Understanding the importance of job costing
Learn the importance of job costing in this useful guide. Discover the best way to do it accurately, and how that boosts your profits.
7 min read
Winning new business means getting your estimates right. But quoting competitive prices which also return a healthy profit for you isn’t easy. At all.
To start with, identify your costs. After all, if you don’t know all the costs associated with a new project, how can you determine the profitability? So, once you’re clear about what you’re dealing with, take the total costs, then add on a percentage for your profit. And there’s your quote.
So far, so good
Great! You won the contract. Now you’re on the job, you need to track your costs, and the importance of job costing will become clear. But as every small business owner knows, working on a project basis means tracking costs is difficult - as every job is different.
A word of warning. If you don’t track your total project costs accurately, you’ll end up taking on work that’s not profitable. Getting this right is essential if you’re to generate consistent profits.
Job costing vs process costing
For starters, you need to understand what type of costing system you use – job costing or process costing.
Job costing assumes you’re working on a project-by-project basis, and that your total costs on each job are different. This’ll include people who work in the trades, such as painters, plumbers, carpenters and decorators, who provide each customer with their own estimate.
To fit a new bathroom, for example, a plumber will estimate labour costs, equipment, and materials required, then add a profit margin and provide an estimate. Each job is different, as customers’ requirements are never the same.
Process costing is used when you’re mass producing identical or near-identical products. For example, a small start-up making cakes – you’ll incur labour costs, materials, and packaging, but these will be the same for every cake you produce. And if you run a line of different cakes, you’ll be able to identify how your costs vary between individual lines.
Process costing is easier for the owner because you can easily identify your costs per item produced. All you need to track is the quantity and delivery, whether per item or for a particular batch. Job costing, on the other hand, means approaching every project individually, and tailoring your estimate according to the different customer requirements. And you could be running dozens of individual projects at the same time.
So, if you’re going to be using job costing to run your business, you need a reliable system to track costs.
Lucy owns and operates The Garden Guys, a gardening business based on the south coast. She visits each customer personally, discusses the project with them, and provides a written estimate. If the customer accepts the quote, she schedules her crew for the job. This could be anything from one person sorting out new bedding plants to a major job involving three people and equipment to remove mature shrubs and trees.
The Garden Guys’ main cost is labour, but they also incur costs for mileage, equipment repairs and maintenance, and Lucy’s overhead.
Lucy and her accountant decided that the most efficient way to charge customers for mileage, equipment, and office costs was to use labour costs. Jobs requiring more labour would be assigned more of The Garden Guys’ costs - this is a common method used in job costing.
Here’s Lucy’s estimate to lay a 100 square metre new lawn for Mrs Pearson:
ESTIMATE – MRS PEARSON
Top soil £240
Turf & fertiliser £300
Debris removal fees £75O
Total costs £1,377
Price to customer £1,679
Let’s look at Lucy’s costs in more detail.
Mileage: Miles driven by The Garden Guys for the project, and miles Lucy drives to visit the customer to produce the estimate. Lucy also inspects each site after the project is completed.
Overhead costs: Insurance, office lease expenses, marketing, and salary for Lucy’s office manager. Costs are based on an hourly rate of £25.
Itemising all these costs gets complicated, so assigning mileage, equipment, and overhead costs based on an hourly labour rate makes estimating easier. Lucy just needs to estimate her total costs for the year, and the number of hours she expects her employees to work. Once she’s worked this out, she can come up with the hourly rate. Sounds easy?
The problem with timesheets…
Accurate job costing means accurately assessing the number of employee hours worked. And this is a tricky business.
The Garden Guys work on dozens of jobs every month, and each employee has to report their hours worked on a timesheet. However, this information doesn’t always get reported on time, and sometimes not at all - which can lead to inaccuracies.
Lucy spends time every week following up with her employees and correcting timesheets. And it’s hard to track everything accurately.
What’s the impact on profit?
Timesheet errors have a huge impact on Lucy’s estimating capabilities. They make it very hard for her to generate a good level of profit. She can end up overestimating or underestimating her costs for each particular job.
Like every small business owner, Lucy knows to expect some differences between estimated and actual costs – there’ll always be changes in the costs of materials, wages, or fuel during the course of a year. However, these costs are expected and are easy to explain to clients.
The bigger issue here is the knock-on effect of bad information, which is so often generated by timesheets. Take Mrs Pearson’s lawn, for example. Lucy’s estimate assumes 15 hours at a rate of £15, so total labour costs are £225. If the actual hours worked come in at 16 or 17, Lucy can talk to her employees and find out why they needed more time. This will help with more accurate estimating moving forward.
But, what if they only report 15 hours, and spend 20 hours on the job? This presents Lucy with several problems.
The labour costs for Mrs Pearson’s lawn are too low, and the profit calculation too high. Let’s assume one of the employees incorrectly assigned the extra 5 hours to another job (Mr Bateman’s rock garden). The labour costs quoted for Mr Bateman are too high, and the profit calculation too low.
By allocating labour inaccurately on both jobs, all her indirect costs are also wrong. If, like Lucy, a business uses a manual system like spreadsheets, they could make dozens of costing errors. So it’s impossible to manage costs and produce estimates accurately.
Automation = accuracy
Technology will take care of the project costing process for you. Programs like QuickBooks online automate the whole estimating process, assigning costs like materials used and employee hours for each individual job. And with no more manual timesheets, you’ll eradicate human error.
By automating your job costing, you can make informed decisions about changes in costs noted during the year, which means more accurate estimating.
QuickBooks online gives you a bird’s eye view of your projects. You can see immediately which projects are making you money, and which are dragging you down. The cost tracking calculator gives you real-time profitability insights across your business.
Control your costs and increase profits
Most importantly, you’ll increase your profits by generating accurate job estimates based on reliable data. So it’s well worth investing the time and effort in automating your job costing systems.
We hope you’ve found this article useful. If you automate your job costing, QuickBooks can help you get your estimates right and improve your profits.