Construction work in progress (WIP) is a necessary accounting strategy used over long-term projects. But it’s so much more than getting paid for a project. Creditors and banks use WIP reports to understand a contractor’s profitability. WIP shows whether or not a contractor or company is accurately and effectively estimating and billing for job costs in profitable ways. This can greatly impact a contractor’s ability to secure financing and lines of credit for projects. However, billing clients the right amount on time doesn’t have to be an overwhelming process. Here’s everything you need to know about WIP and how to better understand your business financials.
What is construction work in progress?
WIP summarizes the monetary value of the work you’ve provided that has not yet been invoiced. At a high level, a WIP report in construction can help you understand whether you have over or under billed, and your current profitability of a job. WIP reports can also help you manage your cash flow, since they give you a sense of what your billings are likely to be at the end of the month.
How do you calculate work in progress in construction?
In order to determine a construction project’s work in progress, you’ll need to have the fixed price in your contract (Contract Value) and a Budget Cost on hand. The fixed price allows us to calculate the percentage of the total project cost against the budget we’ve set for ourselves for a line item or phase of construction. Additionally, you’ll need the total spent on the budgeted item to date (Actual Cost), as well as the total Billed Revenue on this project to date.
Once you have these numbers readily available, you can begin to calculate construction work in progress as follows:
When calculating construction work in progress, the Actual Cost divided by Budget Cost represents Percentage of Completion (POC), so you can see how far along you are.
Once we have the POC, we multiply that value by the Contract Value to get the percentage of the contract you should be invoicing based on how much of your budget has been spent. Then, previously Billed Revenue gets subtracted to avoid repeat billing.
The goal is to balance WIP by billing for any remaining work that has been completed. By doing so, you’ll remain on track with billing for your project, and your balance sheet should be accurate.
Here’s an example of how to calculate WIP.
One of the line items on a contract is worth $20,000.
Contract Value = $20,000
The budget for the labor portion of that line item is $8,000.
Budget Cost = $8,000
The contractor has not billed for the line item yet.
Billed Revenue = $0
They have already spent $3,000 in labor costs and are currently on schedule.
Actual Cost = $3,000
In this example, the contractor has legally earned $7,500 having completed 37.5% of the work.
What should you do if the WIP value is negative or positive?
Now that you have determined whether you have a negative, positive, or zero balance for your WIP value, we can determine the next course of action.
If your WIP value came out zero, congratulations! You are right where you should be and no further action needs to be taken in terms of billing your client. Just make sure that all your outstanding invoices get paid by your clients in a timely manner.
A positive WIP value means there is completed work that has not been invoiced. This can be fixed by invoicing your client the construction work in progress value calculated and having them pay their invoice for that billing period. Make sure to keep track of all invoices related to that work in progress, as that will be calculated as your future Billed Revenue for that line item or phase of work.
Negative WIP values can be trickier to solve for, especially if the value is excessively large. This negative value indicates that you are billing ahead of costs for that particular project area. Having your bank account increasing on the surface may look like your business is successful and profitable. However, consistently over billing on projects carries significant financial risk and could signal cash flow issues that need correcting asap. Over billing is a liability on a balance sheet, and is sometimes referred to as job borrowing. Job borrowing can easily get out of hand and require professional help and significant time to remedy – creating even more expenses for your business.
Conclusion: make work in progress work for you.
Manually tracking cash flow, using excel spreadsheets, or not having your WIP reports visible within your project can create added stress and room for error. In the case of tracking profitability and determining progress made on a particular project, automated reports and visual representations of where you stand financially can make your job far less stressful. Knowify understands the importance of easy-to-digest information and allows you to maintain an accurate picture of your entire business at any given time.