If you are a construction business owner, you have probably heard the term Work in Progress (WIP) thrown around. What exactly is WIP, and why do you need to understand it?
WIP is more than just another accounting term; it’s a resource that helps you track your projects, manage cash flow, and stay profitable. Let’s break it down in simple terms so you can see why understanding WIP is crucial for your business.
What is Work In Progress (WIP)?
Work in Progress (WIP) is like a financial health check for your projects. A WIP report shows how much work has been completed on a project compared to how much has been billed. It helps you understand where your project stands financially and ensures you are recognizing revenue and expenses accurately.
A WIP report helps answer key questions like:
- Are we billing enough for the work completed?
- Are we staying on budget?
- Are we making the profit we expected?
How is WIP Calculated?
To calculate Work in Progress (WIP), you need to determine how much of a project is completed in relation to the total project. The Percentage of Completion Method (PCM) helps with this. You divide the costs spent to date by the total estimated costs. That percentage is then used to determine how much revenue should be recorded for the current period.
For example, if the expenses on a project are expected to be $100,000 in total and you have spent $50,000 so far, your project is considered 50% complete. Using this completion percentage, you can recognize 50% of the total contract value as earned revenue.
Once you determine the earned revenue, you then compare it to the amount you have billed your client to date. Keeping track of these figures helps you manage cash flow, avoid financial surprises, and ensure your project stays on track financially.
Why is WIP Important?
Understanding and managing your WIP helps you in several critical areas:
1. Revenue Clarity
Your WIP report ensures you are not overstating or understating your revenue (income). Overstating revenue can make your business look more profitable than it actually is, which can lead to cash flow surprises later on. Understating revenue can make it seem like you are struggling financially when you are actually doing well.
2. Managing Overbillings and Underbillings
- Overbilling: This happens when you have billed more than the actual work completed. This boosts short-term cash flow but can leave you with lower profit margins in the later stages of the project.
- Underbilling: This means you have completed more work than has been billed, which means you are essentially financing the project yourself, which is never a good place to be.
Proper WIP tracking ensures you are billing appropriately and keeps cash flow steady.
3. Securing Financing and Bonding
Banks, lenders, and bonding companies may use your WIP reports to assess the financial health of your projects. A well-prepared WIP report can help you:
- Secure loans to fund new projects.
- Obtain bonding to qualify for larger jobs.
- Build credibility with financial institutions.
A solid WIP report demonstrates that your company is profitable, organized, and in control of its finances.
How to Get Started with WIP Reporting
If WIP reporting sounds overwhelming, don’t worry! Here are a few steps to get started:
- Work with your bookkeeper or accountant to set up regular WIP tracking.
- Use construction accounting software that can generate WIP reports easily.
- Educate your team on the importance of tracking costs and billings accurately.
- Consider professional training, like the CFMA 360 WIP Construction Course, to deepen your understanding of WIP and improve profitability.
Tracking WIP can help you stay on track, maintain healthy cash flow, and grow your construction business with confidence. By keeping an eye on your WIP, you will avoid financial surprises and make better decisions for your company’s future.
Looking for more business advice on how to create a profitable construction business? Check out this article on how to boost revenue during slow periods in construction.