The Importance of Job Costing
If you are like most small and medium sized construction companies, you have been focused on growing your business by investing in new equipment, hiring new staff and networking to ensure you have the opportunity to bid on new contracts. But what you might not have considered is whether or not your job costing and financial reporting systems have kept pace with your growth. Such reporting requirements are critical to not only your lender but your bonding company as well.
As you grow and bid on larger contracts, your financial reporting will come under increased scrutiny. It is clear how this impacts your relationship with your lender – you submit your monthly or quarterly financial information and year-end financial statements and ensure that you are in compliance with the financial covenants. What your bonding company is reviewing might not be so obvious and it is critical that the reporting provided to your bonding company is consistent with your financial information.
The Importance of Your Financial Information
The primary difference between your lender’s needs and that of the bonding company is that the lender reviews your financial information to ensure there is adequate security for the amount borrowed, whether that be through equipment, inventory, receivables or personal guarantees. This can be accurately achieved by reviewing the company’s balance sheet at a point of time.
Your bonding company views your financial information differently. Their primary risk is managing your bonding limit by ensuring the costs to complete any jobs in process are within this limit. And that is where accurate job costing becomes so important. The reporting that you prepare for the bonding company relies on three key numbers:
- The project’s total billings (i.e. revenue)
- The project’s total costs (i.e. direct costs)
- Costs incurred during the period
From these amounts, both the projected margin for the project (revenue – direct costs) and the costs to complete (total costs – costs incurred to date) during the period are calculated. The accuracy of these numbers is always important but becomes critical when you have projects that span over multiple fiscal periods as this impacts the amount of revenue that can be recognized. For most construction companies, revenue is recognized using the percentage of completion method which allows for recognition of billings plus the gross margin based on the costs incurred to date over the total costs. Accurate job costing should be an integrated function and product of your financial reporting system but this is not always the case. If you are not able to reconcile your financial statement’s direct costs to your total project costs for a given period, you are not getting an accurate picture of your job costs.
Here are some key items to consider:
- Does the total project cost include an accurate overhead allocation and is that allocation consistently applied to the job as it is performed.
- Do you have the appropriate processes within accounts payable to ensure all invoices are job costed, particularly where certain costs need to be allocated amongst multiple jobs.
- Are standardized fees required to cost equipment usage amongst multiple jobs.
Your bonding company reviews your reporting to ensure that it can be reconciled to the financial statements that are produced. Therefore, it is a reconciliation that you must perform prior to submitting it to them. The more consistent and accurate these amounts are, the more confidence your bonding company will have which will allow you to pursue larger contracts and continue to grow your business.