14
Total costs $68
Profit (15% of sale price) $12
Price to customer $80
Let’s take a closer look at the costs listed in the estimate:
• Vehicles and equipment: This accounts for the cost incurred to repair and maintain vehicles and equipment. Costs are assessed at a rate of $1.50 per labor hour.
• Mileage: This covers the miles driven by the work crew vehicles, and miles that Emma drives to visit the customer and provide the estimate. She also inspects each job site after work is completed.
• Home office costs: These include insurance, office lease expenses, marketing costs, office supplies, and the salary cost for Emma’s office manager. Costs are charged based on a rate of $7 per labor hour.
Assigning vehicle, equipment and home office costs based on a rate per labor hour makes estimating job costs easier. Emma just needs to estimate her total costs for the year, and the number of labor hours she expects her crews to work. With that information, she can come up with the rate per hour figures.
However, accurate job costing relies heavily on the accuracy of the labor hours worked, and many businesses have trouble managing this information. Without an accurate time tracking system, estimating labor hours is nearly impossible. And Lakeside’s crews still use outdated time tracking technology.
Time tracking for accurate job costing
Lakeside’s crews work on dozens of jobs each month, and each worker must report the hours worked per job on a paper timecard. However, this information sometimes gets reported days after that fact. As a result, the hours reported per job are sometimes incorrect, or not reported at all.
Emma invests time each week to follow up with work crews and correct the time tracking information. But this inefficient system often leads to expensive errors. Timecard errors have a huge impact on Emma’s ability to provide reliable job estimates and generate a reasonable level of profit. These mistakes can result in either over-charging (assigning too much cost) or under-charging (assigning too little cost) to a particular job.
Business owners should expect some differences between estimated and actual costs, based on changes in the cost of materials, wage rates, or gas prices during the year. However, these costs can be explained and are expected in business.
The bigger issue is computing job costs based on bad information, and the manual timecard issue may produce incorrect labor data.
Take the Johnson tree removal job as an example. Emma’s job estimate assumes 20 hours, at a cost of $25 per hour, or total labor costs of $500.
Let’s assume that actual hours incurred was 21 hours. Not too big a deal, because labor costs are only 5% higher than planned. Emma can talk to the work crew, find out why more time was needed, and make more accurate estimates moving forward.
But what if the work crews only report 17 hours, when 21 hours were actually spent to the job?
This type of error creates several problems:
• The labor costs on the Johnson job are too low, and the profit calculation is too high.
• Assume that the missing four hours were incorrectly assigned to the Smith job. Labor hours on the Smith job are too high, and the profit calculation is too low.
The incorrect labor hour calculation on both jobs also means that the vehicle, equipment and home office costs are incorrectly allocated.
A business that uses a manual time tracking system or manual job costing system may have dozens of job costing errors, making it impossible to manage costs and price specific jobs accurately.
Automate to manage job costs and increase profits
Unfortunately, one in four construction companies say they would go out of business if they made just two or three inaccurate estimates, according to a recent survey. If you’re a business owner, job costing is one thing you simply can’t afford to get wrong. The solution to accurate job costing lies in automation.
Smart business owners use technology for time tracking, project management and job costing. Accounting software can streamline the job estimation process by collecting and assigning job cost information, including materials used and labor hours worked per job.
Using an “estimated vs. actuals” report, you can easily see if your project costs are on track, or if your profitability is about to take a hit. More importantly, job costing software learns more about your different jobs as you go, resulting in increasingly accurate estimates and fewer surprises when it comes time to invoice your customers.
Because labor hours are such a pivotal part of job estimates, it’s important to invest in time tracking software that allows every worker to easily and accurately track time on the job in real-time.
By automating your job costing and accounting systems, you can make informed decisions about changes in costs noted during the year, and you’ll avoid over-costing and under-costing jobs. Finally, and perhaps most importantly, you can increase your profits by generating accurate job estimates based on reliable data.
Invest the time and effort to automate your job costing systems to control costs and bring in higher profits.
About the Author: Ken Boyd is a co-founder of AccountingEd.com and owns St. Louis Test Preparation (AccountingAccidentally.com). He provides blogs, videos, and speaking services on accounting and finance. Ken is the author of four Dummies books, including “Cost Accounting for Dummies.”