One of the biggest challenges small businesses face is deciding how much to charge for their products or services. If you get this right you will have a highly profitable business. On the other hand, if you get this wrong you won’t be in business much longer. Thankfully there is a system to make sure you always get this right! It is commonly referred to as a job costing system.
What is a Job Costing System?
Simply put, a job costing system is a system that takes the known expenses of a business and estimates future project costs based on those expenses. There are three main areas that are being estimated in a job costing system:
- Materials
- Labor
- Overhead
Job costing is extremely useful for businesses that provide services or products that vary depending on the customer’s specifications. Oftentimes, job costing is the sole driver in how profitable these types of businesses are. For example, a general contractor will meet with a customer to detail out the specific expectations for a finished house. Once the details are laid out, the contractor would use a job costing system to estimate the cost of building that particular house. As mentioned above, the three costs he will estimate are materials, labor, and overhead.
Material Cost
Material cost will vary for each job that a contractor bids on. The type of materials, where and whom they are purchased from and even the location the home is built in will affect the overall material cost.
Labor Cost
Labor costs can easily be based on how many guys are needed to complete the project and the total number of hours they will work. Scheduling becomes a must if you are to maintain your profit margins for each project. For each day the crews run over, your profits are eaten up by the amount of labor cost for that day.
Overhead Costs
Overhead costs are the one expense that should not change drastically from job to job. We recommend calculating your business’s daily overhead rate and applying that number to each project you bid on. To calculate your daily overhead rate, add up all of your monthly expenses except for direct materials and labor. Be sure to include any balance sheet payments such as equipment payments and owner’s draws. Then simply divide that number by how many days in the month your business is open. For example, if your total expenses equal $20,000 and your business is open 20 days a month (M-F 4 weeks) then your daily overhead expense would be $1,000 per day. Be sure to add this fixed rate to each job you bid on. If not, your supposed profits will be eaten up by overhead costs on each project.
Conclusion
Having a job costing system in place to help calculate all of these expenses will provide your business with a consistent pricing model. If your company needs help clarifying the details of your organization’s finances, give Still Water Financial Operations a call. We guide companies through job costing strategies on a weekly basis. Contact us here to learn more!