Profit margins are what makes your business go round, but if you aren’t paying attention, unexpected and underestimated costs can eat away at your earnings. Stop project cost creep with job costing.
Appropriate job costing lets you see which projects are successful, and by how much. Company management can use that information to make more informed choices about where the company is going and which projects it will take on. Accurate job costing also helps to ensure that operations and strategy favor the most profitable projects while sales and marketing can gear their efforts towards the more profitable activities.
In other words, job costing benefits the entire company, as well as its individual parts. Here is what you need to know to get started:
Calculate Your Costs
Good job costing starts with your bookkeeping services and controller services. You have to know what you are actually spending before costs can be attributed to a particular project. In general, you will have direct material costs, labor costs and overhead costs. If your current accounting system does not support that type of differentiation, consider hiring a professional bookkeeping company or outsourcing your controller services.
Allocate Spending
Work with your accounting department or controller to identify different projects and code expenses accordingly. Financial records can illustrate some costs but others will require input from operations or project managers. For instance, if your company makes stuffed toys, you may want to cost dolls differently from teddy bears, but at the same time, you may purchase the stuffing for both items on a single purchase order.
Divide Overhead
You also have overhead costs that cannot be directly allocated to an individual project, like rent, utilities and office supplies. These will need to be pooled and divided across projects. You could do this evenly or in accordance with how many direct labor hours each project requires. The latter is usually the more accurate of the two. For example, imagine your company has two projects. One project takes 200 hours and the other takes 1,800 hours. Dividing overhead costs in half wouldn’t accurately represent the costs attributable to each project, so you should use a percentage for each project instead.
Calculate Project Profitability
Once you have identified your projects, allocated spending and divided overhead, you are ready to calculate the profitability of each project. Do this by adding together direct material costs, direct labor costs and applicable overhead to determine the total cost for the project. Now compare this figure to how much you earn for each project. You can express the profitability as a whole (i.e., “Project A earns $1,000”) or as a percentage (i.e., “Project A’s profit margin is 25 percent). You can also look at profitability before a project is completed by using a combination of estimates and actual figures.
Determine Your Needs
Job costing works best with individual projects. If your company produces several products or provides different services that are very similar, process costing may be more appropriate. In this type of cost accounting, you assign costs to the products produced and the processes required. For instance, you might calculate the manufacturing costs incurred by producing the items separately from the shipping costs. You might also use process costing to determine the costs of customized orders, like adding a monogram to a tote bag or choosing the color of a surfboard.
When you apply job costing to your business, you can see how much each project is really making – and the results can be illuminating. In the end, your most profitable projects may not be the ones that you expect. Staying on top of the numbers will help you choose the most profitable projects and illustrate the value of your operations strategy.
