Cost Accounting – Case Study

“Pull out your checkbook”. “OK” the client responds. I continue, “Now write out a check for $200, and leave the ‘Pay to’ spot blank. The next time a customer for restoration work calls, get their name and address, write the name in the blank spot and send them the check. Give them a name of another restoration company and thank them for being a great customer”. The client looked at me as if I were an idiot.

“What are you saying?” he quips.

I continued by explaining to him that he was by far better off paying potential customers $200 each and send them to his competition than to continue in this industry. I further explained that because he lacked controls over the process, which included cost accounting and project management, he was in effect paying out a little over $400 per project than what he earned. And furthermore, I was saving him a lot of money!

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During that particular accounting year he completed just a little over 400 projects. When I received the books and went through them in detail, I calculated that he lost a little over $160,000 from this department/division. The way I figured it, I was saving him over $80,000 per year and I was providing the following benefits:

1. A whole lot less stress, no longer did he have to deal with those 400 customers
2. He could fire the entire restoration staff and not have to deal with the employee issues (calling in sick, destroying equipment, using the phones, and the back talk)
3. He would have a lot more time to enjoy his favorite hobby of fishing

It all started at the end of the year. I was a new accountant in the practice but I came from the restoration industry as a controller. I was well aware of the nuances of accounting for items in that industry. The client came in for his annual tax return and was feeling pretty proud of the growth in revenues he had achieved during the year. But he remarked how much he spent to get there and that overall he felt pretty good about the whole situation. However, he was concerned at the lack of cash available. He didn’t want to go to his personal resources or borrow money from the bank.

He had two divisions; one was a carpet cleaning division that gave him referrals to the restoration division. If a client had an insurance claim associated with water damage, he got the call. It meant very little marketing for him and a lot insurance paid work.  The checks never bounced and the best part was there was plenty of work. He voiced his concerns about the phone calls from customers in reference to getting the work done and some employee issues on the job sites. But overall, he was thrilled at the volume of revenues he had achieved.

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Well, to my surprise, he did keep decent records in QuickBooks but he didn’t exercise cost accounting principles. In effect, he booked the revenues in one group and the costs for the construction work in another account. He separated materials, labor, subcontractors, and supplies in the costs of goods sold section of the financial report. I was unable to match the cost of materials and subs to the respective jobs but in the aggregate he did spend a lot more than he earned.

He engaged my services and I did the following to help him (and these are in the order of importance):

1. Set up a job costing system in QuickBooks and taught the staff how to input the data, I built reports in summary format and in job detail format so the project managers could figure out where they spent more than what was estimated.
2. Set up a job numbering and phase numbering system so that onsite employees could key their time to a job and a function.
3. Sent out a letter to the subcontractors indicating how they were to invoice the company for their services and code their invoices to a job and the phase of work.
4. Reviewed the estimating program used by the project managers. I discovered that they were averse to detailing the jobs. This was the initial start of trouble. If the estimator failed to include shoe molding at the proper size and for adequate length then the client lost money. One of the keys was the lack of thinking the project all the way through. The project manager would record 6’ as the length, but he forgets that the supplier has them in 12’ lengths only. He would charge for 6’ and the client paid for 12’. This existed in almost all of the phases of the job. Imagine the shoe molding issue in a more costly area such as the flooring phase. Carpet layers charge a minimum even if the job is a very small area. The estimating software doesn’t look at the project that way. To compensate, the project estimator has to detail out the differences associated with those minimums in order for the insurance company to pay enough money to cover all the additional costs.
5. Looked at the transportation issues associated with the work crews. Too much time was spent traveling between jobs (due to a lack of materials on the job site) and therefore he was paying for labor to sit in a truck and smoke cigarettes between sites.  Not too efficient if you ask me.

About every 3 months for the first year, I would go into the office and review the status of jobs. I taught the project managers how to evaluate and key in on the cost elements of the work. They learned from the information how to get even more detailed in their estimates and the feedback loop made significant changes to the revenue and reduced the costs for the company. Within a year the client went from losing money to breaking even and he was learning how to evaluate the better jobs from the not so good ones. As time went on, he was rejecting certain jobs and allowing his competition to have those because the characteristics would match historical jobs with losses.

Within two years, he went from losing $180,000 per year to earning in excess of $200,000 net profit from this division alone. This was even after allocating overhead costs to this division and some of the owner’s salary to boot.

The key here is that not everything looks great on paper at first. Somebody has to dig into the details and discover why the operation is making or losing money. If your organization doesn’t have cost accounting, I encourage you to do this one step as it will identify where you are making money or losing money. Act on Knowledge.