In Part 1 of our Job Costing for Contractors series, we discussed several key concepts that are vital to an effective program of accurate costing, which leads to better bidding and increased profits. In Part 2, we will dig deeper and explore the importance – and best practices – of how to maintain your job costing system and measure your performance.
Understand Your Work-in-Process Report
Also commonly known as “WIP”, this report is absolutely critical to managing any construction-oriented business. The first step in understanding your WIP report, of course, is to have one. We are not referring to a list of simple list of jobs (backlog or pipeline) or a job schedule. The WIP is a particular report that is fairly standard in the construction industry and among lenders who provide capital to the industry.
The WIP is based on the accounting concept of percentage-of-completion. In this space, we will not analyze the differences between percentage-of-completion and completed-contracts methods (that is a topic for another day). However, we will note that a WIP report is based on costs. In short, the percentage-completion of a job is based on the ratio of costs incurred to date on the job, divided by the total estimated costs. In turn, that ratio is presumed to also equal how much job revenue has been “earned” to-date (regardless of whether it has been billed or paid). Finally, the difference between earned revenue and total billings to-date tells the reader of the WIP report how much the contractor has left to bill, and how much it has left to spend on the job. This is known as “future cash flow” on the job. Bankers focus heavily on these components of the WIP report in making lending decisions.
Measure Your Gross Profit Results
Another benefit of a robust WIP report is that it creates reliable data from which the contractor can measure its “actual” gross profit on jobs against its original estimate. Here, you are looking for what we might call “profit erosion” – that is, jobs on which the original estimated gross profit was, let’s say, 15%, but at the end of the job you find that it actually came in at 12%. On just one job, this may not seem like a big problem, but if jobs are finishing out consistently below the original profit target, it is an indication of poor estimating (and an inadequate costing/pricing system). Consistent, regular measurements of “actual” against original estimates are indispensable to a well-managed contract business.
Count those Hours, Count that Inventory
Technology can do a lot of things for us, but it cannot replace discipline. Employee hours must be counted – and not just so you know if they are owed overtime or not. The other reason is that labor hours are the key component to understanding job costs; you must have reliable time tracking, per employee, on every job. You also must count your materials inventory on a systematic basis, and compare with your internal reports of what is on-hand. Some employers allow employees to “pull” material directly from the yard, and then return any unused materials at the end of the day. Without a system of record-keeping that holds those employees accountable, inaccurate inventory costing is virtually guaranteed.
Reward Exceptional Performance
A downstream benefit of accurate time-tracking and inventory management, yielding accurate Job Costs and profit measurement, is Management’s ability to use that data. One way to use accurate data in measuring expected profit versus actual profit is to develop a bonus plan. The idea of a bonus plan is to reward your employees for completing jobs on-time and “under budget.” It’s up to you, as Ownership/Management, how much of that excess profit you are willing to share with your crews, but it is an easy way to build and promote teamwork and happy employees – employees, by the way, who will now take a keen interest in the efficiency of the work.
Your Accounting Software Might Be Your Most Important Tool
Most small businesses use some version of Quick-books, and at CLM Advisors, we have found this to be true. As trained Quick-books advisors, we – and our clients – have enjoyed great success in creating exceptional accounting systems, and training our clients’ internal accounting team on how to record key data and then organize and retrieve that data in meaningful report formats. Quick-books and other software programs, when used to maximum effect, can create powerful measurements, such as profit and loss by job type, by job location, by customer, and even by employee. In Quick-books, this is usually accomplished by using Classes.
Inventory accounting is also made easy in a well-designed software system. In Quick-books, the most common way to track inventory costs in a job-costing system is to establish Items for each inventory component or assembly of various components.
Effective decision-making is highly dependent on the availability of reliable financial data for your business. If you know exactly what is happening, you can figure out why it is happening, and what to do about it. But too many business owners – including contractors – are “flying blind”, relying on incomplete and/or inaccurate data – and they usually recognize that this is a problem, but lack the time or training to correct the problem. At CLM, we believe that a major component of business success is the result of “knowing your numbers”, and that is why we place great importance on establishing and maintaining systems that ensure the accuracy and availability of those numbers.