Job Costing and Inflation in the Construction Industry

Article

By Brent Impecoven, CPA

Project 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 sink?

The supply chain is only as strong as its weakest link. If something occurs that causes disruption along any point of that chain, the ripples are bound to affect the construction industry. Appropriate monitoring of both the volume and timing of future work is always a smart practice to employ. Construction job costing is a vital tool to identify issues as well as opportunities to focus and direct organizational strategy.

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, 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 material 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: Although job costing is often seen as an accounting responsibility, for it to be most effective, employees involved in all facets of project completion should be involved. Field employees, foremen or supervisors, project managers, project accountants and management personnel can all contribute to the job costing process.

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Why is Job Costing Important?

Construction job costing is important for the financial health of contractors, but when the supply chain faces disruption and uncertainty, with shipping costs soaring, it’s vital.

When the construction industry confronts soaring prices for materials, due to increasing demand and massive breaks in the supply chain, many projects come to a standstill. Supply chain disruption leads to inflated cost of materials due to shipping difficulty and halted manufacturing of products and materials — all of which affect your company’s bottom line, not to mention potential damage to your reputation.

During a time of supply chain chaos, having accurate insight and data regarding job costs is absolutely critical. Successful contractors employ robust job costing processes in order to focus their efforts and direct strategic initiatives.

Project Type
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.

  • What size contracts are most profitable? Do you struggle to perform on contracts greater than $5 million?
  • Are contracts of a limited scope 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 versus 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 you’ve 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 appropriately and avoid accepting a change order when doing so would unfavorably affect contract performance and profitability.

Flexibility
Change is often unavoidable: 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?

As a business leader, ensuring your involvement in the construction job costing process, requires just a few simple steps:

  • Analyze Current Costing Processes: Determine whether current job costing processes are sufficiently capturing timely information relative to 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 to a given project than the use of labor hours would.
  • 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.

Better manage your construction job costing with the guidance from our experienced construction industry advisors.

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