Imagine that a lead contacts your contracting company and asks for a quote for the construction of a new house. You’re excited at the new prospect and sit down to come up with a reasonable but competitive quote.
But how do you figure out how much to charge for your work?
That’s where job costing comes in. Job costing is the process of determining how much your work will cost you to complete. From there, you can use that figure to price your products and services competitively.
In this guide, we’re going to cover the basics of job costing, including how to accurately estimate the expenses involved in a given job, when to use job costing, and more.
What Is Job Costing?
Job costing is the act or process of figuring out how much money it will cost you to complete a job. In other words, it’s a way of calculating the expenses you’ll accrue to provide a service or create a product.
Typically, job costing is used for custom orders or services, not long-term productions. For example, a caterer would need to do job costing when asked to prepare food for a party, but an electronics company wouldn’t necessarily consider a cost analysis of manufacturing their new game system an instance of job costing.
Job costing is important because it gives businesses an idea of how much they will be spending when completing a product or service. Consequently, it allows them to decide how much to charge for said service.
Without proper job costing, it’s easy to charge less for a product than it costs to make, leaving your business with a loss.
How to Calculate Job Costing
Now that you have a better idea of what job costing is all about, let’s take a look at how you can start to calculate the costs of your jobs.
Typically, this is divided into four steps (the order doesn’t need to be followed exactly):
Step 1. Calculate Direct Material
The simplest place to start is generally with direct material. This encompasses the cost of all the materials you will directly be using in your products and services.
For example, if you’re building a house, you might need cement, concrete, wood, insulation, etc. Calculate how much each of those will cost and add them up.
Be careful not to include indirect material costs, like tools you use to make your products. That’s a part of your overhead, not your direct material costs.
Step 2. Calculate Direct Labor
Next, calculate the cost of your direct labor. This includes all workers who are immediately and directly involved in bringing the product or service to fruition.
In the house building example, that would include all construction workers and contractors. However, it would not include supervisors or managers.
Step 3. Determine and Allocate the Overhead Rate
Overhead costs are the hardest to calculate because they are indirect expenses and can’t be easily divided up by projects. Examples of overhead costs include rent for an office, the cost of equipment, utilities, and manager salaries.
To make handling overhead expenses easier, many businesses calculate an overhead rate. This means that you add up your total overhead costs and then divide it by what’s called an activity driver, like labor hours. The key is to make sure your activity driver works for all your projects.
For example, if you pay $3,000 in overhead each month, and your laborers worked for 640 hours last month, you would divide the $3,000 by 640 to get $4.69 per labor hour (the overhead rate).
When you calculate the amount of labor you’ll need, just add on this cost to each hour of labor. This is referred to as allocating the overhead. Now you have an estimate of your overhead costs for the project.
If you use another activity driver, like manufacturing hours, the process remains the same.
What Is a Predetermined Overhead Rate?
Sometimes, businesses already have a flat rate they use for all their overhead costs. This is called a predetermined overhead rate.
Step 4. Add Everything Together
Once you’ve calculated your direct material, direct labor, and overhead costs, simply add everything together to get the estimated cost for the job.
Job Costing Example
Let’s walk through a real example to get a better feel for how this all works.
Imagine a small T-shirt printing company gets a custom order for a limited run of 1,000 T-shirts. How will it calculate the costs of this job?
First, it will add up the costs of the raw materials. The custom order is for 100% cotton T-shirts, so that is the only material involved. The company determines it costs $0.68 per T-shirt, so it will cost $680 for 1,000 T-shirts ($0.68 * 1,000).
Next, it will need to calculate the labor costs. It needs to employ one worker to operate the machinery for 6 hours to make the T-shirts. This worker is paid $15/hour, so that comes to $90.
After that, the company will need to calculate its overhead rate and allocate the overhead. If it paid $5,000 in overhead last month between rent, utilities, machinery, etc., it can divide this by an activity driver, like the total number of direct labor hours over the same period, to get an overhead rate.
So, if the company had 160 total direct labor hours, the overhead rate would be $31.25 per labor hour ($5,000/160 = $31.25). Then, it will allocate the labor to this job by multiplying the rate by the hours: $31.25 x 6 = $187.50.
Now, simply add up all these expenses to get a total job cost of $957.50 ($680 + $90 + $187.50).
Who Uses Job Costing?
Any kind of business can use job costing. However, it is most common among businesses that take custom orders. That means that construction companies, contractors, manufacturers, medical services, hair stylists, and other similar businesses will find job costing most useful.
Job costing is important to any business that relies on custom orders or limited manufacturing runs. The same process may be used by other types of businesses to determine costs, but they may not refer to it as job costing.
If you’re starting a new business, make sure you fully understand how to calculate the costs involved with your work so that you don’t end up losing money instead of making it.