Job Costing -An Execution Guide for Operations

Brad Dempsey/Solutions360 Inc.

What gets measured …Gets done.

The purpose of this seminar is to introduce financial concepts that will help operations staff better understand and manage projects.

Overview• Job costing is typically thought of

as an accounting function• Margins are only getting tighter• Every point possible must be

achieved in execution• The project team’s understanding

of the financial aspects can make the difference

Overview• This course assumes that you are

not an accountant

What we will cover• What is job costing?• Why do we need it?• The sales handoff• Project / Job creation• The budget• Resources• Managing material• Managing labor• On-going financial analysis

What we will cover• Project KPI’s (Key Performance

Indicators)• Invoicing• Sub Contracting• Labor burden• Material burden• Over/Under billing• Change Orders• Sample jobs for analysis

Glossary• GM = Gross Margin

– Dollar value of revenue minus cost of goods• GP = Gross Percentage

– Percentage of GM / revenue• Price – what we charge the customer• Cost – what we pay our vendors• Brokerage – or box sales, simple sale of product without

labor• T&M – Time and Material• Progress Billing – A job that we earn revenue on based

upon our estimate and a fixed price

Alternate Course Names

The 7 Habits of Effective Job Costing

Alternate Course Names

How to Job Cost and Influence People

Alternate Course Names

Game of Job Costing

Alternate Course Names

50 Shades Of Job Costing

Alternate Course Names

Job Costing “r” Us

Alternate Course Names

The One Minute Job Coster

Discussion - What Challenges Are You Currently Facing?

What we see happening• Margins are slimmer than ever• PM’s that watch job costing

closely are achieving greater results

• Jobs that are well managed and measured lead to better proposals

What we see happening• There is frequently a gap between

sales / operations / accounting with respect to information sharing

• Many operations teams have no interest and or visibility into the financial aspects of the job

What is a project/job?

A project is essentially a unit of work that allows us to manage, measure and execute the delivery of products and/or services to our customer.

Why a project and why is the financial aspect so important?

Sales are made based upon an estimate of the cost to deliver the goods and services. The accurate measurement and control of those costs are critical to the survival of the company.

Project accounting (job costing) is a tool to help us manage those costs, and make adjustments if required as early as possible in the process.

Goals For This Seminar

• Understand and appreciate the 4 GP’s

• Introduce tools to help you improve your financial project management

• Help bridge the gap between operations and finance

Do we really need to learn some accounting?

What is job costing?From Wikipedia, the free encyclopediaJob Costing involves the calculation of

costs involved in a construction "job" or the manufacturing of goods done in discrete

batches. These costs are recorded in ledger accounts throughout the life of the job or

batch and are then summarized in the final trial balance before the preparing of the job

cost or batch manufacturing statement.

Why

Without a method of job costing, we don’t know which projects were profitable and why.

The Business WhyWithout job costing, we lack valuable knowledge to bid and manage the next job.

The Accounting WhyAccounting standards (GAAP) dictate that revenue and costs should be in sync (Matching principle).

The revenues and costs that hit our income statement are used to report to the bank and bonding companies. It is important to maintain consistent profitability to sustain our bank covenants and our ability to obtain performance bonds.

Accounting Concepts

AssetsLiabilitiesEquityRevenueExpense

Assets• A spy working in his or her own country and

controlled by the enemy.

• The entries on a balance sheet showing all properties, both tangible and intangible, and claims against others that may be applied to cover the liabilities of a person or business. Assets can include cash, stock, inventories, property rights, and goodwill.

Liabilities• A company's legal debts or

obligations that arise during the course of business operations. 

Equity• Funds contributed by the owners

(the stockholders) plus the retained earnings (or losses). Also referred to as "shareholders' equity".

Revenue• Funds received during a specific

period, for products and services.

Expense• Costs incurred through

operations to earn revenue. 

Cash Accounting• An accounting method where

receipts are recorded during the period they are received, and the expenses in the period in which they are actually paid.

Accrual Accounting• An accounting method that

measures the performance and position of a company by recognizing economic events regardless of when cash transactions occur.

Company Level Reports

• Income Statement• Balance Sheet

Income Statement

• The income statement shows the revenues and expenses accrued over a period of time

Income Statement – Above / Below The Line

• The “line” is the division between Gross Profit and Sales/General/Admin expenses

Income Statement Example

Income Statement Example

Balance Sheet• The balance sheets shows a snapshot,

or a point-in-time• Includes assets, liabilities, equity• Assets = Liabilities + Equity

Balance Sheet Example

Project Level Reporting

The 4 GP’s1. Budget2. Current projection3. Invoicing position (Actuals)4. Earned

Project Snapshot

The Sales Hand Off

1. Budget• The original contracted amounts

2. Current Projection• Current budget inclusive of– Internal change orders– Customer change orders

• Internal change orders may be cost-only changes to the budget so that estimated cost at completion is correct

3. Invoicing Position (Actuals)• Invoiced amounts and expenses incurred• This is an “accrued position”• Assumes customer collections and

vendor payments are about the same period of time

• Analysis of unpaid amounts should also be viewed

4. Earned• This is what has hit our income

statement

Simple BudgetItem Budget Amount

Contracted Price $100,000

COGS – Material -$50,000

COGS – Direct Labor -$20,000

COGS – Sub-Contract Labor -$5,000

COGS – Miscellaneous -$,1000

Gross Margin $24,000

Gross Percentage 24%

Cash vs. Revenue• An invoice billed is not always revenue, and a

check cut is not always an expense– When a pre-paid service is invoiced, it becomes a

liability on your balance sheet– When the service or product is actually delivered,

and the cost is incurred, the revenue can be recognized

– Deferred revenues and prepaid expenses are proper accounting, but they complicate discerning your actual cash position

Invoicing vs. Rev. Example 1

Project Start

Month 1 Month 2 Month 3 Month 4 End0

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CashRevenue

Invoicing vs. Rev. Example 2

Project Start

Month 1 Month 2 Month 3 Month 4 End0

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CashRevenue

Invoicing vs. Rev. Example 3

Project Start

Month 1 Month 2 Month 3 Month 4 End0

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CashRevenue

Invoicing vs. Rev. Key Points• The gap between invoicing and revenue is

critical to the sustainability of the business• A clear understanding of the contract terms is

key for the operations team to help manage this gap

• Payment for stored materials, draw schedule, and retention terms are all elements of the contract that impact cash flow

Breaking Down CostsFour major categories1. Material2. Labor3. Sub-Contract4. MiscellaneousHow much detail should we use?

Breaking Down CostsOnly justify more detailed information if such data would impact your decision criteria.

Cost Categories vs. WBSWork breakdown structureFrom Wikipedia, the free encyclopedia

A work breakdown structure (WBS), in project management and systems engineering, is a deliverable oriented decomposition of a project into smaller components.

A work breakdown structure element may be a product, data, service, or any combination thereof. A WBS also provides the necessary framework for detailed cost estimating and control along with providing guidance for schedule development and control.

WBS – See Example

Current Projection vs. BudgetItem Budget Amount Projected

AmountChange

Contracted Price $100,000 $100,000 $0

COGS – Material -$50,000 -$55,000 -$5,000

COGS – Direct Labor -$20,000 -$20,000 $0

COGS – Sub-Contract Labor

-$5,000 -$5,000 $0

COGS – Miscellaneous

-$,1000 -$,1000 $0

Gross Margin $24,000 $19,000 -$,5000

Gross Percentage 24% 19% -5%

Revenue Recognition Methods

1. Time and Material2. Cost to Cost3. Hours to Hours4. Complete Contract

T&M – Time and Material

• Charge based upon delivered labor and material

• Recognize expense of labor and material at time of invoicing

T&M – Example

• Ship 2 displays on Jan 20• Install the displays on Jan 22• Invoice customer on Jan 31• Jan 31 entry• Revenue $1200 material and labor• COGS – Material $800• COGS – Install Labor $200• GM = $200

Hours to Hours Revenue Recognition

To do this, we compare actual hours against estimated hours. This ratio is expressed as a percentage

Actual Hours------------------------Estimated Hours

This percentage represents the completion of the project.

Hours to Hours Revenue Recognition

e.g. If we estimate that a project will take us 500 hours labor to complete, and we have expended 200 hours of actual labor:

200------------ = .40 = 40%500

Hours to Hours Revenue Recognition

This job was contracted for $50,000.So we have now earned: • 40% x $50,000 = $20,000

Cost to Cost Revenue RecognitionTo accomplish this on a project, we use the cost to cost method of job costing. To do this, we compare actual expenses against estimated expenses. This ratio is expressed as a percentage

Actual Cost------------------------Estimated Cost

This percentage represents the completion of the project.

Revenue Recognitione.g. If we estimate that a project will cost us $500,000 in material and labor to complete, and we have expended $200,000 of actual cost:

$200,000---------------- = .40 = 40%$500,000

Revenue RecognitionThis means our project is 40% complete, which also means we can recognize 40% of the revenue.So in this case, if our contract was for $1,000,000

Revenue earned = 40% x $1,000,000 = $400,000

Revenue RecognitionCash flow on a project is out of sync with the performance of the work. The relationship between revenue recognition and cash flow is very important as well.

This represents our over / under billing.

If we are over billed, we are using the customer’s money, and are in a positive cash position.

If we are under billed, we are using our own resources, and in a negative cash position.

Revenue RecognitionManaging the revenue recognition process is critical to strong financial statements on a monthly basis. The statements are critical to maintaining our bank relationship and covenants, and bonding relationships for performance bonds.

Match revenue to costs – GAAPRevenue does not follow cash flow – important to understand the relationshipEven out revenue recognition – Bank covenants, performance bonds

Retention• Common practice for withholding a

portion of the contract amount until final acceptance

• This dollar amount should not show up as a receivable and be aged

• It must be included on the balance sheet as an asset

Retention Invoice

Retention Posting• $12,614 posts to project deferred

revenue• $11,352.60 posts to AR• $1,261.40 posts to Retention

Backlog• The contract amount is what we have sold,

and have a customer commitment for• Earned revenue is what we have delivered• Backlog is the difference• It represents essentially “guaranteed work”• It is important to compare closed job GP

against Backlog GP. If jobs aren’t finishing on budget…then the backlog GP may be overstated

Backlog• See backlog example spread sheet

Labor and BurdenBurden is the actual cost to a company to have an employee, aside from the salary the employee earns. Other than salary, costs include benefits.e.g. • health insurance• payroll taxes• pension contributions• technology and tools

Burden• Labor burden is usually a percentage• J. Smith earns $20 / hr• Burden is 40%• Each hour of project time posts $28

Material and BurdenMaterial may also be subject to a burden. This could cover the internal handling costs for purchasing, warehousing etc.

Material Costing MethodsDirect – SerializedDirect – Drop shipInventory – Avg Cost, FIFO, FISH

Material Costing - Serialized• Generally items over a threshold

value• Each item has a unique number• Cost is captured at time of

acquisition

Material Costing - Identified• Generally drop shipped or job

allocated upon receipt• Commonly done on a P.O. basis

Material Costing – Avg or FIFO• Most commonly weighted average• Risk of costs not matching budget• Can be especially problematic when

negotiating special purchase prices

Material Costing – Avg Example• Part # AB1234• 5 in warehouse worth $500• Average cost is $100 each• Purchase 5 more at $250• 10 in warehouse worth $750• Average cost is now $75 each

Material Costing – Burden Example

• Part # AB1234 with a 3% burden• 5 shipped at $500 cost• Project costs allocated:• $500 debit to material expense• 3% x $500 = $15 debit to material

expense

Material Costing – PPV

• Purchase Price Variance• Difference of PO price and invoiced

price• Can affect the job in a positive or

negative way

Material Costing – PPV

• We cut a P.O. for a display at $500• On receipt we increase inventory

value by $500• On shipment to customer we DB the

job $500 COGS material• Vendor now charges us $475• $25 PPV must be applied somewhere

Allocation of In-Direct CostsAllocation of in-direct cost should be done using logical “cost drivers”.  E.g., allocating superintendent time based on direct labor dollars to each job

Allocation of In-Direct CostsSee example spread sheet

PM AllocationPM time should be direct cost to a job or allocated using a cost driver

PM Allocation – Cost DriverSee example spread sheet

Change Orders

Change Orders - ICO• Internal Change Order• Changes the cost budget only• Possible reasons:• Equipment no longer available• Labor over budget• Unexpected installation challenges

Change Orders - CCO• Customer Change Order• Changes price and possibly cost

budget• Possible Reasons:• Increased scope• Equipment models no longer available

Finance CostsThere is an expense to financing receivables. In some cases, companies will allocate a cost to overdue invoices.

Minimum KPI’s and Reports

• WIP• Gross Profit per Period• Labor Budget vs. Actual• Revenue Backlog• GP Backlog

WIP – Work In Process

• Point in Time report, much like a balance sheet

• See example spread sheet WIP

WIP – Analysis Tips

• Sort by projected GP and look for the highest and lowest numbers

• You will have a good idea of what is “normal” for you business (25-35% possibly)

• Analyze the outliers first

WIP – Analysis Tips

• Use the same process as used for projected GP on earned GP

• Hide columns and put projected GP next to earned GP and look for differences

Gross Profit per Period

• Change over a period of time, much like an income statement

• See example spread sheet Monthly GP

Labor – Budget vs Actual

Revenue Backlog

GP Backlog

Project ForecastSee example spread sheet

Closing the ProjectCheck list:• Invoicing complete• All material accounted for (shipped,

cancelled etc.)• Material cost posted• All time bill entries logged and posted• All PO’s received or cancelled• All vendor invoices received (PPV)

Closing the Project• Misc expenses posted (expense

reports, credit cards etc.)• All revenue posted• Lien and bonding documentation

completed

Summary1. Monitor the 4 GP’s frequently2. Focus on budget changes3. Break the budget down to a detail

level you can manage, and one that will assist in making decisions

4. Gather job cost information early enough to take corrective actions

When will you start monitoring the 4 GP’s