Understanding Cost Categories in Construction

Now that you've learned what job costing is and why it's important for your business, the road to organizing your costs begins with understanding the structure for categorizing them. These are called cost categories.

What are cost categories?

As we mentioned in Chapter 1, cost categories are divisions in which individual cost codes exist. The category is often called the “parent,” and the code is called the “child.” This relationship is important in understanding the need for codes to exist within a category. 

To help illustrate, imagine a child with step-parents and birth parents. If that child asked you to call their mother, you would need more information to know which of the two mothers that child is referring to. Using this as an example, each parent would be a separate category, and the child would be a single code belonging to each of them.

In a similar way, a cost code, such as labor, can have multiple parents. So if you’re trying to isolate high labor costs, you’ll want to know which category (or parent) it belongs to. 

How to determine which costs to categorize

Cost categories primarily facilitate budgeting, forecasting, cost control, and analysis by grouping the many expenses that arise in construction. These categories often are made up of direct costs, indirect costs, and overhead costs.

Direct costs

These are costs directly attributed to the physical construction process. They typically include labor, materials, and equipment and can be easily tracked and quantified. Examples of direct costs include wages paid to workers, equipment rentals, and purchasing raw building materials.

Indirect costs

Indirect costs, also known as soft costs, are expenses not directly tied to the hands-on construction work but vital to project completion. They include architectural and engineering services, legal and permitting fees, project management fees, and contingency reserves. Indirect costs can be more challenging to predict and manage as they depend on external factors such as market fluctuations, regulatory compliance, or unforeseen issues.

Overhead costs

Overhead covers the general operational and administrative expenses of running a construction business. These costs are associated with maintaining the organization, including office space, utilities, insurance, software, and staff management expenses. Overhead is essential for ensuring the smooth functioning of the company and supporting ongoing construction projects.

In addition to these primary categories, cost categories in construction can also be tailored to specific industries or project types depending on the unique operating environments, materials, or specialized labor required.

What are the most common cost categories?

While there are no hard and fast rules on which categories you create, many people follow the MasterFormat from Construction Specifications Institute (CSI), which is based on 16 Divisions for organizing specifications, costs, and other written information for commercial and institutional building projects in the U.S. and Canada.

These widely used standard categories are: 

• Division 01 — General Requirement
• Division 02 — Existing Conditions
• Division 03 — Concrete
• Division 04 — Masonry
• Division 05 — Metals
• Division 06 — Wood and Plastics
• Division 07 — Thermal and Moisture Protection
• Division 08 — Doors and Windows
• Division 09 — Finishes
• Division 10 — Specialties
• Division 11 — Equipment
• Division 12 — Furnishings
• Division 13 — Special Construction
• Division 14 — Conveying Systems
• Division 15 — Mechanical/Plumbing
• Division 16 — Electrical

Understanding the cost category structure

If you’re following the industry standards, each division is categorized by both a two digit number and a name. For example, the first division is referred to as 01 numerically and as General Requirements topically. 

With cost codes included, the numeric identification of each cost driver consists of five digits, two for the category and three for the code. The convention allows for numerical alignment and differentiates similar costs within separate categories. 

Here is a simple example: 

Cost Category: 03 Concrete

Cost: 000 General Labor

Cost Code: 03-000

Since labor is a common cost and associated with nearly every division, you can see how the structure helps provide better clarity with your finances. 

How can you create cost categories?

Creating cost categories doesn’t have to be complicated, and you don’t have to follow any standard conventions in order to do it. You can start by simply evaluating your previous project costs and entering them in a spreadsheet or on your notepad. This will help you understand spending patterns, common project costs, and any holes you have in your financials. 

Then, you can realize when making new budgets which aspects need more control, like the cost of materials. Once you’ve gathered your past costs, you can begin to group them into categories that you create from scratch or by following the MasterFormat. 

If you want to give yourself a head start, download our free job costing template, or better yet, consider utilizing construction software that offers a job costing system, such as BuildBook.

Creating cost codes

Now that you have a solid understanding of cost categories, you are well on your way to managing your costs! Utilizing cost categories is the first step in maintaining critical visibility and control of your operational costs. 

In the next chapter, we go one layer deeper and talk about cost codes - what they are, why they are beneficial, and how you create them.