As a contractor, adopting cost codes is crucial because they enable you to have better control over your project finances, track expenses more accurately, and make informed decisions about resource allocation and project budgets. By utilizing cost codes, you can improve your estimating accuracy, identify areas of profitability, and streamline your cost tracking processes. This ultimately leads to better overall business management and increased project success.
What are cost codes?
In construction, cost codes are used to track and categorize expenses & revenue related to specific activities or items on a construction project. These codes are typically alphanumeric and assigned to different cost categories, such as labor costs, materials, equipment, subcontractors, and overhead.
An example of a cost code for "painting" could be "PNT-001." This code would be used to track all costs related to painting activities on a construction project, such as the cost of paint, brushes, labor for painting, and any subcontractor fees. As a project progresses, each expense should be entered into a central location. Cost codes essentially allow you to "tag" each expense that gets entered to provide a detailed, organized picture of all costs once the project is completed.
Any given construction project may have a variety of material purchases, vendor payments & overhead expenses as the project progresses. Organizing these expenses into cost codes allows construction companies to easily track and analyze their costs, helping them make informed decisions about project budgets, resource allocation, and overall business management.
What are the benefits of using cost codes?
Accurate and Streamlined Cost Tracking
It doesn't take long for a project to accumulate a ton of expenses and receipts. If you aren't categorizing these costs in real-time using cost codes, it can quickly become overwhelming and difficult to track and analyze your project expenses. Cost codes provide a systematic way of organizing and categorizing expenses, making it easier to track costs accurately and in real-time. This allows you to have better control over your project budget and prevent any unexpected surprises.
Save time and increase the accuracy of your estimates.
A majority of contractors and construction businesses will estimate or quote projects by:
- Breaking up the project into trades or categories (for example, 'flooring' or 'kitchen remodel')
- Assigning internal costs to each trade/category by determining what they expect to spend on materials, subcontracts, and employee time.
- Applying a % markup to the entire project, or by category/trade
It can be time-consuming and tedious to nail down the exact internal costs associated with each task and therefore, many contractors may rely on rough estimates or guesswork. By assigning each expense to a cost code, you can truly learn how accurate you are in your estimates and make adjustments as necessary. This allows for more precise project budgeting and helps avoid unexpected costs or overruns for future projects.
At the beginning of a job, it's strongly recommended to list out your expected costs in a budget. This enables you to track actual costs against your estimate as you accumulate subcontracts, purchase orders, labor costs, and various expenses.
Easy identification of profitable activities
Cost codes provide a clear breakdown of expenses related to specific activities or items on a project. This allows construction companies to analyze their costs at a granular level and identify areas where they can reduce spending, improve efficiency, or negotiate better deals with vendors. You're also able to pinpoint activities that are the most profitable. We've seen countless examples of construction businesses determining which trades/activities should be moved in-house versus completed by subcontractors or vendors.
Creating your cost-code library
A commonly used set of cost codes in commercial construction are the MasterFormat® (CSI Codes).
It's a list of categories developed by the Construction Specifications Institute. It's incredibly comprehensive and has a tiered hierarchy of categories. The list may not work for each business and you should be customizing your cost-code library to your business. If you incorporate too many cost codes, you run the risk of misalignment across your organization - it may become confusing and difficult to track expenses consistently. On the other hand, if you have too few cost codes, it may be challenging to gain a detailed understanding of your project costs.
Fill out your email here for a free list of boilerplate, standard construction cost codes you can start using (these cost codes are designed for general contractors and homebuilders).
It's best to initially identify how you'd like your expenses to be categorized. You can start by creating a budget for a specific project, and then breaking down the different tasks and activities involved. From there, you can assign cost codes to each expense category based on your company's specific activities.
As your business evolves and new projects arise, it's important to regularly review and update your cost codes to ensure all expenses are being accounted for, and to avoid too many expenses landing in the "miscellaneous costs" pile.
If you vary between in-house and subcontracted labor, you may want to tag each cost code with an additional letter, to indicate if the expense is:
- Labor
- Vendor
- Material purchase
- Other/Fee
This cost code structure can provide additional insights to your team to improve decision-making & estimating accuracy.
Training your team
If your team, from project manager to bookkeeper to field associate, isn't properly trained on how to use cost codes, it can lead to confusion and mistakes in tracking expenses. It's important to provide thorough training on the purpose and usage of cost codes, as well as any specific guidelines or procedures your company has in place. It's also best practice to avoid having two very similar cost codes - it will inevitably lead to members mis-categorizing expenses. This will ensure that everyone is on the same page and able to accurately assign expenses to the appropriate cost codes.
It's best to provide a list of codes and their respective definitions/use cases to each teammate who is making or managing payments or invoices.
Upload your cost code library to your accounting or payment software
In general, we highly encourage construction businesses to use some sort of accounting software to ensure that there is 1 central location for expenses & costs. It will also save you a ton of time come tax season. (If you're interested, Beam provides financial software designed for construction businesses).
Your accounting or payment software should enable you to categorize expenses using cost codes. By uploading your customized cost code library into the software, you can streamline the process of assigning expenses to the appropriate codes. This not only makes it easier to track and analyze costs but also ensures consistency across your organization. Admittedly, a majority of accounting software is not built for construction. It may not have progress invoicing, change order management, etc. If you're interested in an add-on on top of your accounting software, check out Beam.