Maintaining profits and keeping jobs on track is not easy in the construction industry. There are bills to pay, materials to order, teams to manage, and everything else in between. That’s why you need accurate, real-time Work in Progress (WIP) reports to keep projects running smoothly—and to grow your bottom-line profit.
So, how does it all work? We’ll deep-dive into all there is to know about WIP reporting and how you can set your projects and business up for success.
WHAT IS WORK IN PROGRESS (WIP)?
Work in Progress (WIP) is an essential part of construction/ manufacture accounting. It calculates the progress of all ongoing work, allowing you to see what’s been done and what’s left to do—helping you manage budgets effectively. This information can then be used to generate reports and track project development using “percentage complete” figures.
If, for example, a WIP report shows that a project is 30% complete but has used up 70% of its budget, you can likely predict it’ll go over budget. As such, this encourages a more proactive than reactive approach to project management allowing companies to take action before it is too late.
In addition, WIP reporting enables you to create accurate financial statements, outlining exactly what was spent on individual projects and where. This can then be used to inform wider decision-making, especially concerning the business’s overall financial health and growing bottom-line profits.
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HOW TO CALCULATE WORK IN PROGRESS
Calculating WIP allows you to see whether a project has been over or underbilled.
Overbilling happens when you’ve charged more than needed for the work completed. While this can positively impact cash flow, it could also mean that the work is being completed slower than expected, rather than just being billed in advance. It may also leave contractors out of pocket further down the line if they’re unable to finance jobs later in the project.
Underbilling occurs when contractors bill for less money than what was earned for the work completed to date. This can be problematic for negative cash flow and can leave you in charge of financing the rest of the project.
In order to calculate whether a project is over or underbilled, you’ll need to know the projected cost at completion or revised estimate. Once you calculate your projected cost you can calculate the percentage of work completed to date and the earned revenue to date.
The percentage of work completed relies on a simple calculation of the actual costs to date divided by the revised estimated costs.
You can then use the percentage of project completed figure to calculate the earned revenue, multiplying it by the total estimated profit.
(Contract Amount minus Revised Estimated Costs equals estimated profit).
You can then calculate the over under billing by subtracting the earned revenue to date from the (total amount billed minus the total cost to date).
WHAT SHOULD A WIP REPORT INCLUDE?
So, we know that WIP reports show a construction project’s status, but what information do you need? Generally, WIP reports should include:
HOW OFTEN SHOULD YOU RUN A WIP REPORT?
In terms of how often you need to run WIP, it all depends on your business goals. If you run regular financial reports and have a lot of ongoing projects, you may decide to create WIP reports monthly or weekly. Other businesses may opt for quarterly WIP reports, while some only run them at the end of projects. However, if you run a WIP report based off of the previous week or month’s data, your decisions are already a week or month behind actual costs—giving you the inability to make critical decisions in a time-sensitive matter. It’s best practice to create a company-wide WIP report and a WIP report for each job to give you greater oversight of the well-being of your company as a whole, and of individual project progress.
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Case Study: Effective Use of the WIP Accounting in Construction
Let’s explore a case study that exemplifies the interconnection between WIP accounting practices and the utilization of a WIP schedule in construction.
Concrete Crew, a concrete subcontractor, implements WIP accounting as an integral component of their financial management system. The firm generates a WIP schedule monthly, which aligns with their payment application cycle, a practice that reflects industry-standard WIP accounting principles.
Using WIP accounting standards, Concrete Crew meticulously records and tracks the direct costs of materials, labor, and overhead attributable to their projects, Job A and Job B. They recognize these costs as they are incurred, consistent with the accrual basis of accounting, which is also fundamental to WIP accounting. This approach allows for matching the revenue earned with the expenses incurred during the same period, providing a more accurate picture of project profitability.
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Concrete Crew’s WIP schedule offers a detailed view of project-specific financials, reporting on the status of their construction contracts (Job A and Job B) and the percentage of completion.
Job A: As per the WIP report, Job A has a revised budget of $100 and a revised contract amount of $150. With a job-to-date (JTD) cost of $80 and a completion percentage of 80%, the earned revenue is $120. However, billing to date is only $75, resulting in an underbilling of $45. This discrepancy indicates that, while the work has been nearly completed, the billing has lagged. The schedule notes a forthcoming change order, which stalls further billing until November, affecting cash flow management. The inability to bill until then can strain the company’s liquidity, emphasizing the need to navigate through this period without compromising of business financial stability.
Job B: Similar to Job A, Job B also shows a revised budget and contract amount of $100 and $150. The job is also 80% complete, with an earned revenue of $120. The billed amount to date is $125, indicating an overbilling of $5. In the WIP report, Concrete Crew notes that the project is on hold until Spring 2024, and the billing status will remain as is for the time being.
Concrete Crew’s application of WIP accounting, reflected in their monthly WIP schedule, serves as a vital instrument for fiscal oversight and strategic financial planning. It helps the business to identify and adjust to underbilling and overbilling situations, thereby securing cash flow and preserving client relationships.
For Job A, the impending change order necessitates a careful reassessment of the project budget and timeline. For Job B, managing the overbilling requires communication and transparency with the client to ensure that when the project restarts, the financial reconciliation aligns with the client’s expectations and the contract stipulations.
This example underscores the importance of an effective and accurate WIP schedule in providing transparency, fostering client trust, and ensuring the financial agility of construction firms. It also highlights the significance of proactive financial management in dealing with the ebbs and flows of project lifecycles, ultimately ensuring that companies maintain a steady cash flow, adhere to contractual obligations, and sustain long-term client relationships.
COMMON WIP REPORT MISTAKES TO AVOID
WIP reports are only reliable when used correctly. It’s easy to simply compare the total costs spent to date with your estimated budget and assume that a project is running smoothly if your cost spent to date has not exceeded your budget. But, using multiple calculations, you can see a more accurate picture of a project of where the job stands, including if it’s been over or underbilled.
For instance, you may assume that a project is 60% complete simply by comparing the costs to date with your estimated budget. But the percentage spent doesn’t mean the percentage complete. While you may have spent 60% of your budget, the work could be only 40% finished.
Keeping on top of your WIP report using multiple calculation methods is therefore crucial for accurately scoping projects. This allows you to identify potential problems early, such as chasing invoices for payments or re-evaluating budgets where costs are adding up.
Here are some other WIP pitfalls to avoid:
- Not tracking committed costs: Committed costs are those you are committed to paying, such as employee wages or material or subcontract costs that you have committed to with a purchase order or subcontract agreement. These need to be accurately tracked to ensure your project remains profitable and the WIP report is accurate.
- Entering figures incorrectly: It’s easy to miss an extra zero or enter a “4” rather than a “5.” Incorrect figures caused by human error can greatly impact the WIP data and subsequent calculations.
- Not running regular WIP reports: WIP reports need to be created regularly to keep up to date with the progress of jobs and ensure they run efficiently. Otherwise, budgets may be exhausted before you even have a chance to rectify the issue.
- Using overbilling as profit: Overbilling is not profit; it’s cash flow to be used for future scheduled work. If businesses use this for a profit, it may leave projects without funds to continue.
- Not linking the WIP with P&L statements: Using WIP reports allows you to identify over and underbilling amounts. These must be reflected in the business’s profit and loss statement and balance sheet to provide an accurate snapshot of its financial health.
- Delayed tracking of expenses and costs: Tracking expenses and costs in real-time makes your WIP more accurate. Otherwise, the budget may show a profit, but you’re forgetting to account for expensive bills that haven’t been added yet.