If your business is profitable on paper but you're constantly scrambling for cash, the problem might not be your pricing or your expenses. You might simply not know which specific jobs are making you money and which ones are quietly draining it.
Job order costing fixes this by tracking every dollar of materials, labor, and overhead directly to individual projects. Instead of averaging costs across all your work, you assign expenses to specific jobs as they happen. This transforms profitability from educated guessing into hard numbers, giving custom builders, contractors, and service professionals the clarity to make smarter decisions about pricing, which projects to chase, and where their business actually grows.
In this article, you'll learn exactly how job order costing works, when to use it, and how to calculate true project costs using a clear formula. You'll also discover how to implement this system in your business without overhauling your current workflow, so you can start seeing which jobs actually deserve your time.
How Does Job Order Costing Work?
Job order costing assigns materials, labor, and overhead to individual projects as you work on them. Each project gets its own cost sheet that accumulates expenses in real time, so you always know what you've spent and what margin you're looking at.
Here's what makes something a "job" in this system: it's custom work that differs from project to project. A cabinet maker building a walnut bookshelf for one client and a pine entertainment center for another is running two distinct jobs. Same with a contractor renovating a kitchen versus adding a bathroom, or a marketing agency creating a brand campaign versus managing social media. Each gets its own tracking number.
The mechanics are straightforward. When you pull lumber for that walnut bookshelf, you charge those material costs to that specific job number. When your carpenter logs 15 hours building it, those labor costs get assigned to the same job. Overhead like shop rent and equipment depreciation gets allocated using a predetermined rate, usually based on labor hours or machine time.
Everything flows into a single cost sheet for that job. You can see costs building throughout the project rather than waiting until it's done. By the time you deliver the finished bookshelf, you know it cost $1,200 in materials, $600 in labor, and $300 in overhead. Total cost: $2,100. If you quoted $3,200, that's $1,100 in profit, a 52% markup. Those aren't estimates or averages. They're the actual numbers from that specific project.
This precision is why custom manufacturers, contractors, and service firms rely on job order costing. When no two projects look alike, you can't average your way to profitability. You need to know what each job actually costs.
What Are the Components of Job Order Costing?
Job order costing breaks every project into three cost categories: direct materials, direct labor, and manufacturing overhead. Each category captures different expenses, but they all flow into a single cost sheet that shows exactly what you spent to complete a specific job.
1. Direct Materials
Direct materials are the physical inputs that become part of the finished product. Lumber for a custom bookshelf, fabric for an upholstered chair, steel for a machine part. If you can point to it in the completed work, it's a direct material cost.
Tracking starts when you pull materials from inventory or receive a delivery for a specific job. You issue a material requisition that charges the exact cost to that project. A $1,200 lumber order for Job #347 gets recorded on Job #347's cost sheet immediately, not averaged across multiple projects. This precision matters because material costs often represent your largest expense, and tracking them accurately protects your margins before problems compound.
2. Direct Labor
Direct labor captures wages, payroll taxes, and benefits for anyone working directly on the project. Your carpenter building that bookshelf, your welder fabricating a bracket, your designer creating mockups. If they're hands-on with the deliverable, their time counts as direct labor.
Employees log hours against specific job numbers. When your lead carpenter clocks 20 hours on Job #347 at $30 per hour, that's $600 in direct labor. Add payroll taxes and benefits, and the true cost might hit $750. The key is daily tracking while the work is fresh. Trying to reconstruct who worked on what two weeks later creates guesswork that defeats the system.
3. Manufacturing Overhead
Manufacturing overhead includes production costs that keep your business running but can't be traced to a single job. Shop rent, equipment depreciation, utilities, insurance, maintenance. These expenses affect profitability, but you can't assign them to specific projects directly.
Instead, you allocate overhead using a predetermined rate. If you expect $120,000 in overhead and 6,000 direct labor hours this year, your rate is $20 per labor hour. A job using 30 labor hours gets assigned $600 in overhead. This approach keeps allocation consistent across all jobs without complex tracking. You're ensuring every project carries its share of the costs required to keep your doors open.
When Should You Use Job Order Costing?
You should use job order costing when each project involves unique specifications, different materials, and varying labor requirements. If no two orders look the same and you quote prices before work begins, this system gives you the clarity to price confidently and track profitability accurately.
The approach works best when you need to answer specific questions about your business: Which clients are actually profitable? Which types of projects should you chase more of? Where are you losing money without realizing it? Averaged costs across all your work can't answer these questions, but job-level tracking can.
How to Calculate Job Order Cost
Job order costing uses the straightforward formula below. Once you have that total, you can set your markup and see your actual margin before you ever submit a quote.
Direct Materials + Direct Labor + Applied Overhead = Total Job Cost.
Follow the steps below to calculate each component of a job order:
Calculate Direct Materials. Add up every material cost for the project. For a custom cabinet job, this includes lumber ($1,800), hardware ($400), and finish ($200). Total direct materials: $2,400.
Calculate Direct Labor. Multiply hours worked by your labor rate, then add payroll taxes and benefits. If your team logs 80 hours at $22 per hour, direct labor totals $1,760.
Apply Manufacturing Overhead. Use your predetermined overhead rate (typically per labor hour) and multiply by hours worked. At $12 per labor hour for 80 hours, applied overhead equals $960.
Add it all up. Add your materials ($2,400), labor ($1,760), and overhead ($960) to get your total project cost of $5,120. Now you can price with confidence. Target a 50% markup? Multiply by 1.5 and quote $7,680. That leaves $2,560 in gross profit, a 33% margin that actually shows up in your bank account.
Track every job this way and you'll stop guessing which projects pay the bills.
What Are the Advantages of Job Order Costing?
When every project has its own price tag, you can't afford guesswork. By tracing materials, labor, and overhead to individual jobs, this system shows you exactly where the money's made or lost.
The following are the key advantages of job order costing:
Accurate pricing and quoting. With each nail, billable hour, and kilowatt tied to a specific project, you build quotes on real numbers, not averages. This protects margins before work even starts and prevents the all-too-common scenario where you think you're profitable until you actually count what went into the job.
Clear profit signals. Side-by-side project reports reveal which work fattens your bottom line and which quietly drains it. You'll discover that the custom kitchen renovation you thought was your bread and butter actually barely breaks even, while those simple bathroom updates you take for granted consistently deliver strong margins.
Real-time cost monitoring. Flagging overruns early gives you room to course-correct rather than apologize later. When materials hit 80% of budget with 60% of work remaining, that's actionable intelligence, not an unpleasant surprise at project completion.
Data-driven growth decisions. Historical project data highlights high-margin work so you can double down on what works and ditch the rest. When costs roll up by customer, you can better understand profitability by customer, which may help inform decisions about loyalty perks or price adjustments.
Knowing your winners and losers at this level turns speculation into strategy. That's where real growth starts.
How to Implement Job Order Costing for Your Business
Setting up job order costing doesn't require overhauling your entire operation. These five steps build a framework that tracks costs accurately without adding unnecessary complexity to your workflow.
1. Define your cost categories
Split every expense into direct materials, direct labor, and manufacturing overhead. These three categories form the foundation that makes tracking reliable and consistent across all projects.
2. Calculate a realistic overhead rate
Total last year's indirect production costs and divide by your activity driver. Most businesses use projected labor hours. If overhead ran $120,000 and you expect 6,000 direct labor hours this year, your predetermined rate is $20 per labor hour. Apply this figure to each project so you're not guessing at the invisible costs that sink margins.
3. Create a clear job numbering system
Give every project its own unique identifier. That single code threads through purchase orders, time sheets, and invoices, preventing costs from drifting into the wrong bucket. Whether it's Job #347 or Project-Smith-Kitchen, consistency matters more than the format.
4. Set up tracking tools that fit your workflow
Use material requisition forms, digital time clocks, and project cost sheets, or invest in specialized software that ties them together automatically. The right tools save you from late-night spreadsheet sessions and reduce errors from manual entry.
5. Review and refine regularly
Compare estimated costs with actuals after each project. Investigate overruns, update your overhead rate as needed, and adjust processes that aren't working. Small course corrections compound into major profit gains over a full year.
Job Order Costing vs Process Costing
Job order costing tracks costs for individual custom projects, while process costing averages costs across large volumes of identical products. That single distinction determines which system fits your business.
You should use job order costing when each project has unique specifications. A custom furniture build costs different amounts in materials and labor than the next one. You need to know what each specific job costs to price accurately and protect margins.
You can use process costing if your operation produces identical units in continuous flows. Think cement manufacturers, cereal producers, or chemical plants. When you're making thousands of identical widgets, tracking individual unit costs is pointless. Instead, you pool all production expenses for a period, then divide by total units produced. If your department spent $50,000 making 10,000 units this month, each unit costs $5. Simple, dependable averages that work for mass production.
The deciding factor is product variation. Unique specs and small batches? Job order costing. High volume, uniform output? Process costing. Some businesses run both systems for different product lines, but never mix them on the same product.
Start Tracking Job Profitability Today
Job order costing shows you which projects build your business and which ones drain it. By tracking materials, labor, and overhead to specific jobs, you see real profitability instead of averages that mask the truth.
Start with one project. Record costs as they happen, compare the total to your invoice, and calculate the actual margin. That single data point changes how you quote the next job.
Now connect your costing clarity to cash flow control. With Relay's multiple checking accounts, park each job's revenue in its own account and use automated allocation rules to split money between materials, payroll, and profit. No midnight transfers, no accidental overspending on supplies that should be profit.
Relay is a financial technology company and is not an FDIC-insured bank. Banking services provided by Thread Bank, Member FDIC. FDIC deposit insurance covers the failure of an insured bank. Certain conditions must be satisfied for pass-through deposit insurance coverage to apply.
