WIP (Work in Progress): Is It a History Lesson or a Strategic Tool?
When you look at your work in progress (WIP) schedule, what do you see? Do you see a history lesson? Or do you see a strategic tool?
This is a conversation we routinely have with our construction contractor clients, whether we are assisting with compliance (preparing tax returns and financial statements) or with discovering and selecting their construction accounting and project management systems.
Do you know that your WIP isn’t – and shouldn’t – only be a history lesson?
Today’s leading contractors are viewing their WIP as a strategic tool – a planning tool – and a tool for analyzing, and using, the best accounting methods for their business.
As in a tool to affect the score, not just report the score.
Your WIP is more than just a report that helps you review job status with your project managers and find out if you (and they) are happy or sad about how your jobs are doing. However, that is how most contractors use the WIP. The owner, the controller or CFO, and the project managers meet to go over their WIP spreadsheet, or they review a digital report if they are managing it in their ERP system. Then they go through the jobs to learn why they are making or losing money.
The truth is that your WIP shouldn’t just be a history lesson — it should be so much more. Today’s leading contractors view their WIP schedule as a strategic tool — a planning tool — and a critical component of their business’s accounting method.
In other words, it’s a tool that doesn’t just report the score, it affects the score. It does so by helping you analyze and implement methods of accounting for your business that will help you minimize your tax liabilities while also maximizing the strength of your financial statement.
The correct method, or methods, are particular to your business, the types of jobs you do, your cash position and, perhaps most importantly, where you want your company to land when you file tax returns and produce financial statements.
Hopefully there are no surprises when you get to that point. Sure, there will be times when something happens on a job that leads to a more positive or negative position. However, outside of these instances, as you meet to discuss the WIP, there should not be a big reveal about whether the job is making or losing money. Tracking the job from inception to completion with your team and the help of your ERP system should take a lot of the guesswork out of the equation.
Most WIP schedules follow what is known as the cost-to-cost me¬thod. This is a generic type of percentage of completion method in which the revenue you earn is simply a metric of costs incurred to date, divided by estimated total costs at completion. This seems simple enough, but the question we receive quite often is, “What are my actual costs? Direct materials, labor, subcontracting, and equipment rental are simple to account for, but what about insurance, depreciation, and indirect labor? These costs could be significant. If you don’t account for them correctly, then the score you derived above will be incorrect.
This is where the right team, both internal and external, along with the right ERP software come into play. Company leaders often say, “I don’t get it — I am putting a WIP schedule together and every job is making 15%, but my bank account is going down every month.” If your “indirect” costs account for 20% of your total cost of revenues and you have not accounted for that in the equation above, then the positive 15% margin you thought you had is actually a loss of 5%. That is why it is very important that you understand your indirect overhead and have the means to control that figure.
Cash basis and completed contract methods are also commonly used, mainly for tax purposes. Cash basis is relatively simple: You recognize the cash you take in versus cash you’ve expended. Note that in the cost-to-cost method described above, the word “billing” was never used. That’s because what you bill, or collect, has no impact on revenue and therefore, no impact on income. The completed contract method is also quite simple because you don’t report income or expenses until the job is complete. That sounds simple but if you have a contract that extends multiple years, it’s tough not to show how that job is progressing until the final year. Users of financial information tend to be wary of both methods. As a result, the cost-to-cost method is preferred.