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Cost overruns are the bane of the construction industry. In fact, a 70-year analysis showed that 85% of construction projects in 20 countries experienced an average of 28% cost overruns.
Job costing/ project-based accounting is crucial in reducing or even eliminating such cost overruns.
Job costing helps construction businesses accurately calculate project expenses and improve budgeting by monitoring individual costs. With job costing, you can manage your cash flow and protect your profit margins, even when new requests and changes occur mid-project.
Let's explore why job costing is so valuable.
What is construction job costing?
Construction job costing is a crucial process to accurately calculate project expenses.
It’s a complete and detailed breakdown of all possible costs associated with a specific job, including labour, materials, and overhead. The more detailed the breakdown, the more accurately your business can track expenses and identify issues that could affect profitability. With construction costs increasing by more than 25% over the past five years, job costing is more important than ever.
Proper job costing can safeguard your profit margins even with unexpected expenses or ballooning worker hours.
How do you calculate job costing?
Job costing is calculated by adding together all direct and indirect costs for each individual item related to a project.
Such project costs are typically categorized under four major areas: labour, materials, equipment, and overhead expenses.
Hence, the job costing formula is:
TOTAL JOB COST = MATERIALS + EQUIPMENT + LABOR + OVERHEAD
Here's a sample job costing for a patio construction project:
Project: Patio Construction for Mr and Mrs Smith
Direct Materials:
· Paver stones: $800
· Gravel base: $200
· Sand: $50
· Edging stones: $150
· Total Direct Materials: $1,200
Direct Labour:
· 2 Labourers at 8 hours each: $320
· Total Direct Labour: $320
Equipment Rental:
· Bobcat rental: $500
· Concrete mixer rental: $100
· Total Equipment Rental: $600
Other Direct Costs:
· Permits: $100
· Delivery fees: $75
· Total Other Direct Costs: $175
Total Direct Costs: $2,295
Indirect Costs:
· Overhead costs (utilities, office expenses, etc.): $500
· Project management (supervision, planning, etc.): $300
· Total Indirect Costs: $800
Total Job Cost: $3,095
Mark-up:
· 20% mark-up on total job cost: $619
Total Project Cost: $3,714
What should you include in construction job costing?
Construction job costing requires meticulous attention to detail and monitoring of all project expenses.
Here’s an overview of what to include:
1. Labour costs:
Labour is generally the largest expense for many construction businesses. It includes expenses for crew members and subcontractors, such as hourly or day rates, worker's comp, overtime hours, and any other relevant expenditure. Note that prevailing labour shortages can delay completion times, leading to extra holding costs.
2. Material costs:
Material costs can be either direct or indirect. Direct materials feature items like steel, wood, concrete, electric wiring, and others. Indirect materials are often used on multiple projects featuring items like helmets, gloves, fasteners, and lubricants. It also includes material-related costs such as delivery, which can be covered in a margin charged on the materials.
3. Equipment costs:
Equipment can be rented (typically large machinery) or owned (e.g. drills, PPE, and other machinery).
4. Overhead costs:
Overhead costs can be direct or indirect. The direct overhead costs relate to the particular project, featuring temporary office spaces on construction sites, permits, surveys, inspection fees, job-specific supervisor salaries, and sanitation facilities. Indirect overhead costs are general operating expenses of running your business, such as marketing and office supplies. Some construction companies charge an overall overhead fee, either as a percentage of other project costs or a predetermined amount.
What are the benefits of construction job costing?
Construction job costing offers numerous benefits.
It helps construction companies to:
Improved project profitability: Job costing allows construction clients to accurately calculate the costs associated with each project, ensuring that they price their services appropriately and maximize their profits.
Better resource allocation: By tracking costs associated with each project, construction clients can allocate resources more effectively, ensuring that they have the necessary materials, equipment, and labor to complete each project on time and on budget.
Improved decision-making: Accurate job costing provides construction clients with the information they need to make informed business decisions. With a better understanding of project costs and profitability, clients can make decisions that align with their business goals and objectives.
More accurate financial reporting: Accurate job costing allows construction clients to prepare more accurate financial statements, which can be useful in securing financing, attracting investors, and making strategic business decisions.
Reduced tax liability: Proper job costing can help construction clients minimize their tax liability by identifying deductible expenses and tax credits, ultimately leading to a lower tax bill.
Ultimately, construction job costing will help you save money, as highlighted in a McKinsey study which showed that productivity changes could reduce spending by 40%, resulting in an annual saving of $1 trillion globally.
What are the challenges with construction job costing?
Although job costing is a fundamental accounting practice for the construction industry, it comes with several challenges affecting different types of projects.
For instance, prior forecasting and budget allocation for unique projects may lead to prepaid costs that may not be applicable to the project. A contractor may pre-purchase 100 units of a particular building material and only end up using 50 units. The remaining 50 units will be wasted, impacting profit margins.
Accurate job costing is also challenging with lengthy projects. For example, constructing a skyscraper would likely take a few years to complete. You may have to pre-purchase certain building materials, such as steel beams, that will be needed later in the project. During this time, material costs may reduce, which would be a missed opportunity to reduce costs.
Besides, delays in megaprojects typically lead to cost overruns. It can be complicated to measure the costs associated with a specific project, especially if the organization works out of multiple locations and conducts a wide variety of jobs. Streamlining the process would require costly IT systems using such tools as barcodes and RFID chips.
Another challenge with job costing is that it may require some guesswork, especially at the beginning of a project. For instance, if you’re building a particular style of home for the first time, you may not have an accurate idea of the labour costs involved. This can lead to underestimation or overestimation of labour and material costs.
Change orders and inflation can be problematic too. They add unexpected labour and material costs which need to be closely monitored.
How to Improve Construction Job Costing
Construction companies must ensure their job costing processes are accurate and effective.
That requires constant improvement through:
Implementing time-tracking with automated job costing applications to capture labour hours without the inaccuracies associated with manual timecards. According to a recent study, 61% of construction companies reported that technology processes reduced project errors.
Using cost codes to group different expenses and compare against similar jobs and track historical performance
Monitoring billing closely and tracking change orders to produce accurate invoices and avoid unexpected costs.
Review projects frequently to make appropriate adjustments.
Double-checking and verifying tabulations with a knowledgeable second party
Investing in construction accounting software for accurate and quick job costing operations.
How Cleverly Accounting can help with construction job costing
Our expert team at Cleverly Accounting possesses extensive experience and an in-depth understanding of the unique set of accounting requirements in the construction industry.
Above all, we understand the importance of implementing the best accounting methods to support your construction company. We have the capacity, skill, and ability to oversee multiple projects, manage decentralized work, and stabilize cost fluctuations to help your business succeed financially.
We’ll help you:
Establish a job costing system: we can help us set up a job costing system that allows them to track costs associated with each project. This system can help you understand the true cost of each project and make more informed decisions about pricing, resource allocation, and profitability.
Track direct and indirect costs: Job costing involves tracking both direct and indirect costs associated with a project. We can help clients identify and track these costs accurately, including materials, labour, subcontractors, equipment, and overhead.
Analyse profitability: With accurate job costing, we will be able to determine the profitability of each project. This analysis can identify areas where costs can be reduced and profits increased, ultimately leading to better business decisions.
Prepare accurate financial statements: Accurate job costing allows us to prepare financial statements that accurately reflect the company's financial performance. This information can be useful in securing financing, attracting investors, and making strategic business decisions.
Provide tax planning advice: We can help construction clients develop tax planning strategies that align with their business objectives.
To learn more about how we can help, call us at (08) 6186 1998 or book an obligation-free 15-minute discovery call.