A business raking in money can still go belly up if its costs are too high. To control costs, you have to know how much your company spends. Two methods manufacturers use to track spending are process costing and job order costing.
Job Order Costing
Some manufacturers mass produce hundreds or even thousands of units for sale in a short period. Other companies focus on making fewer, pricier items. It's the difference between, say, creating custom furniture and mass-manufacturing identical plastic chairs. Or specialized, tailored computers versus generic laptops.
Job order costing works best for the custom-made, individualized end of the market. It's simple and logical: add up the cost of the labor involved in working on one item, plus the cost of the component parts. Suppose, for example, that you're installing 30 square feet of custom marble countertop that costs you $60 per-square-foot. You have $900 in material costs, plus the cost of the labor to install the counters.
On top of that, you add in overhead for expenses other than parts and labor:
- Administrative salaries
If you have $200,000 in overhead and you do 50 custom-countertop projects a year, that would be $4,000 overhead allocated to each job. You can also use other methods to break down overhead, such as costs per labor hour.
The total cost for each project is the job order cost. You can use that figure to figure out whether you're charging the customer enough to cover overhead, or to track which projects pay for themselves and which don't pull their weight.
Some projects involve a series of individual items, for example, six custom computers for one customer. To get the job order cost you'd figure out the total cost and divide by six.
Companies use process costing for production runs with lots of units, none of them distinctive from one another. When a factory makes medicines, for instance, one bottle of pills is no different from the next.
For example, imagine a refinery that makes a million gallons of gasoline a month. There's no point to job order costing each gallon of gas. That's a lot of extra paperwork for a million identical items. Instead, add up the total costs of the oil used to make the gas, the labor in the facility over the entire month and the overhead. That gives you the process cost, which you can divide by 1 million to get the cost per unit.
Process costing is simpler to track than job order costing. But because it goes for the big picture rather than the details, it's easier to miss figures or costs that job order costing would have turned up.