An Introduction to Job Costing
We understand the challenges of your life as a contractor. The construction industry is one of the most dynamic industries with multiple stakeholders, labor-intensive operations, unpredicted change orders, and low-profit margins. With all the chaos presented by the project, job costing can be the last thing on your mind. But don’t forget that the smoother the financial system of the project is, the smoother your life as much as your team's. Construction job costing is one of the most critical processes that ensure the stability of the project as well as your whole company. In this guide, we will explore the key components of construction job costing and share insights to help you optimize your project budgets.
First things first, let’s understand what construction job costing means. Unlike the retail industry, the output of the construction industry is unique for each project. Therefore, each project will consist of a highly customized set of inputs that needs to be analyzed separately in terms of cost. Construction job costing is a method that gives a comprehensive depiction of budgeted costs as well as real-time expenses across all cost centers.
In the business world, nobody likes surprises much and construction professionals are even more so. The main advantage of maintaining proper job costing for projects is the ability to dive deep and observe the fine details. It empowers the user to track expenses systematically, forecast the project's financial behavior, and identify cost issues at an early stage – remember, prevention is always better than cure. It is also a powerful tool that enables you to monitor project progress, and track efficiency as well as the project cash flow.
Understanding the Jargon
Now that we are done and dusted with the concept and its importance, let’s get down to some technicalities. There are thousands if not millions of cost activities in a given project, but all these can be categorized into 4 cost centers, which are labor, material, equipment, and overheads. All these costs can be further scrutinized as direct and indirect costs.
Direct costs as the name suggests, are the costs that can be directly traced to an activity. For example, the cost of electrical cable supply is a direct cost. Direct costs are fairly easier to manage when compared to indirect costs. Indirect costs are expenses that cannot be directly linked to an activity but are nevertheless essential for the management of the project. For instance, the cost of warranty or site utility bills.
The cost of materials that are required for the project, everything from cement and sand to the doorknobs and faucets are your material costs. Most often material costs fall under direct costs.
This would include the cost of in-house labor as well as the subcontracted labor. This could be in the form of hourly/daily payments or activity-based contracts.
This refers to the cost of machinery and equipment that you would rent or purchase for the construction activities. It includes both direct and indirect costs related to owning and maintaining the equipment. Expenses such as rental or purchase costs and fuel and operator wages can be considered direct costs while costs such as depreciation, insurance, and storage can be sorted as indirect equipment costs.
In simple terms, the overhead of a business is the cost of carrying out its operations. This includes costs such as insurance costs, rent, and software costs. It is not practical to allocate these costs to any specific project, therefore it is common to determine a percentage of overhead and distribute it to every project.
There are a couple of technicalities to bear in mind before we move any further. Those are the definitions of committed costs and WIP (Work in Progress) reports.
Accruals or committed costs are instances when you are liable for payment to another party. Even if the party has not yet billed for the service, the cost must be considered as a cost incurred.
WIP reports represent the cumulative value of materials, labor, and other costs incurred in the construction process up to a specific point in time. WIP reporting is crucial for accurate financial reporting, as it allows construction companies to track the costs and revenue associated with ongoing projects.
How to Improve Construction Job Costing
Everyone starts a project with so much hope and excitement. But as the project grows so does the complexity. Unless you have a steady costing system in place, you might start to lose control of the project. Some of the common mistakes we see in companies are neglecting to record expenses as and when they happen, forgetting the committed costs incurred, and failing to manage change orders. Another pitfall is over-billing and under-billing, with both affecting the project's cash flow.
Let’s look at a few steps you can take to set up or tweak your job costing system.
1. Establishing a Comprehensive Cost Code System
Establishing a standardized cost code system is the first step in effective construction job costing. Cost codes categorize project expenses into various elements, such as labor, materials, subcontractors, equipment, and overhead costs. By assigning specific codes to each cost item, you can easily track and analyze expenditures throughout the project lifecycle. A well-structured cost code system also enables you to generate accurate reports, compare actual costs against estimates, and identify areas for cost optimization.
2. Allocate Direct and Indirect Costs
Differentiate between direct costs specific to a particular project, (like labor and materials) and indirect costs (like indirect labor). Allocating these costs ensures accurate job costing.
3. Granular level cost breakdown
The secret to an accurate big picture is in the well-refined details. So, breaking down all the cost activities is a great place to start any project. Only then can you understand the value of the nuts and bolts that hold up the entire project. This will enable you to accurately estimate project expenses and will aid in better resource allocation, ensuring that each aspect of the construction process is adequately funded.
4. Continuous cost recording
Amidst all the hustle and bustle of the project, promptly recording costs can seem like an unnecessary hassle. But it is a crucial step that ensures better financial control and project success in the long run. It provides real-time insights into project expenses and helps in tracking cost fluctuations to identify potential cost overruns, allowing for timely corrective actions and better cost control.
5. Don’t forget the committed costs!
Committed costs are financial promises waiting to be fulfilled. Tracking committed costs helps in anticipating future expenses based on committed contracts and purchase orders, providing a clearer picture of the project's financial health. Forgetting to track committed costs will impact both your cash flow and profitability because you might be spending more than your budget.
6. Effective document management
Effective document management can be the easiest remedy for most common issues in a construction project. Keeping clear records of all documents such as approvals, RFIs, change orders, purchase orders, and subcontracts will smoothen the project delivery as well as the project financials.
7. Frequent project reviews
Periodically review your job costing reports and make adjustments as needed. This helps you stay on top of changes and make informed decisions throughout the project lifecycle. Generate regular WIP reports and cash flow reports to track the financial progress of the project. Analyzing these reports will improve overall transparency and accountability.
Why you should use specialized construction cost management software
As obvious as it is, we still think it’s worth reiterating - manual work is time-consuming. And switching to specialized software will save you time that’s better spent on other exciting aspects of the project - like building stuff.
With specialized construction cost management software on your side, you don’t have to worry about pesky miscalculations. Let the software handle those number-crunching tasks ensuring your project stays on budget. With real-time insights and reporting, you can keep an eye on both the delicate details and the overall health of the project.
Real-time tracking enables immediate insights into project expenses, allowing for optimized resource allocation. With automated WIP reports and the use of artificial intelligence to replace tedious manual data entry, job-costing software is changing the way construction companies track and manage work in progress.
The seamless integration and collaboration features make communication a breeze, ensuring everyone is on the same page and working together in harmony.
By utilizing software, you can detect cost discrepancies, potential overruns, and inefficiencies right from the get-go, so you can take action before things spiral out of control. Plus, advanced analytics and comparison tools enable comprehensive analysis, highlighting trends and patterns that may lead to cost or schedule challenges.
How can Adaptive help?
We at Adaptive have dedicated a lot of time and effort to crafting a solution that will put your life as a construction professional at ease. Our solution automates your project finances and we are 100% integrated with your accounting software, helping you streamline your project and your business.
The Adaptive solution offers you interesting features such as:
- Centralized account payables
- Track project costs in real-time
- Automated WIP reports
- AI-powered receipt capture
- Link company cards
- Automated reminders to employees to upload receipts
- Maintaining a digital cost record
- Flexible payment options
And if the thought of setting up the system sounds a bit daunting, you have nothing to worry about – It’s extremely easy to set up and takes less than 30 minutes and in any case, our customer support team is always ready to help you out.
Construction job costing is a critical process that enables construction companies to estimate, track, and manage expenses associated with their projects. Accurate job costing plays a vital role in budgeting, decision-making, and overall project success. By understanding the nuances of job costing, you can enhance cost control, boost profitability, and ensure the smooth execution of construction projects.
Integrating specialized software into your system is the key missing element that completes the puzzle. With this powerful addition, you can unlock a whole new level of efficiency, accuracy, and productivity for your construction projects.