If you can’t identify all of your project costs, how can you calculate the profitability of the engagement?
Company owners that conduct business on a project basis may be a difficult time tracking each cost associated with a particular job. You need to know the total costs, so you can add a dollar amount of profit and quote a sales price.
Owners who cannot track total project costs accurately may take on work that is not profitable. Use these tips to understand project costing, and to take control of your business costs and generate consistent profits.
Job costing vs. process costing
For starters, you need to understand what type of costing system you use, either job costing or process costing.
Job costing assumes that you complete work on a project basis and that the total costs required for each job are different. People who work in the trades, such as carpenters, plumbers, and tree services companies use job costing, and they provide each customer with a job estimate.
If you need a tree removed, for example, the tree service company will estimate the labor costs, equipment, and materials required for the project, add a profit margin, and provide an estimate. Each job is different, given the size and location of the tree, and the distance required to drive to your home.
Process costing is used when each product or service you produce is identical or close to identical.
Imagine a company that manufactures black plastic combs, for example. Making the combs is a process that requires material and labor costs, and costs are incurred as the product moves from one department to another. Plastic material is cut into the proper shape, then each comb is painted black, and finally, the combs are packaged for shipment.
Process costing is easier for the owner because the business only has to track costs for a particular batch of combs. Job costing, on the other hand, requires the owner to manage dozens or even hundreds of individual projects.
To work efficiently in a job costing business, you need a reliable system to track costs.
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. If the customer agrees to have the work performed, her 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 for labor, but the company also incurs mileage costs, costs to repair and maintain assets, and costs to operate the office.
Emma and her accountant decided that an efficient way to charge customers for vehicle, equipment, and home office costs is to use labor hours worked. Jobs that require more labor hours should be assigned more of Lakeside’s costs, and this is a common method used in job costing.
Here is Emma’s job calculation estimate to remove the Johnsons’ 40-foot oak tree:
|Johnson Job Estimate|
|Vehicles and equipment||$30|
|Home office costs||$140|
|Profit (15% of sale price)||$120|
|Price to customer||$800|
Here are some details about the costs listed in the estimate:
- Vehicles and equipment: Cost incurred to repair and maintain vehicles and equipment. Costs are assessed at a rate of $1.50 per labor hour.
- Mileage: 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: Insurance, office lease expenses, marketing costs, 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 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.
The timecard issue
Lakeside’s crews work on dozens of jobs each month, and each worker must report the hours worked per job on a timecard. However, this information sometimes gets reported days after that fact, or at the end of the week. 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 timecard information, and this inefficient system leads to errors.
What is the financial impact?
Timecard errors have a huge impact on Emma’s ability to provide reliable job estimates, and to generate a reasonable level of profit. These mistakes can result in either overcosting (assigning too much cost) or undercosting (assigning too little cost) to a particular job.
A business owner should expect some differences between estimated and actual costs, based on changes in the cost of materials, wage rate, 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 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 4 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 system, or even a process using spreadsheets, may have dozens of job costing errors, making it impossible to manage costs and price jobs accurately.
Automate to manage costs
The solution is automation.
Smart business owners use technology for the job costing process. Programs like QuickBooks Online can automate the job estimate process, and to collect and assign job cost information, including materials used and labor hours worked per job.
By automating your job costing system, you can make informed decisions about changes in costs noted during the year, and you’ll avoid overcosting and undercosting 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 increase profits.