Job Costing – The Two Most Misunderstood Words in the Construction Industry

If you ask contractors if they job cost, a majority will respond positively. But do they really? There are two methods of job costing, which I call “passive” and “active”. “Active” job costing is much more effective in improving the bottom line than “passive”.

I am constantly surprised by the number of contractors which don’t practice “active” job costing. Just what is job costing? Is it accumulating the costs of a project and then comparing these costs to the contract price at the end of the job to see how much money the job made? Is job costing driven by the accounting department? Absolutely not, to both questions! It is more…much more.

Let’s get the role of the accounting department out of the way first. The accounting department can provide those costs that have been accumulated to date. The accounting department operates only in a support role by collecting information and generating the reports that are needed in order to do cost projections. The accounting department can only tell you what happened in the past. The accountant is the historian of the company. History can’t be changed (unless you’re a politician). This is the “passive” method in a nutshell. “Passive” job costing, as a form of project management, would be similar to driving a car forward by looking through the rearview mirror. You wouldn’t see the obstacles or potholes until you have already hit them. “Passive” job costing helps fuel a reactionary environment of constant fires which always need immediate attention.

They are not the right people to forecast the costs to complete, which are needed in order to develop the work-in-process and generate the financial statements.

Job costing is an “active” on-going process that involves each key employee that is associated with the performance of the contract, which includes the key field people and the Project Manager. Job costing is a project management tool— not an accounting tool.

There are four steps to “active” job costing:

• Accumulating the costs to date.
• Projecting the costs to complete, which is a forward-thinking process.
• Using the information to change (improve) the outcome.
• End of job autopsy.

If you were to survey contractors, you would find that a higher percentage do step #1, less do #2, and even less do #3. And #3 is most critical and is the step that will have the most impact of improving your company’s bottom line.

As a project management tool, effective job costing is more concerned with the time and costs remaining to complete the job so that corrective action can be taken if needed. I have often heard that once a job is going south, it is really hard to turn it around. There could be several reasons why, but the major reason is that the practice of “passive” job costing doesn’t recognize that there is trouble on a job until it is too late to do anything about it.

The job costing process begins as soon as the job is “turned over” to project management. Components of “active” job costing include the following:

• An estimate based on direct and indirect costs to complete the work.
• An accounting system that is capable of capturing and charging costs to the appropriate cost codes.
• The job estimate should be broken out into intermediate phases that reflect the “construction plan” to perform the work. This step is critical. It’s impossible to manage a job where the costs are lumped together.
• The total costs for each intermediate phase are separated by labor (including manhours), materials, equipment, and subcontractors’ costs.
• A daily field report that is completed by the foreman/ superintendent that allocates the manhours worked to each phase.
• A weekly manhour report that requires the foreman/ superintendent to keep track of the job-to-date manhours and project the manhours to complete each phase, and thus the total job.
• Project management reviews the weekly manhour reports to identify phases that may require some sort of corrective action.
• A job cost summary report that is periodically generated (at least monthly) that accumulates all the phase costs to date.
• A documented monthly review process to project the costs to complete each phase of the project.
• A “close-out meeting” to review the final time and costs as compared to the estimated time and costs, along with explanations for variances in case estimated productivity rates need to be changed in future bids.

Benefits of “active” job costing include:

• Knowing the estimated time and estimated costs of a construction project at the beginning of a project enables the project manager and job foreman to pre-plan the project and establish intermediate milestone dates to protect the estimated gross margin (gross profit) of that job.
• Job costing reinforces project planning as it is a forward- thinking process.
• It gives the job foreman and his crew team benchmarks from which they can measure their own performance. It provides a method for them to keep their own score— a strong motivational tool!
• Employees are better able to connect their performance—what they do each and every day—to beating the estimated costs.
• Sharing job performance and job cost expectations is a critical ingredient to being able to hold the project manager, job foreman, and construction team accountable for their job performance.
• The job costing process reinforces the planning process as the thinking is always forward.
• Actual productivity is tracked and estimated productivity rates can be verified and/or revised for the future bids.
• An estimated final cost that is based on how the job is performing will enable your accounting department to generate more accurate monthly reports—financials that you can trust!

The job foreman and lead personnel should be actively involved in the job costing process. After all, don’t they have the most daily influence on how much it will cost to complete the job? They need to be aware of the costs accumulated to date and, with the help of the Project Manager, be able to forecast the time and costs to complete the job as it progresses. If they don’t have the skills to do this right away, train them.

Active job costing is a critical control process. This process will enable you to know which jobs, and which employees, are generating your profits. If you aren’t practicing “active” job costing now, implementing it will improve your bottom line. It is an all important, fundamental business practice for any economic time.

Doug Phelps, President of Management Consultants for Contractors, has over 40 years experience in the construction industry and has been a trusted business adviser to many small to mid-size contractors since 1998.