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Estimates vs Actual Costs: Do You Have an Early Warning System?

Estimates vs Actual Costs: Do You Have an Early Warning System?

 

Estimates vs Actual Costs: Do You Have an Early Warning System?

With the constant threat of load shedding, fuel hikes and many other escalating costs to contend with, businesses have to keep on top of their estimates to minimise any loss. In this piece, we’ll give you a clear idea of how estimates and actual costs can differ, and how to manage this so your business doesn’t suffer.

What Is an Actual Cost?

This is simply the actual amount you pay for a product or service recorded in the accounting books. It will include the cost for an entire project such as labour, materials and any other miscellaneous expenses.

What Is a Cost Estimate?

When compiling a cost estimate, you will gather the standard cost related to items such as labour and materials to provide an estimate for a project. This is a highly flexible number as various circumstances will come into play here that could impact the actual cost.

Factors that impact your job costing:

  • Clearly outlining the tasks of the project;
  • The availability of updated and valid data;
  • Provisioning for any uncertainties;
  • A broad participation in preparing the estimates;
  • An independent review of estimates;
  • Taking inflation into account;
  • Standardising all the structures for estimates;
  • Considering possible excluded costs; and
  • The review of estimates for any major project change.

What Are the Key Differences Between Estimates and Actual Costs?

1. Variance

This is literally the difference in amount between the estimation and the actual cost of a job – you want a favourable variance where the actual cost is lower than the estimate, rather than the other way around.

2. Financial statements

The estimated costs include the net sales amount and remain separate from the financial statements whereas the actual cost will be a separate entry in the statements.

3. Inventory value

Job costing will value inventory at a pre-established price with variances added to the product costs, whereas actual costs show the final production cost.

Tips for accurate cost estimation

Minimising variance is key to costing, which is why you want to get it right the first time. Here are a few tips to consider before we look at the actual techniques involved in cost estimation.

1. Define the purpose: Figure out how much detail is required and who the estimate is intended for.
2. Develop a plan: Get your cost-estimating team, outline your approach and timeline before assigning relevant tasks.
3. Figure out the characteristics: Create your baseline description such as system configurations, schedules and strategies.
4. Determine your approach: What’s your work breakdown structure and estimating method for this?
5. Rule and assumptions: Know what will be excluded from the estimate.
6. Data collection: How will this be done and how will the cost drivers be identified?
7. The point estimate: Create a cost model by estimating the work breakdown structure.
8. Sensitivity analysis: Determine the sensitivity of your costs to changes in estimations.
9. Risk and uncertainty analysis: All the risks associated with each item and management techniques.
10. Document: Keep every step of the estimation documented.
11. Presentation: The estimate should be presented to necessary stakeholders for approval.
12. Updates: Changes to the estimate must be updated and reported on, with notes taken for future projects.

Techniques for Cost Estimation

Now you have a firm grasp of the steps involved in getting to and implementing a cost estimate, here’s a guide to some of the techniques currently used for the most accurate costing.

– Statistical Modelling

This estimation technique relies on historical data to calculate projected costs, including the changing of any project elements.

– Analogous Estimating

Experts who’ve worked on such projects previously can assist you in creating cost estimates, particularly for the early project stages.

– Three-point Estimating

This is where you consider three scenarios when estimating; most likely, optimistic and pessimistic ranges.

– Bottom-up Estimating

This is where you estimate every individual task and tally them for the project cost.

– Reserve Analysis

This determines how much contingency reserve is needed to avoid any uncertainty.

– Digital Tools

One of the most useful tools for accurate cost projection to prevent inaccuracies is implementing relevant job costing software. This will incorporate the aforementioned techniques to facilitate the entire process while tracking the costs as the project continues.

What Are the Benefits of Using Job Costing Software?

There are many reasons why industries across the board are implementing job costing software to decrease the variance between estimates and actual costs.

– Cost Comparisons

Reputable job costing software will allow you to import prices from your suppliers and compare them with others, as well as amend quantities where needed.

– Storage and Tracking Information

Cost tracking software can store all the relevant data in one central database so that you can easily access details related to pricing without duplicating and mislaying files.

– Easy Recalculations

There are always changes to project costing as quantities or prices change, and performing this manually is not only time-consuming but high in risk. With job costing software, you’re minimising hassle and risk. In fact, the right software will automatically adjust all relevant areas so there is no room for error.

– Monitor Construction Costs

For those in the construction industry, job costing software is suited to preparing bids, calculating prices and quantities. It is also suited to monitoring any changes to cost estimates once the project is underway. This means keeping on top of project costs at all times.

– Technological Integration

This particular cost estimating software should be able to communicate with your other project management applications including accounting and management tools. This gives you the freedom to collaborate with all stakeholders so everyone is constantly on the same page.

– Scalability

Your job costing software should be scalable so that, no matter the size of your business, the software should suit your operating needs. This means anything from an advertising agency to a complex manufacturing industry should be able to rely on the software.

– Determine Profitability

Because the software allows you to assign separate costs to individual operations, you can calculate the profit margin for each specific product so you can make informed business decisions.

– Assess Performance

Your great job costing software will allow you to monitor not only the progress of the project but also the performance of your employees in every department. This provides valuable insight for performance evaluations at a later stage.

– Increased Accuracy

A quality job estimation tool will ensure complete accuracy throughout the project. This will ensure complete accuracy by calculating direct and indirect costs, and keeping track of all project changes every step of the way.

What to Look For in Job Costing Software

When choosing the right job estimation software for your business, there are a few things you’ll want to consider before investing. These are:

Depth of features: If you require more than simply comparing estimates with actual costs, then check the level of features your software provides. You might need to assign budgets and costs to activities as well.

Industry-specific: Generic software will often be cheaper but you might require something that is more industry-specific for construction, manufacture and the like.

Customer support: Most of us would prefer to have quick and comprehensive customer support, so check what your provider can assist you with in terms of training and ongoing assistance and support.

Report templates: Even with an entry-level system, check the software has basic templates that can convert your data into an easy-to-understand format.

Scalability: Anticipate business growth which means investing in a system with sufficient scalability. This allows you to take on new employees and contracts where needed.

When it comes to the top choice in job costing software, it’s best to work with Omni Accounts. These tools will allow you to manage costs accurately including labour, buy-out, stock usage and outwork costs. You can also plan raw material requirements, analyse actual costs against job estimates, determine the value of the work at all times and create additional job costing where needed.

Contact Omni Accounts today to find out more!