Should My Business Use Job Costing?
Project-based businesses rely on exact estimates and timely invoicing. Typically, these types of businesses provide a unique service to customers. As a result, pricing will fluctuate from one project to another.
Whether you are a contractor or a wedding planner, before you are hired, a potential client will likely ask for a quote. Naturally, that figure could vary dramatically depending on the client’s needs and preferences. For instance, a 300-person wedding set at a unique venue and dripping in luxury will cost significantly more in terms of expertise, labor, and supplies, than a 50-person, no-frills, backyard wedding.
How, then, can you provide the most accurate estimate possible for that specific job?
Adopt an accounting method known as job costing.
What Is Job Costing?
Job costing is an accounting process that tracks the costs and profitability of each unique job. It tells you the true costs to deliver a service or perform a job so you can ensure accurate pricing.
Equipped with this information, owners can make data-driven business decisions, such as charging more to reach their targeted gross point margin or attempting to reduce the COGs in future jobs.
What does it entail?
Ultimately, the goal is to estimate the total expenses for producing a single, custom SKU or performing a unique service. Typically, three elements go into this equation. However, some industries will have a fourth:
- Materials – This includes both direct material costs (i.e., raw materials that go into the final product) and indirect material costs (i.e., materials used to complete the job, such as tools or machinery).
- Labor costs – This figure comes from paying employees (i.e., direct labor) or third parties and subcontractors (i.e., indirect labor). To calculate labor costs, you must multiply the number of workers by their hourly pay rate and hours worked. Simply calculating this figure can be tricky since employee pay will vary according to position, skills, and experience.
- Overhead – This covers the company’s indirect daily operating costs. But since a company may work on several projects simultaneously, the overhead costs must be broken up and apportioned accordingly. Examples of overhead costs include office space, utilities, taxes, and so on. As Oracle points out, because your overhead is difficult to calculate, some businesses apply a blanket fee to every project, like 10% per job.
- Equipment and facilities – Manufacturers require space and machinery to produce goods. While this could technically fall under overhead, there are additional expenses involved like:
- Equipment maintenance
- Equipment replacement
- Fuel costs
- Parts repair
An Example of Job Costing
Paul is a plumber that makes $45 per hour. Today he will go to three different jobs.
- Job 1 – Paul works for two hours unclogging sinks and fixing leaks. He uses $35 worth of materials on this job.
- Job 2 – Paul works for three hours to replace two sinks. He uses $150 worth of materials on this job.
- Job 3 – Paul spends an hour replacing the kitchen sink’s garbage disposal unit. He uses $15 worth of materials on this job.
How much should Paul charge his clients?
Job 1 will cost $90 in labor, $35 in materials, and 10% in overhead, bringing the total cost to $137.5.
Job 2 will cost $135 in labor, $150 in materials, and 10% in overhead, bringing the total cost to $313.50.
Job 3 will cost $45 in labor, $15 in materials, and 10% in overhead, bringing the total cost to $66.
Difference Between Job Costing and Process Costing
Job costing is an ideal measurement for businesses where the cost of their product or service will change per customer.
For instance, a cake shop that only makes custom cakes will benefit from job costing. However, a bakery that produces the same type and amount of baked goods would be much better off using process costing.
Although it operates similarly to job costing, process costing differs slightly. It takes the total cost to produce homogenous goods or services over a given time frame and then averages that figure out over the total units or jobs. According to ACCA Global:
“Process costing is a method of costing used mainly in manufacturing where units are continuously mass-produced through one or more processes. Examples of this include the manufacture of erasers, chemicals or processed food. In process costing it is the process that is costed (unlike job costing where each job is costed separately).”
In summary, job costing is a better methodology if there is a variance in pricing from one job to the next. Conversely, mostly uniform pricing should utilize process costing.
Benefits of Job Costing
Many service businesses face constraints like limitations on skilled labor resources, increased business competition, finite time to complete projects, and market volatility. Job costing helps business owners answer essential questions like:
- Are our jobs running on budget and within our target margins?
- Who are our most profitable clients?
- Which clients need to be repriced or dropped?
- Where are our operational inefficiencies?
- Who are our most productive employees?
- Where should we focus our sales and marketing efforts?
Put simply, job costing helps you avoid taking on bad (unprofitable) jobs, makes it easier to budget, and improves your operational planning and efficiency. And while each business is unique, the industries that generally benefit the most from this type of accounting process include:
- Construction and engineering companies
- Consulting firms
- Design firms
- Energy utility companies
- Health care organizations
- Transportation and logistics providers
Outsourced Accounting for Job Costing Optimization
If you run a project-based business, job costing is an essential accounting practice you should leverage to influence the jobs you accept, prices you quote, and budgets you set. It’s the most reliable method for businesses that perform unique jobs or deliver customized services.
But what if you lack the time or accounting expertise to perform these calculations across your entire business?
The solution is to outsource the task to the accounting professionals at CFO Hub. Our financial controllers and accounting advisors have the requisite tools and experience to provide accurate and useful financial reporting.
Ready to get your finances in order?