Do you know how much it costs your business to complete one project, produce one product or satisfy one client? If you are not job costing, then your answer is likely, "No."
If you have an accurate profit and loss statement, you can quickly identify your company's total direct (above-the-line) costs. A company's profit and loss statement alone, however, cannot reveal how those expenses are divided between products, services and projects or between employees, departments and locations.
When done right, job costing allows you to see how and where each of your company's precious dollars are truly spent.
Properly Allocating Your Direct Costs
First, you must identify which of your costs to categorize as direct and which to categorize as indirect. Basically, if you need the material or labor in order to deliver a service or make a product, then it is a direct cost.
These direct costs (above-the-line costs) break down into two categories:
- Direct Material Costs
- Direct Labor Costs
Most businesses allocate material costs correctly, as these expenses are fairly straightforward; if you purchase wood to build a deck, then you charge the wood to that project.
Direct labor costs, however, prove more difficult to allocate. The first mistake businesses often make is not including all employee expenses in direct labor costs, and we do mean all employee costs, including:
- Payroll
- Taxes
- Health Insurance
- Retirement Plans and Contributions
- Benefits
- Paid Time Off
- Training
- Employee Engagement (staff parties, events, outings and team building)
Once all employee expenses have been correctly categorized as direct costs, you must then determine how these expenses should be divided and allocated by employee and employee tasks. This is called time-tracking, and it is the second challenge faced when allocating direct labor costs.
There are two ways to allocate time: Use Time Tracking tools, or Estimate time spent on services.
- The simplest and most accurate method takes advantage of time-tracking software tools, like those from Insperity® and Intuit Payroll, which automate time-tracking and build it into your payroll processing.
- The second way to allocate time is to estimate how your employees spend the day. For example, you could estimate that an employee spends 20% of his or her time on marketing, 30% on sales, 40% on services and 10% on products.
In QuickBooks®, you can then save time-allocation templates for each employee in order to allocate the correct percentage of direct labor costs to the corresponding job classes or categories.
Job Costing Hint: Don't Forget Internal Jobs!
One trick to implementing a really thorough job costing method is to treat internal jobs the same as billable or revenue-generating jobs, with respect to cost allocation. Internal jobs might include projects like restructuring on-boarding, developing sales training or implementing key performance indicator tracking.
Allocating expenses to both internal and external jobs is the only way to be absolutely certain every penny of your company's direct costs are accounted for and categorized.
In QuickBooks, internal projects are tracked the same way as external jobs, by adding class tracking categories to expense entries.
Unit Economics: How Job Costing Informs Action
Allocating all of your direct expenses to a customer, project or job enables you to use unit economics, meaning you can evaluate your profit and loss by different units.
Analysis of your company's unit economics, made possible by job costing, generates actionable information. You can use this to make data-driven decisions regarding where and how to spend your company's money in order to generate the greatest return.
A business owner should first look at profitability by product or service (the smallest unit). For example, a construction company would assess different projects, asking questions like what's the profitability of building a small, medium or large home?
In order to compare these, a contractor must understand the direct cost of delivering each of these products, including the price of demolishing the existing structure, engineering and architecture costs, permits, building materials and the cost of direct labor.
A business with several locations or regions, would then look at profitability by location, starting with each customer and then by looking at all of the customers from each location. The company can then analyze profitability by departments and as a whole company (the largest unit).
Another way to parse profitability into units is to do so by lead generation or lead source. Using QuickBooks, a business can create custom fields on every customer or project to record the lead source. This allows you to analyze profitability by sales representative, sales strategy, marketing strategy and industry.
How Liberty Pipeline Used Job Costing to Transform Breaking-Even into $1 Million in Profit
After leaving Enron Corporation, Allan Weatherford founded a successful pipeline services company. Liberty Pipeline started out doing eight figures of business per year. In spite of booming business and satisfied clients, the company was not generating profits.
Weatherford enlisted GrowthForce for help. We found two major issues: certain labor costs were not being correctly classified as direct costs and time-tracking needed improvement. Liberty Pipeline's P&L listed major labor costs ( such as 401(k) contributions, health insurance and paid time off) as indirect, overhead expenses. The company also failed to account for on-the-clock travel time employees needed to reach job sites. As a result, Weatherford was not pricing these major expenses into his bids.
To solve these issues, we worked with Weatherford to re-classify direct labor costs and implement accurate time-tracking software on company phones, tablets and computers. This software seamlessly integrated with the Insperity payroll system, allowing Weatherford to painlessly actualize time-driven activity-based job costing to determine the true cost of every job, optimize Liberty Pipeline's pricing and re-negotiate contracts. Restructuring accounting to accommodate accurate job costing helped Liberty Pipeline generate $1 million in profits in a single year.
The Risk You Take When You Don't Job Cost Correctly
In any business, but especially in service businesses, the vast majority of a company's expenses are in employees. In service, direct labor costs often account for 70% or even 80% of direct costs.
If you fail to allocate your direct labor expenses, you leave the primary portion of expenses sitting in an indecipherable line item on your profit and loss statement. Which puts you at risk of:
- Losing money
- Charging too little
- Investing in the wrong services or products
- Training employees in inefficient methods
- Cash flow shortages
Allocating direct labor and material costs efficiently, thoroughly and consistently provides transparency into all of your expenses. Job costing also allows you to see how much each of your clients, services or jobs really costs.
Proper job costing empowers you to optimize your company's pricing structure, payroll strategy, customer acquisition costs and investments to increase profits and drive growth.
