How Job-Costing Helps Construction Companies Improve Their Bottom Line

Business ownership is hard. Grueling hours, financial risk, and constant unknowns are the life of most entrepreneurs. And for what? Most business owners are working harder and harder to grow their revenue, yet making meager profits, if any profit at all.

Consider this. Would you rather run an $11 million business that generates $350,000 in profit or an $8 million business that generates $750,000? Why work so much harder to make less money?

It is arguably more work to operate an $11 million business than to operate an $8 million business. Why would anyone want to do it while making less money? In many cases they lack the understanding of key financial metrics that tell them this is where they are going to end up.

Take for example a construction company that was doing well, growing every year, hiring more team members, serving more customers and increasing revenue. But its profit was declining. Sales staff were signing new projects regardless of margin, administrative staff weren’t capturing the right data to produce relevant financial reporting, ownership and management struggled to interpret the financial data they had, preventing them from making informed decisions that would have had a positive impact on the bottom line.

Something had to change. 

Key Financial Issues:

Margins

Project margins were too low to sustain the overhead costs of the business. A company’s gross margin is the amount left over after taking total revenue and subtracting the direct costs associated with producing that revenue. In a construction company, margin would be the project revenue minus the materials, labor, equipment and other supplies needed to complete the project. Margins are typically reviewed as a percentage of revenue. Through review of the company’s margins, it was clear that low margins were one of the biggest problems. Because its margin percentage was so low, it did not serve the company well to increase revenue. Each new dollar of revenue did not produce enough margin to cover the increased cost of doing business.

Job Costing

As a construction company, or any company that has direct costs associated with each project or customer, it should have been job-costing. Job-costing is the process of assigning all expenses incurred on a project to that project in your accounting or project management system. By job-costing, a company can track the direct costs associated with producing revenue, helping to provide information that can show whether a project or customer is profitable or not. Since the company was not job-costing, management had no way of knowing which jobs were profitable, and which jobs were losing money. They knew they had to fix their margins, but they didn’t know how to fix them because they had no insight into what the margins were on each job, on different types of jobs, or for different types of customers.

Lack of Understanding

Ownership and management had a lack of understanding of what the financials were telling them. They looked at the profit and loss statement each month, but it wasn’t accurate. And, they didn’t even realize it wasn’t accurate, because they did not understand the balance sheet and how to use it to verify accuracy. They didn’t look at trends, understand margins, or even know what they should be looking at to tell them how they were doing. They thought that consistently increasing revenue meant they were doing well, when in reality, they were in a growing business that was producing less and less profit each year.

Fortiviti

Solutions

The first step to fixing the company’s financial pain was to implement job-costing. With the primary issue being gross margin, management knew they couldn’t fix anything until they had some insight into what was causing their margin issue.

Implementing job-costing is no small feat. Job-costing requires increased tracking, additional tools, and participation from more than just the accounting team. With job-costing, every cost associated with producing a project is assigned to that project or customer – materials, labor costs, equipment and tools. Every cost should be assigned. For example, labor cost is not just the hourly wage or salary paid to a team member. Labor costs include benefits, taxes, workers comp, retirement match, paid time off and any other costs associated with that team member. While it is a big undertaking for any business, the insights and data job-costing provides are invaluable.

After 6-12 months of job-costing, management was able to determine a couple of key problems that were causing the margin issue. First, two of the four salespeople on the team were producing consistently lower margins than the others. This highlighted the fact that these two salespeople were struggling to price jobs appropriately to generate the necessary margin. Through coaching and training, the company was able to elevate one salesperson to the level needed for consistently hitting the margins required, while the other salesperson was not willing to adjust to meet the requirements and is no longer with the company.

The realization that they had a sales team issue was not the only outcome of job-costing implementation. The company also realized they had certain types of projects that were consistently underperforming. These projects were in a specific industry and type of work that was regularly generating lower margins. Further research determined that the specialized labor needed for this type of work was too costly for the price set for these jobs. After much consideration and evaluation of more than 6 months of project margins, management discontinued that type of work.

In addition to implementing job-costing and fixing margins, the company also focused on what the numbers were telling them and used that data to drive business decisions. Management learned how to read financial statements, including not just the profit and loss statements, but job profitability reports and the balance sheet. They received timely and accurate financial reports every month. They analyzed those reports to glean insights into what was happening in the business, using that data to make meaningful decisions that moved the business forward.

By diving into the numbers and understanding the true story, over just 18 months, the company doubled their annual profit, while cutting 45% of its jobs and reducing revenue by $3.5 million.