Understanding job costing for contractors

Why job costing matters

A company-wide P&L can show a healthy profit while hiding a job that lost money and two that carried it. Job costing breaks revenue and costs down by project, so you can see which kinds of work, customers and estimates are paying off.

It also improves estimating. If kitchen remodels consistently come in 15% over the labor you budgeted, you'll only learn that if labor is tracked against each job. Without that feedback, every new bid repeats the same mistake.

Job costing doesn't have to be elaborate to be useful. Even a simple setup, with every cost coded to a job number and a monthly report comparing estimate to actual, will show patterns within a few months. Sophistication can come later, once the habit of coding costs correctly is in place.

Direct costs and indirect costs

The first step is deciding which costs belong to a specific job and which belong to the business as a whole. The line isn't always obvious, and different contractors draw it in slightly different places. What matters is that you draw it once, write it down and stick to it, so job results are comparable from one project to the next.

Overhead still has to be covered. A job that earns a 25% gross margin before overhead may look fine until you realise overhead runs at 20% of revenue. Many contractors work out an overhead rate and build it into their estimates so each bid carries its share.

• Direct costs: field labor on the job, materials delivered to the site, subcontractors, equipment rented for that project, permits tied to the job.
• Indirect costs, often called overhead: office rent, office staff, insurance, owned trucks and tools used across many jobs, estimating time, marketing.
• Grey areas: a supervisor who splits time across sites, or fuel for trucks that visit several jobs a day. Pick a reasonable allocation method and use it consistently.

Allocating labor, materials and subcontractors

Labor is usually the hardest to get right. Crew members need to record hours by job, and those hours need to carry the full cost of the worker, not just the hourly wage. Employer payroll taxes, workers' compensation insurance and benefits add to the true cost. That extra is often called labor burden.

For example, if a carpenter earns $30 an hour and burden adds a hypothetical $9 an hour, each hour charged to a job should cost $39. A job that used 200 carpenter hours carries $7,800 of labor cost, not $6,000. Pricing work off the bare wage is one of the most common ways contractors underbid.

Materials should be coded to a job when purchased or when pulled from stock, with leftovers returned to inventory or moved to the next job deliberately. Subcontractor invoices should reference the job and, ideally, the line of the estimate they relate to, so you can compare what you budgeted for the electrician with what you actually paid.

Change orders and customer deposits

Change orders alter the scope and price of a job after it starts. Treat each one as an adjustment to both the contract value and the cost budget. If a $40,000 bathroom job gains a $3,500 change order for upgraded tile, the job is now worth $43,500 and the materials and labor budgets should rise too. If change orders live only in text messages, the job will look like it went over budget when in fact the scope grew.

Deposits received before work begins are not yet earned. Like any advance payment, they are usually recorded as a liability until the work they cover is performed. Progress billings and any retainage held back by the customer also need tracking job by job, so you know what's been billed, what's been collected and what's still owed.

The idea behind work in progress (WIP)

On longer jobs, what you've billed and what you've earned can drift far apart. A WIP report compares the two for each open job. At a general level, it estimates how complete a job is, often by dividing costs incurred so far by total estimated costs, and compares the revenue earned on that basis with the amount billed.

Here is a simplified, hypothetical case. A job has a $100,000 contract and $70,000 of estimated total cost. So far $35,000 of cost has been incurred, so the job is about 50% complete and roughly $50,000 has been earned. If you have billed $60,000, you are overbilled by $10,000. That cash came in early and partly belongs to work not yet done. If you had billed only $40,000, you would be underbilled by $10,000, which often signals a billing delay worth chasing.

Which revenue recognition method your business should use for financial statements or taxes depends on your situation, and is a question for your CPA. Job costing is what makes any of these methods possible. Sumday’s contractors page covers how our bookkeeping supports this kind of tracking.