Part two in a 2023 series from Deltek
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 electrical business up for success.
What is Work in Progress?
Work in Progress (WIP) is an essential part of construction 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 how much revenue should be recognized for each project. This can then be used to inform wider decision-making, especially concerning the business’s overall financial health and growing bottom-line profits.
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 billed for more than 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 spend these overbillings as if they are profit and then are unable to finance the remainder of the project.
Underbilling occurs when contractors bill for less money than what was earned for the work completed to date. This can be problematic and lead to negative cash flow and can leave you in charge of financing this part 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 the 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 work 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 underbilling 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 project’s status, but what information do you need? Generally, WIP reports should include:
- The total current value of the contract
- The total original estimated costs
- Revised estimated costs
- The total costs to date
- The amount of revenue earned to date
- The amount billed to date
- Percentage completion of the project
- Whether a project is currently over or underbilled
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 bi-weekly or weekly. Other businesses may opt for monthly WIP reports. While some only run them at the end of the year, or when asked to by an outside agency such as the bank or surety underwriter, it is recommended that they be run at least monthly to support your monthly financial statements. The WIP report should be based off of current data and not data that is weeks old, giving you the ability to make critical decisions in a time-sensitive matter. It is a 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.
WIP Calculation Methods
The key component of the WIP report is the projected cost which is needed to calculate the percent complete. The percent of budget spent is very rarely an indicator of the actual percent of work completed so rather than use the percent of budget spent as the percent of work completed many businesses use additional methods to calculate their projected cost when creating their WIP report. The three methods most commonly used to calculate the projected cost are estimating the percent complete to date, using units completed to date, or estimating the cost to finish.
Here’s a breakdown of the most commonly used WIP calculation methods:
- Percentage complete: Track progress using the estimated percent complete to calculate the revised total estimated cost.
- Units complete: Compare the number of units completed with the total amount of units budgeted to calculate the percent complete and then use the percent complete to calculate the revised estimate.
- Cost-to-finish: Add the total amount spent to date to the estimated cost to finish to calculate your revised budget.
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 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 poor labor production or reevaluating 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 for labor that has been performed but not paid for yet 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.
Construction Accounting Software and Training
As your electrical contracting business grows, construction accounting software can support you to proactively manage jobs, obtain financial assistance (loans, performance bonds, lines of credit, etc.), maintain a strong cash position, and stay compliant. Free construction accounting training is offered by Deltek ComputerEase through Construction Accounting University. Visit https://info.deltek.com/construction-accounting-university to register.
John Meibers and Deltek ComputerEase are bringing an educational series designed to guide electrical contractors through the transformation from standard accounting methods to construction accounting methods. Upcoming topics include job costing, construction payroll and revenue recognition. You can see the first article in the series, The Basics of Construction Accounting, in the January / February 2023 issue of Insights.