Financial statements are an indispensable tool for gauging your construction company’s historical results and financial health. But relying on them alone is like driving a car by looking in the rearview mirror. To see the road ahead, you need a work-in-progress (WIP) report for every job.
Too often, contractors view these reports as a burdensome requirement imposed by sureties or lenders. But used correctly, WIP reports can be a valuable management tool.
Creating the info
There are many ways to create WIP reports, including spreadsheet programs and accounting software add-ons. Whichever method you use, the report should track key information for each project in progress, such as:
- Contract price (including approved change orders),
- Estimated job costs,
- Estimated gross profits,
- Costs incurred to date,
- Revenues recognized,
- Percentage of completion,
- Billings to date, and
- Billings in excess of earnings or earnings in excess of billings.
Most contractors should run WIP reports at least monthly. But some companies review them every week. Warning: The process requires a current, complete and accurate assessment of estimated costs to complete for each project. Otherwise, the information will be incorrect and could be misleading.
Looking for trouble
Monitoring WIP reports closely can help you recognize revenue more accurately, monitor profitability (or lack thereof) and spot red flags. For example, say a job is 25% complete but your costs incurred to date are 40% of budget. That’s not good but, thanks to your WIP report, you’ll have time to investigate, make adjustments and, one hopes, get the project back on track.
WIP reports also indicate whether a job is underbilled or overbilled. Either situation is a potential red flag of financial trouble but, in many cases, there’s a benign explanation.
For example, underbilling (that is, billing that fails to keep pace with a job’s progress) may be attributable to cost overruns, inefficient project management or sluggish billing. Any one of these issues can portend cash flow difficulties. But underbilling may instead reflect less troublesome circumstances, such as a large number of legitimate change orders yet to be approved, or significant front-loaded costs that will be recovered over the course of the project.
Overbilling, on the other hand, is usually viewed as a good thing because it enhances cash flow. Again, it’s important to examine the underlying reasons. Overbilling that reflects strong management and billing practices is a positive sign. Yet overbilling caused by substantial unrecorded costs may point to trouble down the road.
Keeping profits sharp
WIP reports can also help you spot profit fade. This is the gradual decline in projected gross profits over the course of a job. There are several potential causes of profit fade, including inaccurate estimates, lax project management, sloppy change order practices and unanticipated job-site problems. Again, a WIP report can tip you off to project discrepancies before the job gets too far along.
Reaching your destination
It’s much easier to reach your destination efficiently and in one piece when you can see the road in front of you. That’s the viewpoint a WIP report provides. Your CPA can help you set up the structure and choose the data points that are right for your construction company.