When businesses start, the goal is to start making sales and generating revenue.
As time goes on, demand increases and you might find yourself juggling different opportunities. Saying yes to one might mean saying no to the other and, once that’s the case, how do you decide which one is right for you?
Knowing which jobs or projects are generating you profit most efficiently is essential as you start to weigh different opportunities against each other. If you want to maximize the profit you can generate given the work you do, you need to know your job costs.
What is job costing?
Job costing (also called project costing or project-based accounting) is the process of recording and analyzing the revenue and expenses associated with a single project.
Your financial reporting is an overview of every dollar spent and earned by the business. This is useful for determining how profitable your business is as a whole, but what about determining the profitability of a single job or project?
This is where job costing comes into play. By tracking the associated expenses of labor, materials, and other direct costs, you can determine how profitable a job has been down to the nearest cent.
Job costing is most commonly used by project-based businesses like construction companies, marketing agencies, or law firms. But any business can start tracking costs associated with a specific job, product type, or sector of their business to get a better understanding of what’s driving profit.
How to calculate job costing
There are three main components to a job cost calculation. Let’s break down each part of the equation.
Calculate direct labor costs
The direct labor costs need to be calculated using the salary or wage rate for any individuals who will work on the project. This will require you to know the total hours worked by each individual on the project.
Once you have the hours worked, you have two different approaches depending on whether the employee is paid through a salary or wage.
For waged employees, simply multiply the total hours worked by the hourly wage.
For salaried employees, multiply their daily payroll amount by the hours worked divided by eight.
If you use subcontractors, include their payments in the direct labor costs calculation.
Calculate material costs
Material costs are all raw materials that are directly or indirectly used in the completion of the project. For example, a landscaping company may include the plants, seeds, and soil used on the property.
It’s best to track the exact costs, but some may be difficult to track like the gas used to take a vehicle to and from the job site. In these cases, businesses use either a rough estimate or a flat amount to approximate the costs of the job.
Estimate the applied overhead
Overhead costs are the recurring business expenses that aren’t associated with any one aspect of the business, like your rent or utilities. You can think of overhead costs as the cost of “keeping the lights on.”
These costs are the hardest to allocate to a single project and businesses use different approaches to estimate applied overhead.
The easiest way to estimate applied overhead is to use a blanket overhead percentage. This means setting a flat, steady percentage that is used to calculate the applied overhead across all jobs.
In other cases, businesses use a predetermined overhead rate.
The predetermined overhead rate is a calculation that estimates overhead costs per unit of activity. The calculation requires an estimated overhead amount and an estimate on the total activity you’re planning to use as a barometer.
Some examples of units of activity used by businesses are total direct labor hours or total projects.
For a business looking to use total direct labor hours in the predetermined overhead rate calculation, they would use the following calculation:
Predetermined Overhead Rate = Estimated Total Overhead Costs / Estimated Total Direct Labor Hours
If they estimate their total overhead costs to be $200,000 and their total direct labor hours to be 5,000, their predetermined overhead rate would be $40 per direct labor hour.
To estimate the applied overhead, they simply need to multiply the predetermined overhead rate by each direct labor hour in completing the job.
Ultimately, there’s not one set way to calculate applied overhead. If in doubt, talk with an accountant or finance professional to find the method that best reflects your business.
10 steps in job costing
With the fundamentals of job costing figured out, use these steps to start using job costing in your business.
1. Choose the job or project to cost
The job costing process begins before the work starts. Choose the job you want to track the costs of before the work begins to get the best results.
2. Identify the direct costs
Each job will be unique in what will be required to complete it. Identify the direct costs that will be included in the completion of the job.
The usual costs you need to consider are the materials used and labor required to complete the project.
3. Create a budget or estimate for the project
Estimate the costs associated with the project including the direct costs and applied overhead costs.
Start by mapping out the hours of work required (including any costs of subcontractors) and raw materials required.
Remember that this is an estimate. The purpose of the estimate is to get an idea of what the job will cost and how profitable it will be.
You may also want to use your estimate to set a budget on the project. The budget will help you keep costs in check so you’re keeping your project profitable based on the agreed-upon price.
4. Allocate a portion of overhead costs
Using a chosen percentage, calculate how much of your overhead costs are allocated to the project.
There’s no set percentage that businesses use. Some businesses use a flat percentage no matter how many projects are worked (e.g. 10% regardless of whether they’re working one job or ten).
A more complex but accurate way is the predetermined overhead rate calculation (covered above).
If you’re unsure about what percentage you should use, consider consulting with an accountant or finance professional to better understand how to calculate job costs.
Some overhead costs to consider including in the calculation are rent, utilities, office supplies, insurance, and advertising.
5. Calculate total job cost
Throughout the project, track the actual direct material and labor costs. This can be done in a spreadsheet or in your accounting platform.
To calculate your total job costs, put your totals into the following equation:
Job Costs = Direct Material Costs + Direct Labor Costs + Allocated Overhead Costs
6. Compare the actual costs to the budget
Regularly calculate the total job costs over the course of the project. You should be comparing the actual costs to the budget to see if you’re trending towards a more or less costly project than expected.
Staying on budget is paramount to maintaining the profitability of the work you do. If you’re finding that projects are regularly going over budget, you may need to change your approach to making estimates.
In some cases, you may want to create two project estimates: a best-case and worst-case scenario. If you price based on the worst-case scenario, your margins will likely be better than expected.
7. Determine the profit of the job
Once the job is complete and all costs have been accounted for, you have the information you need to determine the profit of the project.
Subtract your total job costs from the price to find the profit. Take your analysis a step further by finding the gross margin.
Gross margin is what percentage of the total job price stays in the business after all costs are accounted for. The gross margin calculation is:
Gross Margin = (Total Job Revenue - Total Job Cost) / Total Job Revenue
It’s important to understand your gross margins as profit isn’t always the best indicator of how efficient a job is at making you money.
For example, if you pocket $1,000 on a job with a price of $2,000, your gross margin is 50%. But if you pocket $2,000 on a job with a price of $10,000, your gross margin is 20%.
Looking at profit, you’d favor the $10,000 job over the $2,000 job. But the $2,000 job is netting you a better return on your resources.
8. Iterate on your learnings
Job costing helps businesses understand how much profit each job is generating. Through this understanding, you can start to optimize your operations by:
- Updating your pricing to reflect your costs
- Choosing the jobs that offer you the best returns
- Setting more accurate budgets to keep costs in check
Take time to sit down and review the costs, profits, and gross margins associated with each job. Over time, you’ll better understand what’s driving the most efficient returns on the work you do.
Job costing vs process costing
Job costing and process costing are similar approaches of connecting costs to a specific category. But they differ in some key areas.
Process costing is used by businesses that have long-term, large-scale production runs. By tracking all costs and revenue associated with the production run, they get clarity on the goods they produce that generate the most profit.
An example of a business that would use process costing is a clothing manufacturer. If they’re producing a new run of t-shirts, they’ll track all direct material, labor, and applied overhead costs for the production.
Job costing and process costing differ in the scale of the work. While job costing looks at single-unit jobs or small-scale production, process costing looks at large-scale productions focusing on individual business units.
Example of job costing
A kitchen renovation company has been sizing up its operations and taking on bigger projects. But as they’ve been taking on bigger projects, they haven’t been able to understand how each job has impacted their bottom line.
To make sure they’re spending their time effectively, they start job costing.
For an upcoming large-scale job, they estimate $10,000 in material costs, $5,000 in labor costs, and $3,000 in overhead costs.
For calculating labor costs, they use a $50 per hour rate.
For overhead costs, they use a predetermined overhead rate of $30 per direct labor hour.
Their material costs end up coming in at $9,500. Since taking on bigger projects, they’ve been buying in higher quantities and saving money from bulk purchases.
But the job took more time than expected, totaling 110 hours.
At 110 hours, the labor costs totaled $5,500 and the overhead costs totaled $3,300.
What was planned as $18,000 in job costs ended up being $18,800, $800 over the estimate.
Through job costing, the business learned that their material costs may end up lower than expected but labor hours are higher. For future jobs, they’ll adjust their estimates to reflect what they’ve learned.
Advantages and disadvantages of job costing
Generally speaking, job costing is a valuable accounting process for businesses that are trying to understand the profitability of the work they do on a micro level. However, it’s not right for everyone.
Weigh these advantages and disadvantages when deciding if you should incorporate job costing into your processes.
Advantages
- Accurate project pricing: Understanding your costs is an essential aspect of setting prices. As you start to track costs per project, you’ll know how to price projects to make sure every job is worth your while.
- Profit maximization: Part of the job costing process is estimating costs and setting a budget. Keeping costs in check protects the profit of every job you take on.
- Improved time management: With insight on the profitability of each project, you’ll know which jobs to accept and which to reject. Over time, you’ll optimize your operations by working the top profit-generating jobs.
Disadvantages
- More recordkeeping: Job costing creates additional steps in your accounting process. Transactions will need to be recorded in the accounting platform and again wherever you’re tracking the job costs.
- Requires attention to detail: Accurate job costing means staying on top of every transaction to ensure it’s recorded in the right place. This can be time-consuming and requires buy-in from everyone in the business.
- Calculations can be difficult to navigate: Estimating labor and overhead costs requires manual calculations that may be tough to navigate as a first-timer.
Benefits of accounting software for job costing
Job costing requires extra work to ensure every transaction is accurately tracked and allocated to the right project. But knowing how to effectively use your accounting software and other finance tools helps cut down the time required.
A big step you can take is running all job-related expenses through a single credit card or bank account. When you reconcile the account, you’ll know that every cost is tied to a specific project.
Another tip is to make use of mobile apps and real-time receipt capturing. This cuts down on the possibility of a receipt getting missed or a transaction going untagged.
Cal Wadsworth Construction uses a combination of BILL Spend & Expense and corporate credit cards to skip manually coding projects on transactions and streamline their reporting. Now they get perfect insight into their job costs without the extra labor.
Request a demo to learn how BILL can improve your accounting processes and save time.
