Job Costing in a Time of Economic Uncertainty

August 5, 2020 | Article

By Brent Impecoven

Opportunities are plentiful. Your construction crews are busy, backlog is growing and margins are strong. It’s as if everything is working in your favor. But what happens when the once buoyant economy starts to soften? Economic uncertainty is a fickle creature poised to strike at the most inopportune of times. Your preparedness for such changes may mean the difference between your ability to weather the storm or being forced to shutter your doors.

In addition to a deterioration in cash flows, two primary indicators of financial stress for most contractors are decreasing gross margins and dwindling backlog. During periods of economic uncertainty, it’s expected that competitive pressures may increase as the volume of available work decreases. As a result, gross margins are likely to tighten. Decreases in the volume of available work may also result in dwindling backlog, creating the potential for idle crews and mounting overhead costs. To avoid drastic action, appropriate monitoring of both the volume and timing of future work is important.

During these times, construction job costing can be a vital tool to identify issues and opportunities and focus and direct organizational strategy. 

Learn how organizations can adapt cash flows and contain costs during times of economic uncertainty.

What is job costing?
Job costing is a critical tool for many contractors and can serve as a report card for completed and uncompleted contracts as well as a guidepost for future work. Effective job costing can identify indicators of financial stress and help organizations shape a plan to overcome these challenges.

To be effective, however, job cost information must be timely, accurate and understood by all employees in a position to influence those costs.

  • Timely: For best results, job costing information should be as close to real-time as possible. If it takes weeks or months to compile job cost information in a usable format, the ability to react quickly to changing conditions is greatly diminished. Technology can be a powerful tool in generating real-time data. Timekeeping software operating on a tablet or smartphone can be used to record labor and equipment hours directly to jobs. Accounting software can be used to record materials costs incurred based on the purchase order amount prior to receipt of the invoice. Similar processes can be used to record certain subcontract costs.
  • Accurate: Determining direct labor, materials and subcontract costs for a job is generally a relatively straightforward process. However, to determine the true cost of a project, indirect costs, such as depreciation expense, repairs and maintenance, indirect labor and supplies, cannot be overlooked. The failure to consider indirect costs can result in invalid conclusions and poor strategy.
  • Understood: Job costing is often seen as an accounting responsibility. However, to be most effective, employees involved in all facets of project completion should be involved. Field employees, such as foremen or supervisors, project managers, project accountants and management personnel can all contribute to the job costing process.

Make sure you’re doing job costing correctly.

Why is job costing important?
Construction job costing is important for the financial health and well-being of contractors. During a time of economic uncertainty, it’s vital.

As construction volumes decrease and competitive pressures increase, an understanding of how to estimate construction jobs successfully is critical. Previously, you may have bid against a few competitors for most projects. Now, a dozen or more contractors may now be vying for each contract.

Successful contractors employ robust job costing processes in order to focus their efforts and direct strategic initiatives.

Project Type
As margins decrease, ensure you are seeking the right projects for your construction business. Razor thin margins leave little room for errors or inefficiencies. Assuming appropriate job costing processes have been applied to current and previous contracts, the resulting data can be analyzed to determine profitability trends.

  • Are contracts of a certain size most profitable?
  • Do you struggle to perform on contracts greater than $5 million?
  • Are contracts of a limited scope more aligned with your industry expertise more profitable than those requiring subcontracted work?
  • Should you seek to expand your relationships with a general contractor with whom you have worked well in the past?
  • Do you perform better on projects requiring a greater proportion of labor vs. equipment or vice versa?

The answers to these questions should drive bidding efforts; however, without appropriate job costing data, errant conclusions can occur, leading you down an undesirable path.

Bidding
Once focused on the projects most likely to be profitable, adequate job cost information can aid in the development of bids. While market factors must also be considered, the availability of accurate and timely job cost information will result in your ability to hedge against unfavorable surprises when it comes time to perform on the contract.

It’s important to note, however, that simply bidding based on estimated total job costs isn’t always an appropriate response. Depending on the circumstance, it may be advantageous to bid a contract at an overall loss to keep crews busy and provide marginal profits to cover overhead costs.

Change Orders
The ability to price change orders can make or break a project. Understanding the marginal costs associated with a proposed change can shape your ability to price the additional work accordingly and avoid accepting a change order when doing so would unfavorably affect contract performance.

Flexibility
Change is often unavoidable, especially in periods of uncertainty. Certain projects get delayed or cancelled and others get modified. If the effect of these changes on project profitability are understood by all affected parties, you can seek to minimize the negative impacts and pursue the best overall outcomes.

How do I use the results of job costing to help in a time of uncertainty?
As a business leader, now is the time to ensure your involvement in the construction job costing process, including the analysis of the results thereof and the strategies that may be generated using these results. Simple, timely steps can help you favorably position your construction organization in this time of uncertainty:

  • Analyze Current Costing Processes: Determine whether current job costing processes are sufficiently capturing timely information relative each job.
  • Allocate Indirect Costs to Projects: Indirect costs matter. Determine a means to allocate these costs to jobs in order to see the complete picture of job performance. Ensure that allocation methods are appropriate and consistent given the nature of the cost being allocated. For example, costs incurred for equipment repairs and maintenance likely correlate with the time the equipment was used on the job rather than labor hours. Therefore, the use of equipment hours as an allocation base is likely to result in a better measure of repairs and maintenance costs incurred relative a given project than the use of labor hours would.
  • Communicate, Communicate, Communicate: Seek regular input from field and management employees on the status of jobs, the costs incurred to date and costs expected to be incurred through project completion. Make data transparent and encourage real-time updates whenever possible.

Job costing is critical for construction entities and contractors.

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