Accurate cost tracking is the lifeblood of construction project success. Yet with numerous direct and indirect expenses tied to each job, gaining true visibility into the financial health of a project can be challenging. This is where advanced job costing techniques become invaluable.
By empowering construction firms to capture all costs related to a specific project – including tricky to-allocate indirect expenses – advanced methods provide unparalleled insights into profitability and cost performance. Armed with this intelligence, managers can course-correct issues before they escalate into major budget overruns or missed deadlines.
In this comprehensive guide, we’ll explore popular advanced job costing approaches tailor-made for the construction industry. You’ll discover realistic strategies for implementation along with tips to choose the right methods based on project complexity. Let’s get started.
Demystifying Advanced Construction Job Costing
Construction financials have a reputation for being notoriously complex. Yet at its core, the concept of job costing simply refers to tracking all costs tied to a specific project. These expenses flow directly from the job site and can be easily traced back to the project.
Definition and Key Concepts
Advanced job costing builds upon basic methods by encompassing additional indirect costs that are harder to accurately allocate. These include:
- Supervisor and foreman salaries
- Temporary site facilities and cleanup
- Small tool purchases and repairs
- Project management software licenses
- Portion of company vehicle leases
The benefit? A fuller, more realistic picture of true project costs. With advanced tracking in place, financial controllers can calculate precise profit margins and identify every factor influencing the bottom line.
Some of the most popular techniques include:
Activity-based costing (ABC): Costs are assigned to activities rather than departments. Granular data is then summed up to determine expenses for final cost objects like projects.
Earned value management (EVM): Compares budgeted costs to actual costs all while tracking schedule performance. This indicates how efficiently dollars are being spent.
Phase costing: Expenses are captured separately across different project lifecycle stages like pre-construction, construction, and post-construction.
Challenges with Basic Job Costing Methods
Traditionally, job costing in construction has relied heavily on direct costs tied to:
- Labor hours
- Materials
- Equipment rentals
The problem? A sizeable 30-50% of project costs come from indirect expenses that are difficult to allocate. If these overhead costs are excluded from analysis, it paints an overly optimistic picture of profit margins.
Managers are then left scrambling when indirect expenses inevitably rear their heads. This notoriously leads to budget overruns, missed deadlines, and decreased profitability.
Benefits of Advanced Techniques
Advanced job costing methods help avoid financial pitfalls by:
Increasing cost visibility: All dollars flowing in and out of a project are tracked, including indirect costs. This uncovers waste and opportunities to improve efficiency.
Enhancing budget reliability: With near real-time expense data, budgets can be fine-tuned to reflect actual spending patterns.
Improving bid accuracy: Understanding true costs empowers construction firms to develop competitive yet profitable project bids.
Identifying cost trends: Historical tracking uncovers tendencies for certain cost categories to go over budget. Teams can then optimize future resource planning.
For complex, high-value jobs, advanced techniques are non-negotiable to remain lean, efficient, and profitable.
Nuances of Tracking Indirect Costs
As we’ve discovered, indirect costs are far trickier to accurately capture and allocate compared to direct expenses. Yet shying away from these line items on financial reports can severely distort a project’s true profitability.
Below we’ll explore nuances of tracking some of the most common indirect costs relevant to construction firms.
Allocating Supervisor Salaries
Site supervisors and foremen play a pivotal role in day-to-day project management and workflow coordination. Yet as salaried employees, tracing their compensation to specific jobs poses challenges.
Here are three potential solutions:
Percentage of salary based on time spent: Supervisors track hours worked across different sites. Their salary is then allocated proportionately.
Number of workers overseen: Another approach is to divide salary based on the headcount of workers supervised at each site.
Equal distribution: With numerous responsibilities across locations, salaries can be divided equally across active projects.
While simple to implement, the drawback is that these methods fail to consider the complexity of tasks being overseen at each site.
Accounting for Site Cleanup
Temporary structures, debris removal, portable washrooms, and general housekeeping don’t come cheap on active construction sites. Yet they are certainly necessary indirect costs.
Strategies for tracking cleanup expenses include:
- Invoicing cleanup activities as individual line items using unique GL account codes.
- Splitting costs evenly across all ongoing jobs.
- Using total labor hours as a cost allocation metric. Sites with more activity require greater cleanup efforts.
- For multi-year projects, anticipate monthly or annual site cleanup costs during the planning stages.
Getting creative with cost coding is key for isolating these expenses.
Capturing Overhead Expenses
Overhead costs consist of ongoing operating expenses required to keep a construction firm running behind the scenes. These include:
- Head office rents and utilities
- Administrative and sales staff salaries
- Business Insurance
- Software app subscriptions
- Portion of company vehicle leases
There are two predominant methods to incorporate overhead activities into job costing:
Percentage of completion basis: Overheads are allocated incrementally over the project timeline based on the percentage completed so far.
Labor hours basis: Overheads can be allocated proportionately based on the labor hours logged at each project site. Sites demanding greater efforts absorb increased overheads.
While not directly tied to a specific site, capturing overhead remains critical for accurate financial reporting.
Activity-Based Costing in Construction
Now that we’ve addressed various indirect costs, how exactly can they be reasonably allocated? This is where Activity-Based Costing (ABC) shines.
ABC provides construction firms granular visibility into all activities impacting a project’s bottom line. Costs are first traced to various activities and then rolled up to determine the final expense for a job site or contract.
Identifying Activity Cost Drivers and Pools
The first step is to analyze all discrete activities that influence costs across the organization. Common examples include:
- Material procurements
- Site Surveying
- Architectural planning
- Permits and legal
- Equipment rentals
Next, general ledger expense line items are divided across relevant activity cost pools based on usage. Expenses now have a logical home.
With costs grouped into activities, appropriate cost drivers must then be determined. These measure the frequency and intensity that activities consumed by projects.
For equipment rentals, a relevant cost driver would be machine running hours. For material procurements, it could be the number of vendor invoices processed.
Linking Activities to Final Cost Objects
Once all activities have been defined with accompanying cost pools and drivers, expenses can be traced to final cost objects. In construction, these are typically specific jobs, phases, contracts, or internal departments.
As an example, the cost of cement material procurements can be allocated across projects based on the quantity of cubic yards consumed at each site.
Similar allocations are performed for all activities across the project portfolio. ABC provides the best possible approximation of how job sites utilize resources.
Implementing ABC Step-By-Step
Here is a high-level overview of implementing Activity-Based Costing:
1. Analyze major activities: Brainstorm all key actions that influence costs at both job sites and the home office.
2. Define cost pools: Map general ledger expense accounts to relevant activity pools.
3. Identify cost drivers: Determine what factors best represent the frequency/intensity that activities are consumed.
4. Capture volumes: Record measurements for each cost driver over a set time period. This serves as allocation metrics.
5. Calculate overhead rates: For each activity, determine the overhead rate per unit based on cost pool expenses divided by cost driver volumes.
6. Assign costs: Allocate activity costs to projects based on the overhead rate times units utilized.
7. Analyze results: Compare allocated costs to actual costs incurred to identify inaccuracies. Refine the model accordingly.
The level of effort required is high initially. But the long-term benefits of understanding true costs across the construction value chain are invaluable.
Additional Advanced Costing Approaches
While Activity-Based Costing provides the most holistic approach, other methods each offer unique benefits:
Granular Phase Costing
Rather than viewing projects as a single cost object, phase costing splits them into pre-defined stages such as:
- Concept and bidding
- Design and planning
- Procurement
- Site construction
- Commissioning and handover
Costs are then tracked separately across each phase. Teams gain visibility into spending patterns during design compared to active onsite build. This granularity uncovers inefficiencies to address for future projects.
Other advantages include:
Earlier cost deviations detection: Budget overruns are spotted quicker compared to tracking expenses across longer periods. Teams can course-correct issues before costs spiral out of control.
More accurate forecasting: Historical data is available by phase to improve predictions of upcoming costs.
Enhanced change management: The impact of moving phase deadlines or altering deliverables becomes abundantly clear.
For owners debating constructability or contractors perfecting proposals, phase costing brings sharper analytical insights.
Change Order Management
Change orders refer to alterations in project scope and schedules that disrupt the original budget. By some estimates, change orders add on average 5% or more to the final cost of construction projects[^2].
To prevent approved changes from sabotaging profitability, savvy managers implement change order management best practices:
- Maintain clear communication with clients on scope and expectation adjustments
- Update cost estimates and progress metrics to reflect changes
- Gain signoff from both parties on alterations to minimize disputes
- Integrate modifications directly into job costing workflow
With diligent change order control, surprises can be averted and margins preserved.
Earned Value Management Metrics
Earned Value Management (EVM) compares the budgeted and actual costs spent so far to assess project performance. It answers a simple but insightful question — are we receiving acceptable value for our project investment based on current progress?
EV metrics provide an early warning signal when costs are outpacing activities. This might necessitate workflow improvements or be indicative of inaccurate initial budgeting.
Two core EVM calculations include:
Cost Performance Index (CPI): Measures efficiency by comparing completed work to incurred costs. A value below 1 signals potential budget issues.
Schedule Performance Index (SPI): Compares completed work to what was originally scheduled. Values below 1 indicate potential timeline delays.
By combining cost and schedule insights, managers gain an accurate predictive view of project completion. This steers corrective actions like addressing resource bottlenecks or revising estimates for remaining activities.
Leveraging Technology for Advanced Job Costing
While advanced techniques provide the foundational blueprint for improved project cost management, technology delivers the tools for efficient execution.
Robust Construction Accounting Software
Investing in purpose-built construction accounting platforms streamlines data collection and reporting across far-flung job sites. Core functionality includes:
Centralized information: Capture and access project documents from anywhere — including daily field reports, change orders, and modifications.
Configurable cost tracking: Record expenses in real-time at custom granularity levels with custom fields for activities and cost categories.
Automated allocations: Define overhead and burden rate formulas upfront for automatic application during expenditures posting.
Custom reporting: Gain on-demand visibility into project cash flow, unbilled costs, and performance metrics through dynamic dashboards.
Leading solutions integrate directly with popular scheduling, document management, and mobile tools. This creates a seamless single source of truth for up-to-date financials.
Integration with Project Management Tools
While accounting software records where dollars are flowing, project management platforms track how construction resources impact schedules.
Bi-directional integrations between the two enable:
Up-to-date budgets: When change orders are approved in PM tools, associated costs are reflected in accounting immediately.
Automated journal entries: Meeting phase milestones or completing workflows trigger corresponding journal entries.
Centralized data: Align entire teams with a unified view of project progress and finances.
This eliminates disjointed workflows that result in mismatched data, confusion, and reactionary decision-making.
Turning Data into Actionable Insights
With advanced costing methods in place — supported by well-integrated technologies — construction firms gain access to incredibly rich data streams. But compiling reports is only half the battle.
The true test is translating analytics into decisive business actions.
Monitoring Profitability and Cash Flow
Dynamic profitability reporting provides executives with clear visibility into the earning potential of active projects. Drilling into the numbers highlights ways to enhance margins moving forward covering:
Estimating accuracy: Do initial projections match actual costs by project phase? Where were deviations highest?
Documentation compliance: What change orders or claims arose from inadequate documentation? Would improved templates or training resolve this?
Cost performance: Which activities or resources consistently exceed initial budget allotments? Here lie waste and inefficiency.
Subcontractor analysis: How do different vendors and subcontractors impact costs based on pricing, quality, and cycle times?
These insights steer sourcing decisions, estimation model improvements, and higher standards for documentation rigor. Now budgets better reflect reality.
Performing Cost Variance Analysis
Cost variance analysis compares actual costs to what was originally budgeted across defined periods. Significance differences indicate potential issues.
Common variance causes include:
- Scope creep from modifications
- Unanticipated weather delays
- Fluctuating material expenses
- Overruns from subcontractors
Based on insights gained, project managers might adjust schedules, renegotiate contracts with vendors, or confirm alterations in scope with owners.
Forecasting for Future Projects
Historical job costing data transforms one-off projects into formulaic processes for future success through:
- Refined cost estimation formulas tailored to project types. A school construction budget now accurately references past academic builds instead of commercial facilities.
- Creation of cost libraries with granular details. For example, electrical costs per square foot are broken down by specific components like wiring and lighting fixtures
- Budgeting assistance for decision-making around equipment purchases, software investments, and team composition planning.
With experience comes wisdom. Cost data accumulates into tribal knowledge that powers competitive advantage.
Best Practices for Implementation
Incorporating advanced job costing requires changes to existing financial data collection workflows. Below we recommend starting on solid footing:
Choosing the Right Technique
Rather than adopt every approach at once, prioritize solutions offering the highest potential impact considering:
Project complexity – Enterprise software implementations suit multi-year jobs with thousands of cost line items. Phase costing fits smaller contracts well.
Capabilities gaps – Would increased financial visibility fill a strategic need around competitive bidding or change response times?
Bandwidth – Ensure teams have availability to diligently track activities associated with advanced costing like ABC.
Training Employees on New Methods
Adequately train all field and office employees involved in data collection. Cover:
Proper categorization – What level of granularity is required? Should equipment be separated by type?
Process changes – Will photo or barcode scanning replace paper-based expense capture?
Job impacts – How will the enhanced data improve daily decision-making outcomes?
Addressing these fundamentals settles new behaviors and elevates data quality.
Starting Small and Scaling Up
Rather than overhaul all cost-tracking processes at once, gradually roll out changes across projects of increasing complexity. Monitor adoption success and keep iterating based on user feedback.
With time, advanced techniques transform from shiny novelties into “just part of how we operate around here” − baking mature project financial management into company DNA.
Conclusion
Crafting skyscrapers and highways demands an orchestra of moving parts. Yet construction is ultimately still a business seeking profits. This is only possible with accurate tracking of all costs – including those sneaky indirect expenses waiting to sabotage budgets.
Advanced job costing methods like Activity-Based Costing provide a structured approach to allocating each dollar. Managers gain visibility into how choices influence profitability margins from material selection to subcontractor hiring. More construction decisions now consider their true financial impact.
Equipped with real project data, the future looks bright. Historical performance steers a trajectory towards razor-sharp bidding, anticipatory risk planning, and maybe even that corner office with a view.
Summary of Key Takeaways
The key lessons to remember about advanced job costing include:
- Carefully tracking indirect costs ensures precise profitability metrics and reliable forecasting
- Popular techniques like phase costing, ABC, and EVM each offer unique cost analysis benefits
- Aligning site and office teams on chosen job costing processes is vital for smooth adoption
- Technology integration between accounting and PM software enables seamless exchange of cost updates
- Exploring variance analysis and profitability reporting uncovers waste plus efficiency opportunities
Still have questions? Contact our construction accounting experts today to discuss the possibilities for your projects.
