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Trying to move from thinking you’re making money on projects to knowing? You’re going to need to make sure you’re calculating job costs accurately. In this article, we’re going to give you a complete guide to answer one question. “How to calculate job costs for a small business.”
Let’s get started.
What Is Job Costing?
Job costing is the accounting process of tracing the costs and revenue for each of your projects. This process breaks down the labor costs, materials, and overhead for each job (more about that in a moment).
It’s used in many industries, but markets like the construction industry benefit the most. That’s because the cost of any given project can vary from one job to another.
Why You Need Job Costing
Job costing is important because it tracks the costs of each job in great detail. There are many costs throughout a project that could slip through the cracks and not be counted. They could cost business owners significant amounts of money.
Knowing what your projects are costing has several direct impacts on your profitability:
- Seeing your project costs in real-time can help you compare costs and cut spending going forward.
- It can also be helpful in improving client billing and collecting more of the reimbursements your company has earned.
- Knowing project costs will help you get better at future estimates by comparing your budget to the actual cost of what you are spending.
Choosing The Right Method
Process costing and job costing are two popular methods for determining costs. We’ll cover the difference below, but the remainder of this guide will be focused on using job costing as a reliable method.
The Process Costing Method
Process costing is a common way of determining costs in a manufacturing job where the resulting products are identical. Think prefab homes, smartphones, or pens.
This method involves taking the assumed amount of parts and labor to complete a job, then assigning a cost to them based on past project costs. Take your averages and use them to come up with an overall budget.
For a business like construction where each project is unique, using the process costing method wouldn’t be a good fit. It could result in your business leaving a significant amount of money on the table.
For example, determining the project cost for a rewire comes down to knowing specific details about the job. How many rocker switches did your employees use on the job? How many feet of sheathed electrical cable was used?
For that reason, job costing and not process costing will be the method we explain in detail.
How Is the Job Costing Method Determined?
The job costing method is determined by accumulating exact information for the direct materials, direct labor, and overhead of a company. The best way to do this is as follows.
- Analyze all your in-progress and completed jobs.
- Put a billing system in place that correlates with your actual costs and the costs you’ve committed to.
- Look at all your jobs to find out if they were as profitable as you projected they would be.
- Based on the above, develop a more realistic breakdown of costs including any unexpected costs that were not included in the original bids.
- Categorize your costs. For example, specific labor tasks, materials, overhead, equipment, subcontracts, and any other cost categories you might have.
- Don’t forget to include often-overlooked costs such as equipment upkeep, interest, or the salaries of construction managers as a few examples.
Your system should be able to track all your ongoing projects and store historical data. It should work to identify trends, job-specific issues, and identify cost-saving areas that could make your projections more accurate and profitable going forward.
Now, let’s dig a little deeper into how to calculate your job, labor, material, and overhead costs.
How to Calculate Job Costs
Several things factor into the formula for calculating your costs—labor, materials, and overhead (which many people forget to include). That means you will need to calculate the total job cost and all related expenses including direct and indirect costs.
To make it easy, you can use this equation to calculate any given job:
Total Cost = The Cost of Direct Labor + Direct Materials + Overhead
1. Calculate Labor Costs
Determine how much it will cost each day (or by the hour) to have each of your employees on the job. You can estimate these projections on paper. To get the most accurate results, use construction time tracking software to collect accurate hours from all of your employees.
Even better if you’re using software that breaks down the hours by tasks they perform each day on individual jobs. You can then use that historical data on all similar projects in the future.
Multiply the rate determined above by the length of time the job or specific task will take to complete. Don’t forget to include all subcontractor estimates and any contingencies to cover unexpected expenses that will arise. This will give you your labor costs.
Employee Costs Defined
- Wages – These are the wages paid to your employees. Be sure to include all annual payroll taxes and annual overhead in this figure. This will help you determine how much an employee costs you each hour.
- Direct Labor Hours – This is the number of hours an employee will need to produce one unit of product or service. Don’t forget to include shift differentials and any overtime the employee worked.
- Direct Labor Costs – The difference between direct labor hours and direct labor costs is subtle. Labor hours refers to the actual work an employee performs to produce a product or service. Labor costs refer to how much money the employer must pay the employee to perform a task.
- Indirect Labor Hours – This is the cost of employees not involved in the planning or construction of a project. These are the employees involved in the day-to-day running of your business. For example, managers, foremen, human resources, accountants, customer service representatives, or other office personnel.
- Dollar Amount – This is the total dollar amount you spend on labor. This includes the pay for salaried and hourly workers. It includes taxes and employee benefits.
- Payroll Taxes – This is a percentage deducted from an employee’s pay that goes to the government.
- Salary – This is a form of employee payment according to a specified employment contract. It’s a fixed regular bi-weekly or monthly amount. This is different from piece wages where every job, hour, or other type of unit that is paid separately, rather than being paid periodically.
2. Calculate Material Costs
To get your total costs it’s also important to track the cost of goods that are used and scrapped during a project. This includes direct materials like wood, wiring, steel, and indirect materials such as caulking, fasteners, cleaning supplies, and miscellaneous tools.
You also must include the cost of any equipment rentals, delivery charges, and waste. That means you need to accurately track the material costs mentioned above for every aspect of every job.
For example, let’s say you have to run rocker switches throughout a home remodel.
- If the project calls for 30 switches installed it would require $2.99 for each switch.
- $2.21 for each decorative wall plate.
- $1.98 for each PVC electrical box.
- We’ve intentionally left out the wiring required to each box.
- Therefore, the total direct material cost would be $215.40.
3. Determining Overhead Costs
Now you will have to determine all your overhead costs to reach your total job cost. Overhead includes things like equipment depreciation, facility rent, office administration, and expenses. These costs aren’t directly related to any given job, so this will be an approximation rather than being a calculation. In other words, overhead costs are all the indirect costs that go into a project.
Many believe that adding 10% as an overhead to each job is a standard. However, some general contractors report overheads of as high as 54% of revenue. Your accountant would be the best person to help you figure out the right overhead to use for your business.
Alternatively, you could calculate and use a predetermined overhead rate.
What Is Predetermined Overhead Rate?
Tracking your overhead is extremely difficult; therefore, you might consider using a predetermined overhead rate. A predetermined overhead allocation rate is a calculation that’s used to determine the estimated overhead costs for individual projects over a specified period of time.
Most business owners have an annual budget that includes estimated overhead and estimated activity for any given year. You can use your budget estimate to calculate your overhead rate and apply it to each job.
Here is an equation to help you calculate a predetermined overhead rate.
Predetermined Overhead Rate = the Estimated Overhead / Estimated Activity
For example, let’s say you estimate that this year you will have $500,000 in overhead costs. Then you estimate your employees will work about 10,000 hours.
Your calculation would read:
500,000 overhead / 10,000 direct labor hours = $5 per direct labor hour.
So basically, this is your predetermined overhead rate, and you would apply that rate to each direct labor hour worked.
A Job Cost Example from the Construction Industry
XYZ Contractor just completed a job. The direct labor cost for that job was $20,000. The material costs were $2,500. The overhead costs were $8,500.
These are all the figures you need to calculate your job costing.
Direct materials $2,500 + Direct Labor $20,000 + Added Overhead $8,500 = $31,000
The total job cost for this construction project is $31,000.
So, that is the end result, but how do you get there? You use a spreadsheet and calculate everything manually. Or, if you want to streamline the process and make it easier and more accurate, you use software (we’ll cover that next).
But first, let’s take a look at how to do this using a spreadsheet so you can see how all the information fits together. We’ve included a simple job cost sheet template that you can make a copy of by clicking on this link.
As we mentioned, you could skip the manual process of filling out spreadsheets and let your job costing software do all the heavy lifting for you.
Quality software will offer mobile time tracking, monitor overtime, document each employee’s work progress along with any pertinent notes from that employee, and track every project’s costs. Then, the software will pull all that information together for you so you can track every dollar you spend on every job, and more!
So, let’s take a closer look at job costing software and how it will literally change how you do business.
The Benefits of Using Job Costing Software
Using job costing software will provide you with many benefits such as being able to price all your projects more accurately. It will also help to avoid customer conflicts because your upfront estimates will be timelier and more accurate. This will generate more positive word of mouth, brand reputation, and more referrals.
Job costing software will also help you calculate more realistic profit margins, and this will make you be more competitive while still remaining profitable. And lastly, job costing software will make it easier to track job progress and job costs in real-time. This will enable you to provide a more streamlined communication process with your customer.
Whew! That is a lot of information. So, what should I do next?
If you would like to make the task of job costing a lot more accurate, consider trying Workyard for free.
Workyard will track employee time and site visits, automatically calculate labor costs, show work progress, and give you real-time reporting on project costs. It will also make your payroll much simpler by providing you with a seamless payroll integration process.