If you don't recognize the term WIP, join the crowd. WIP stands for Work-In-Progress.
WIP confuses most people - mainly because, as it is used by accountants and bankers, it has minimal relevance to the management of your business.
Before diving in, a word of warning: this article may not apply to you. If your projects typically run a month or more, pull out a pen and take notes. If not, put this article aside and move on to more important or enjoyable pursuits.
Today, we're going to explain how to transform your WIP report into a valuable financial management tool. If cost control and income predictability are of interest to you, keep reading.
To get us started, I ventured over to Wikipedia.org to see what it had to say about WIP. It offered up the following, which isn't far off the mark:
WIP identifies the value of construction projects which are currently being worked on by the construction firm. In order to properly account for each project, FOUR values are needed for each project at the end of any given month (or period):
1) Sales Price (excluding sales tax) for the project,
2) Total Cost Estimate for the project,
By taking the Costs-To-Date divided by the Cost Estimate, the "percentage complete" for the project is calculated. For example:
* Assume a project is estimated to cost $70,000 by the time the work is complete
* Assume at the end of December, $35,000 has been spent to date for the project
* $35,000 divided by $70,000 is 50%, therefore, the project can be considered 50% complete at December 31.
Calculation of the Percentage complete is a valuable tool in determining how much the client should be billed - it is important that Billings, and even collection of these billings, are greater than the costs expended to do the work. This ensures that the client is directly funding the construction work, and that the contracting firm minimizes borrowing on behalf of the client. Using the example above, suppose the following:
A) The Sales Price of the project is $100,000
B) $100,000 times 50% (the level of completion) = $50,000
Therefore, for the period ending December 31, the client should be invoiced at least $50,000 in order to properly fund the work.
Not a bad effort for a free website. Wikipeida pretty well sums up the accountants' take on WIP. Notice that the "percentage complete" is financially based.
From your banker's perspective, the WIP report highlights whether you have over-billed your projects and thereby might start losing money as the project draws to a close. The intent is to provide your lenders and insurers with a conservative view of your ability to pay back your loans, pay your vendors, and pay your premiums.
Looking back at the example from Wikipedia, you will notice that it didn't mention adjusting your Cost-To-Complete as you move through a project. The truth is that you ARE supposed to do just that. And that is where you can transform your WIP report from a nearly meaningless accounting report into a valuable financial management tool.
With the WIP report we're going to show you how to create you will end up with two percent completes. The first is the Percent of Work Complete, based on labor productivity, and the second is the Percent of Costs Spent.
The latter is used to calculate your over-billing or under-billing. The former is the one that tells you how well your project is doing.
If you monitor your crews' productivity on the job, you should be able to accurately project the hours they will need to complete the project. Dividing the hours used by the total hours projected for the job gives you the real percent complete of the job. This has been explained in previous newsletters.