Are your products, services or projects profitable?
If you don’t have job costing capabilities, you might be in the dark. So what is job costing? In a nutshell, job costing is the process of assigning costs to a particular product, service, project, etc. The goal in job costing is to allocate costs to the activity they belong to. For instance, if an employee spent 3 hours working on a custom piece of furniture, you would allocate his hourly cost to that custom product. You would also want to allocate the materials used to that product.
So why does job costing matter? As a business owner your goal is to use available resources to maximize profits. If you are not fully allocating the costs of those resources to the product/project/service, you will not have an accurate view of profitability. Let’s look at an example. You have two orders for custom furniture pieces. Order #1 will generate revenue of $3,500 and order #2 will generate revenue of $4,000. The material that goes into order #1 will cost $2,000 and the material that goes into order #2 will cost $2,000. Initially, which order would be the first priority?
Order #1 | Order #2 | |
|---|---|---|
| Revenue | 3,500 | 4,000 |
| Material cost | -2,000 | -2,000 |
| “Profit” | 1,500 | 2,000 |
At this point it looks pretty obvious, order #2 is the more profitable activity. BUT, what if order #1 required 15 hours of labor at a rate of $25/hour and order two required 18 hours at a rate of $50/hour. Now our profitability looks like this:
Order #1 | Order #2 | |
|---|---|---|
| Revenue | 3,500 | 4,000 |
| Material cost | -2,000 | -2,000 |
| Labor | -375 | -900 |
| “Profit” | 1,125 | 1,100 |
Order 1 now looks more attractive and you may decide to devote more resources to increasing sales that resemble order #1. This was a very straightforward and simple example, but imagine if the product required multiple labor types and numerous material inputs. The complexity could result in difficult, or even impossible analysis if you don’t have a job costing system.
The importance of proper and accurate job costing is followed up with the importance of a system that can perform job costing, without disrupting your entire business. Many systems on the market either perform poorly when it comes to job costing, or simply don’t perform at all. When looking to set up or convert to a new system, don’t forget to consider the importance of job costing in the profitability analysis of your business.