Job Costing: Know Your Costs, Know Your Profits

Management
Job Costing: Know Your Costs, Know Your Profits

by: Mark Porter, Diemanic MIS

Summer, 2010

There is a simple equation in business that must be followed:

PROFIT = SALES – COSTS

If a business doesn’t know its costs, then how can it know its profits? In good economic times, companies must know their costs to maximize profitability. In tough economic times, they must know their costs to survive.

These days, understanding true costs is more important than ever. As competitors constantly lower prices to keep work in their plant, they put downward pressure on your prices. It can be difficult to know when to say, “No” and walk away from a job.

The simple truth is that if a business is not using job costing to determine the true costs for each job, then it will never know when a job doesn’t make sense from a cost standpoint. This affects overall profit. If the profit made from each of last year’s jobs was graphed, we would likely see a graph similar to the one below. Because the true costs of each job were not understood, the business simply took each job that was won. As a result, these jobs fall above and below the profitability line.

If the costs had been understood at the time of estimating the jobs, the orders that had no chance of being produced profitably could have been walked away from and more of the jobs would have fallen above the profit line. Job costing can help identify the type of work that can be done profitably, so the sales and production efforts can be focused on that type of work.

Job costing needs to encompass three areas:
1. Calculating the true costs.
2. Applying costs to the estimating process.
3. Monitoring and analyzing the costs on a continuous basis.

Calculating the True Costs
Costs associated with any job-oriented manufacturing business, of which the binding and finishing industries are members, require the monitoring of direct labor, direct materials, and the application of overhead costs (both factory and administrative). The direct labor and material are easy to calculate, but the overheads must be applied based on accounting principles associated with the direct labor hours or Activity Based Costing. Without accurate hourly rates that ensure all overhead costs have been encompassed, then job costing will be useless. Hourly rates can be calculated using either budgeted hourly rate software or an accountant. These hourly rates are not static. Adding or deleting a piece of equipment, adding a new shift, or changing the employee benefit package all can require a recalculation of hourly rates.

The job costing system also needs accurate production standards. Information such as run speeds and makeready times must reflect the times required to perform specific tasks. Most operators of bindery and finishing companies have a good handle on this information. With accurate cost rates for machines and speeds and times for processes, the costing system is ready for use (see Table 1).

Applying Costs to the Estimating Process
Estimating and selling are two different processes. This is probably the most misunderstood concept in the binding and finishing industries. Most companies use “sell” rates to produce estimates, rather than using costs and then marking up the estimate to reflect selling conditions. The advantage of using true costs in an estimate is that the business knows at the estimate stage if the job will make or lose money.

If the estimate states that it will cost $100 to produce this job, but also wants a 20 percent markup, the sell price is $120. This puts a business in a position to make a more educated selling decision if the customer says another company will do the job for $95. The business does not have to walk away from the job, but at least it knows it is paying $5 for the privilege of doing the work and that there’s no profit on the horizon (see Table 2).

Monitoring and Analyzing Costs on a Continuous Basis
Cost and production standards must be monitored and analyzed on a continuous basis. It is vital that businesses ensure that standards used for estimating accurately reflect the standards being achieved on the shop floor. It is of no value to estimate a machine as producing 5,000 pieces per hour if it is actually only achieving 4,000/hr – that loses money before the job comes through the door. Conversely, if a business is estimating at 4,000/hr and actually obtaining 5,000/hr on the shop floor, jobs are being lost that could be produced profitably.

To continually monitor costs, staff must record the time and materials used in the production of each job. This has several advantages. At the end of each job, an actual v. estimate comparison can be run that will show any differences in cost or production between the way the job was estimated and the way it actually ran. Any variances should be investigated and analyzed to determine if it is a change that needs to be accounted for or a one-time occurence.

Time can be collected via time sheets or shop floor data collection devices. The shop floor data collection devices have many benefits over the time sheets, but either method will work. Businesses must track every minute of each employee’s day – both chargeable and non- chargeable time.

There are many other benefits of collecting data for job costing, especially in the current economic conditions. Monitoring the time and material usage of all employees brings an increased level of accountability to the shop floor. Accountability leads to increased profitability and decreased waste. If a business has $2 million dollars in labor and material being processed in its plant each year, even a cost reduction of 5 percent can result in $100,000 savings.

The information collected can be used in other formats as well. Productivity can be analyzed to determine average speeds and makereadies. Average speeds being obtained by individual employees can be tracked, as can chargeable and non-chargeable times. If an employee has only 60 percent chargeable time, his role may need to be evaluated. A solid job costing system is critical in good times and essential in tough economic times.

Mark Porter is president of Dienamic MIS Software, Inc. Dienamic offers a wide variety of software products and services designed specifically for trade binderies and print finishers. Dienamic can offer full systems, including estimating/management information/e- commerce and individual software tools such as delivery management, die management, foil management, and budgeted hourly rates. For more information, call (800) 461-8114 or visit www.dienamicmis.com.