By Fred Ode
According to the United States Census Bureau, there are over two-and-a-half million firms involved in the construction industry in the U.S. That’s a lot of competition!
The good news is, just like you, a lot of them started their business and grew it from the ground up. They made mistakes, learned from them, and gradually improved not only the work they do but also how they do it. The even-better news is that, by expressing an interest in implementing a job costing system, you’ve made an important step for improving your business.
In a recent survey by Construction Research Corporation, 75% of contractors indicated that job costing was among their top concerns for their business. That’s not surprising, considering that successful job costing can mean the difference between a profitable business and one that struggles to stay alive.
Take Rocko Excavating*, for example, a fictitious company that represents the typical construction firm started by a former operator who saw the potential of working for himself. When Rocko* first started his business, he knew a great deal about construction and excavating, but very little about financial statements, labor laws and job costing. The business of his business was something Rocko had to learn through trial and error.
In the early days of Rocko Excavating, Rocko did all the estimating himself and ran an off-the-shelf accounting software that a friend recommended. Instead of formal estimating, he “guesstimated” based on his experience as a laborer, and bid as many jobs as he could possibly handle. Sometimes he made money; sometimes he didn’t. While Rocko’s instincts told him that he was more profitable on those jobs that ran smoothly and didn’t have a lot of change orders, he had no solid proof of that.
The market was good and Rocko did great work. As he gained a solid reputation, his jobs picked up, and Rocko soon found himself frantically busy. It wasn’t long before he was overwhelmed – but even then, Rocko really hadn’t become much more profitable. The margins just weren’t growing, and cash was tight. What’s more, there was just too much work for him to be able to do all the estimating, project management and accounting himself. Rocko Excavating had reached a crucial make-or-break point. Either Rocko figured out a way to make the company grow beyond the mom-and-pop shop where he was involved in every element of the business … or it would stagnate and die.
Rocko contacted a construction-specific CPA and, on his advice, began shopping for a construction-specific accounting package. Eventually, he settled on one that offered a strong job costing element with powerful, customizable reports. He hired an estimator who was familiar with production reporting and could work with his bookkeeper to leverage the power of the job costing system. Slowly, they implemented production reporting that could prove just how accurate Rocko’s off-the-cuff estimating was. They carefully analyzed job costing reports for completed jobs and jobs in-progress. They put into action a billing system that was tied to actual and committed costs to keep the cash flow stable. With time and effort, Rocko Excavating flourished into a company that was profitable on almost every job. Rocko became much more hands-off, freeing up his time to run the business from a much more visionary position, further increasing its potential for growth.
It’s a happy story, isn’t it? And while you may think it sounds like a fairy tale, the fact of the matter is that it is all too true. Those companies who don’t look carefully at the hard facts – especially carefully tracked job profitability – simply cannot grow. The first rule of success is to know where and why you have failed. If you haven’t implemented a job costing system yet, what would doing so tell you about your business? What are your bread-and-butter jobs? What margins are you sacrificing because you don’t have production reports telling you exactly what your estimates should be?
Secret One: Practice Your Vocabulary
When designing a job costing system, it’s very tempting to simply use the same system you use for estimating – and, in some cases, it may make perfect sense. But keep in mind that your estimates and your budgets are not the same thing, and you shouldn’t structure them the exact same way.
An estimate is a detailed breakdown of the estimated costs for a particular project, and if you’ve been doing formal estimating for long, chances are your estimates are very specific, tracking materials down to the last nail. You’ve probably learned that the only way to build in a profit is to anticipate every possible cost and to take into consideration scheduling, availability of labor and materials, and such uncontrollable factors as the weather. This makes for a very detailed breakdown of costs.
A budget for your job, on the other hand, will often summarize or group many of the details on your estimates. It’s typically used by your accounting staff to track purchases and payable invoices against anticipated costs, and it can be much less detailed than an estimate. While an estimate might list the specific lighting fixtures selected by a client with different costs for the fixtures in each office, the budget may simply track the total costs for all lighting fixtures involved in the project.
When Rocko designed his cost structure, the simplest approach seemed to be using the same structure as his estimates. In talking with his employees, however, he soon realized that field workers and office staff would never be able to track costs and activities to that level of detail. It made much more sense to create a more generalized cost structure that categorized costs according to tasks on the job.
Secret Two: Define your goals
If you don’t define your goals at the outset, how will you know what you need to do? The only way to avoid this is to write down your initial thoughts for the job costing system, and then whittle them into specific goals that you can measure and test.
Thoughtful planning of goals early in the process will narrow your task list and help make clear exactly how your system should be structured. Each time you run across an idea, report, or example that you think is interesting, you can run the litmus test of comparing it to your goals. If it helps to accomplish a goal, it’s worth considering. If not, it’s out.
Finally, when you reach the third stage of implementation – probing the success of your job costing system – you can easily determine what you’ve accomplished simply by comparing the results to your goals.
Defining your goals can be as simple as carefully considering the following kinds of questions:
• What business decisions might be made or processes changed based on insight from job costing?
• Are there areas of your business that you’ve considered adding or dropping? Are there areas where you feel efficiency or economy can be improved?
• What is your current per-job profitability and by what amount would you like to improve it?
• How much information about job costing do you currently have? What specific information are you lacking?
• Who will be interested in job costing reports? How will they use the information? Are reports needed for outside entities such as banks or bonding/surety agencies?
• How much time can be devoted to categorizing costs? To analyzing reports?
• Will you estimate or budget all jobs? How will this affect the use of job cost information?
• How much production reporting do you currently do? Do you track the quantity per man-hour (e.g., cubic yards completed in a man-hour), man-hour per quantity (e.g., man-hours for a single cubic yard) or use some other means of determining production? How accurate are your estimates based on this information?
Secret Three: Usability is Priority Number One
There’s an old adage that rings especially true with job costing systems: garbage in, garbage out. If you don’t put accurate information into your job costing system, you won’t get very good reports. In fact, you may get severely skewed and misleading reports. Therefore, it’s essential that you plan carefully for the usability of your job costing system.
There are two important considerations here:
1. How will information come from the field?
Labor information is the obvious factor here. Your foremen, supervisors or field employees must be trained and required to submit timecards that include information relevant to your job costing structure. You may have them include the actual cost categories, or you may ask them to note the tasks on which they worked each day.
A second factor is purchasing done from the field. If project managers or other staff can purchase materials, the POs must include cost categories, and, ideally, they should require approval from someone that has access to budget and actual-cost-to-date information to prevent overspending.
2. How will information be categorized in the office?
Most contractors say that getting information from the field is the most challenging part of a new job costing system, but being able to categorize costs in the office is not far behind. You must remember that every single cost incurred must be carefully categorized in order to avoid the “garbage in, garbage out” syndrome. Therefore, your office staff may spend a lot of time – especially during the initial training period – looking at paperwork and learning how costs should be categorized. Every single purchase order, invoice, inventory receipt, timecard, etc. must include job cost detail.
Keep in mind, as Rocko did, that one of the goals of your job costing system may be to avoid keeping your hands in the details. While it may seem tempting to go through the paperwork and categorize costs for your accounting staff, it will be much more efficient in the long run if you teach them to do it themselves. Rocko found that, as his office staff became much more proficient at this, the time he spent dealing with paperwork was reduced by a third.
Put Technology to Work for You
While it is certainly possible to create and maintain a manual job costing system, it is not easy. The best method involves using an accounting system specifically designed to accommodate construction job costing. Such a system should have the following characteristics:
• Flexibility in job cost structure. The system should allow you to design your job cost categories in the best manner for your goals. It should allow alphanumeric codes for the categories and at least three levels of costs – job, task, and classification such as labor, materials, equipment, etc. Ideally, it should allow even more levels, since your job cost structure might include a grouping of different tasks or sub-projects within a job (units within a shopping plaza, for instance).
• Integration of accounting and job costing. If you have to enter separate transactions or employ spreadsheets for normal accounting functions and the recording of job costs, the technology is not making you more efficient. Instead, everything should be fully integrated. For example, when you enter timecards, you should be able to code the time the employee worked by cost category, and that information should automatically and instantly update job costing. Ideally, the detail allowed in the breakdown should be very flexible. In timecards, for instance, you should be able to code increments of minutes or hours.
• Division of labor and burden. “Burden” is the employer’s indirect payroll costs beyond normal wages. It generally includes such things as taxes and benefits. A good construction-specific payroll system will allow you to track the costs of labor and payroll burden either together or separately.
• Suitable reports. While it’s tempting to just look for the system that offers the most reports, it’s much smarter to look for the system that offers the best reports for your needs. In the best of all worlds, your accounting software will offer reports that show cost breakdowns on many levels, from total costs for the entire company, to labor costs per task, to costs per cost category on a job.
Secret Five: Doing What You Know
If your employees are not fully aware of the nuances of your job cost system, they will not provide you the information you need. As mentioned earlier, if you input incorrect or incomplete information, your reports are virtually useless. Training employees properly is the absolute key to a successful job costing system.
As you begin implementing your job costing setup, know -- that to be successful -- you will spend quite a bit of time with your employees. Plan meetings or training sessions for all employees in all departments and at all levels. Talk to them about what they should do and show them examples of how they should do it; then give them exercises to practice it. Ask them questions to test their understanding. Be sure they know all of the items that need to be costed as well as how to determine the categorization for each cost. Share your motivation for implementing the system and indicate how it will benefit them.
Secret Six: Everything Plus the Kitchen Sink
As your job costing system becomes more stable, you should apply it across all your projects and jobs. This seems obvious; however, a less obvious factor in job costing is overhead. While overhead costs -- such as telephone bills, fuel, marketing, etc. -- are not directly job related, they are costs that you have incurred, and you cannot really understand job profitability without factoring in overhead expenses. As your system matures, you should have the goal of categorizing every single expense that hits your books.
The right accounting software for you will allow you the option of job costing overhead expenses and/or performing overhead allocation. Doing both ensures that you can look at overhead costs from two angles:
1. If you cost overhead expenses to an “overhead job” and categorize the expenses using cost codes, just like you would actual job expenses, you can use job costing reports to prepare future budgets and to analyze where you’re spending too much money on running your business.
2. If you perform overhead allocation, you can examine job expenses with and without overhead, allowing you to get a feel for the impact these types of expenses have on your overall profitability as a company.
Secret Seven: Not Just Job Cost – Job Profit
One of the obvious goals of job costing is to analyze where you may be spending the most money on a job, especially in comparison to estimated costs. As you implement your job costing system, however, don’t forget that information you’re gathering can be used on the flip side – to determine and analyze billings.
There are several ways in which job cost information can be helpful in billings:
• When cash is tight, it’s important that you plan and schedule your jobs carefully to ensure that you will not overextend yourself. Consider these factor as you prepare estimates; they should serve as the “law of the land” during a project. In the real world, however, estimates are an inexact science and things change rapidly as the project progresses. Since job costing reflects actual and up-to-the minute costs, it can provide much more relevant information about your cash flow. This is even truer if you use a purchasing system that allows you to track and categorize committed costs. This information can and should be used to determine how often and how much to bill your customers. The ability to understand and predict cash flow was one of the biggest factors in Rocko Excavating’s long-term success, as it is with most contractors.
• Progress billing such as percent-complete, AIA, or unit price billing, offers you the chance to bill your customers more frequently and accurately, ensuring that expenses never get ahead of income for a project. A sound job costing structure can make progress billing much easier because information gathered through other sources and categorized by job cost category offers hints and verifications of the level of completion for each task on the job. Depending on the nature of your work and how you bill, you may wish to categorize income using the same categories you use for costs. This provides a very straightforward one-to-one comparison of income vs. expense.
Secret Eight: Collect the Arrows that Missed the Target
With all the work of implementing a job costing structure, it’s very easy to lose sight of the real motivation for the system. That’s why, in the planning phase of the implementation process, you should write down your goals for the system with specific, measurable targets. After the system has been in place for a while, dig out that notebook of ideas and goals, and determine how far you’ve come.
The idea is to determine if the job costing system has improved your business – as well as verify that you’ve accomplished your goals with the job costing system. Even more important than the “if” is the “why.” If you’re not meeting your goals, spend some time using the numbers to determine why that is.
Ask yourself the following questions:
1. Where are my highest costs? Where are my largest profit margins? Are there positive or negative correlations between these two areas?
2. Does this information indicate that any business processes need to be changed? Can I make these processes more efficient or less expensive?
3. Is my estimating and scheduling accurate? Does my production reporting show consistency between estimated time/cost to complete a unit and the actual results?
4. Are my billings optimizing my cash flow? Can job costing information be used to improve the process?
5. Should I add or drop a line of business? Should I bring in tasks that I’ve been subcontracting -- or vice-versa?
6. Are particular pieces of equipment, specific materials, individual employees and/or labor-trades making or costing me money?
7. How much time is being spent on categorizing and recording costs? Is the investment of time worth the return on information?
Secret Nine: A Foolish Consistency
Given the information you determine from comparing the results to your goals, you should have a general indication if your job costing system is working. The answer will always be, “Not perfectly.” But the good news is, you’re not locked into the system. If you designed it properly and your accounting system offers enough flexibility, you can run tests on your current system, and make changes.
You may think that consistency is essential, but, as Ralph Waldo Emerson said in his essay, Self-Reliance, “A foolish consistency is the hobgoblin of little minds.” In other words, inconsistent and sometimes correct is much better than consistently incorrect!
Secret Ten: A Not-So-Vicious Circle
You’re not done! The three-phase process of implementing a job costing structure is a never- ending circle. The probing and analysis stage inevitably leads to the planning and questioning stage. Just as your business will grow from your use of job costing, your job costing system will change from the growth of your business. Don’t rest on your laurels – or on your current job costing system. Use the information that you gather from job costing reports to improve not only your business, but your way of doing business.
Your Success Story
The process of planning and implementing a brand-new job costing system was not always easy for Rocko Excavating. In fact, as employees turned in timecards without cost information and the accounting staff struggled to learn more about the industry, Rocko sometimes felt as if they would never get there. But the fact remained that the information provided by the new system illuminated his business and made Rocko understand more about running a successful company than he ever had.
This story is true of so many contractors: A simple change in the way they handle back-office procedures makes all the difference in profitability. Isn’t it time you looked into growing your company into much more than it is today?
About the AuthorTwenty-plus years ago, Fred Ode set out to create America’s #1 construction accounting software.After working with other industry accounting systems, Mr. Ode understood the frustration of processing complex payrolls, trying to pinpoint exact job cost details and needing precise reports. He knew contractors needed a better tool to make it all faster and easier.Over the years, FOUNDATION for Windows has been nationally recognized by CPAs and contractors alike as a clean, efficient and powerful tool. It has helped thousands of construction companies save time, increase productivity and improve their bottom line.To contact Fred Ode, email email@example.com or call toll-free at 800-246-0800.Ready to take a closer look how a construction-specific accounting system could improve your job costing? Contact Foundation Software at 800-246-0800 for a convenient on-line demonstration.