While researching the “work in progress” topic online, we came across a number of different articles and blog posts that all seemed to have a very similar message: for construction companies that perform contract work, the Work In Progress report (WIP) is an essential financial tool. One article we read went so far as to describe the WIP as “the only accurate way to know what the true profitability” of a company performing contract work is.
Since the WIP is apparently such a vital element of construction accounting, we decided to take the opportunity to discuss Work in Progress further.
What Does Work In Progress (WIP) Mean?
The Work In Progress (WIP) report is an accounting schedule that’s a component of a company’s balance sheet. It’s calculated for each accounting period, and required (according to GaaP principles) on projects where the Percentage of Completion (POC) accounting method is used. Though the format of the WIP varies from company to company, it usually includes current period and project-to-date financial metrics that detail each contract that the company is working on (see Components of a WIP Schedule).
The goal of the WIP schedule is to have a financial reporting tool that shows if you are “over- or under-billed and cash positive or negative,” not only for each project,but when all of the individual project WIPs are taken together, for the entire company as a whole. If the WIP is done accurately and in a timely manner, it should also serve as an early indication or warning if and when a project appears to be heading over budget.
Why Is the WIP Important?
As we stated in the opening paragraph of this article, during our research we found no shortage of articles and blog posts stating just how important the WIP schedule is in construction accounting. One of the most persistent things we found regarding the importance of the WIP concerns the project stakeholders that pay the most attention to it (other than the owners and managers of the company itself). We’re talking about the “money guys,” the bankers and other lenders, the bonding agents, and the surety underwriters that may be involved on a project. These external parties have a vested interest in the construction company’s financial performance, since they have a risk exposure in the event that the company runs into trouble when a project goes sideways. And the primary and most reliable way that the money guys have to keep tabs on a company’s financial performance is by close examination of the WIP schedule.
Of course the collective concern of the money guys is second only to the owners and managers of the construction company itself. A well-run construction company will have accurate, up-to-date WIP schedules for each of the projects that they have in house, from the very beginning of a project when the contract is signed, until the very end when the last item on the punch list is done, the final invoice has been sent to the customer, and the final payment (which should hopefully include any withheld retainage!) is received. The owners and managers rely on these WIP schedules to get an accurate measure of exactly where they stand financially with regard to each project, and taking each project’s WIP schedule together, for the company as a whole.
Using the WIP to Your Advantage
Several of the zlien construction accounting articles (links above) have discussed the importance of change order management, and the significant financial problems that may occur if the change orders on a project get out of hand. The best-managed (and most profitable) construction companies use the WIP schedule to keep track of exactly where they stand with regard to the progress on a project, the project costs (both the actual costs that have been spent so far, as well as rigorously-calculated estimation of the total costs required to complete the project), and exactly how much of those costs remain. With this information, the company can get an accurate measure of the percentage of completion (POC), and, by looking at their billing, should be able to see if they are under- or overbilled and by how much. Knowing all of this financial information is imperative – we simply can’t state this enough.
As we discussed in the zlien article on overbilling, there is a natural, pragmatic tendency in the construction business to front-load, or overbill, towards the beginning of a project. Companies overbill to help offset the negative impact on cash flow caused by slow-paying customers (unfortunately a common occurrence in the construction industry). And of course, it’s always better to get your cash in hand sooner rather than later! As long as the company knows exactly the amount that the have overbilled on the job, and is practicing good cash management to cover the period towards the end of the project when they will inevitably be underbilling their customer, then they should be okay (though excessive overbilling can cause a whole new set of issues and complications that we won’t delve into here).
Last but not least, one of the most significant areas of improvement available to many construction companies is to simply do their accounting faster while making sure to record all of the costs and revenues in the correct accounting period. Don’t wait to send your invoices, and don’t let your day-to-day accounting tasks get out of hand!