Work In Progress - It's Not Just for Calculating Your Taxes

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,
3)  Costs-To-Date,
4)  Billed-To-Date. 

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.

Now you can project your gross profit on the job. By adding up the gross profits across all jobs you can evaluate where you stand against your budget. You can figure out whether you're still on target for the planned profits or starting to lag behind.

How To Set Up a Useful WIP
Open up a spreadsheet. Title the columns in accordance with the listed headers. Insert the formulas presented.

Although the spreadsheet will look rather long, you will notice that only two of the columns require a judgment call. Everything else is either pulled from a source (the estimate, proposal, or accounting system) or it is calculated. It should be fairly easy for your project managers to keep your WIP current.

Column A: Job Number

Column B: Job Title

Column C: Current Contract Amount
{Initial contract plus change orders}

Column D: Estimated Field Costs
{Initial budget plus change order}

Column E: Estimated Gross Profit
{Col. C minus Col. D}

Column F: Estimated Hours
{From initial budget plus change order work}

Column G: Hours Used To Date
{From payroll program}

Column H: Estimated % Complete of Work
{As determined by Project Manager}

Column I: Projected Total Hours
{Col. G divided by Col. H}

Column J: Projected Hours To Complete
{Col. I minus Col. G}

Column K: Material Cost to Date
{From accounting program}

Column L: Labor Cost to Date
{From payroll program}

Column M: Misc. Costs to Date
{From accounting program}

Column N: Total Costs to Date
{Add together Col. K, L, and M}

Column O: Projected Labor Cost to Complete
{Burdened labor rate times Col. J}

Column P: Remaining Material and Miscellaneous Costs
{Determined by Project Manager}

Column Q: Projected Cost to Complete
{Col. O plus Col. P}

Column R: Projected Final Cost
{Col. N plus Col. Q}

Column S: Estimated % of Costs Spent
{Col. N divided by Col. R}

Column T: Billed to Date
{From your accounting program}

Column U: Earned to Date
{Col. S times Col. C}

Column V: Over (Under) Billing
{Col. U minus Col. T}

Column X: Projected Gross Profit
{Col. C minus Col. R}

Column Y: Projected Gross Profit per Man-hour
{Col. X divided by Col. I}

Column Z: Budgeted Markup
{Original contract amount divided by original cost estimate}

Column AA: Projected Final Markup
{Col. C divided by Col. R}

Sometime in the future, we will explain the incredible amount of valuable information you can gleam from this spreadsheet. Some of it should immediately jump out at you.

At first glance, your newly formatted WIP will throw your banker, bond agent, and accountant for a loop. It's way different from what they're used to seeing. After you walk them through it, showing them that every piece of information they want is included, they will be impressed by the way you can project your financial performance.

Go ahead and create your new WIP spreadsheet and show your team how to fill it out. Then, demand that they do at least monthly. You may be amazed about how much easier it makes managing the financial performance of your business.

Ron Roberts teams with Guy Gruenberg as The Contractor's Business Coach. They show contractors how to grow their businesses profitably. To sign up for their FREE Newsletter or join their Private Club, visit www.FilthyRichContractor.com.

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