The Work in Process Schedule (WIP) For Your Construction Company
Construction companies typically juggle many complex jobs at once, often with a diverse mix of vendors and stakeholders. This makes managing your financials and tracking profits and costs an ongoing challenge. Fortunately, there is a tool that helps with managing and monitoring the progress of your jobs. “The WIP,” which is the work in process schedule (sometimes called the work in progress or the contracts in process schedule), helps contractors determine their profitability by job while tracking and forecasting their job costs.
The work-in-process schedule enables business owners to see an overall and detailed picture of how the company performs on a job-by-job basis and highlights critical risks. In addition, banks and sureties rely on the WIP in making credit decisions to provide loans, lines of credit, and bonding. Having a WIP (and understanding what to look for when reading one) helps a business owner manage risks and cash flows, and it keeps their creditors happy.
Here are the top three ways you can benefit from working with your CFO or controller to ensure you keep an up-to-date work-in-process schedule as part of your company’s ongoing financial reporting and what to look for when reviewing yours.
Tip 1: Get a Better Handle on the Impact of Change Orders
Any contractor knows to expect changes to a contract even after the client has approved it. Whether major or minor additions or deducts, contractors often work with new plans before the owner agrees on them. For example, we work with a construction company in New York City that works on several projects for a large public institution. In this case, the bureaucracy and turnover with their client make it challenging to get change orders approved in a timely fashion. This creates a considerable risk if the change orders are not authorized, resulting in non-billable costs and profit erosion.
A work-in-process schedule has helped our client evaluate the adverse financial statement impact of those changes if the pending change orders are not approved or not approved on time. Our client can make better business decisions – and evaluate the financial risk as to the pending change orders age – in a way that allows them to focus on how to keep their business moving forward while fighting through the bureaucracy of a slow-moving client.
Tip 2: Strike the Right Balance with Billing
Construction projects are complex and require many tasks to be performed and tracked. It is critical to ensure costs are recorded to the specific jobs they relate to and clients are billed in a timely fashion. The work-in-process schedule allows you to see if overbilling occurs on a job. Overbilling is billing an amount greater than the amount of revenue earned to date based on the amount of cost incurred to date on the project. One of our clients overbills aggressively with the hope that the client will fund more of the project early, allowing the client to build the job with the owner’s money (rather than using their cash reserves or line of credit.) However, banks and other lenders focus on whether those overbilling will ultimately be collected.
Conversely, underbilling a job causes a drain on cash and poses the risk that the total cost of the job may not be recoverable, raising the risk of profit erosion or, worse, losses. It is imperative to strike the right balance. An updated WIP allows the team to stay on top of under billings and overbills to determine the best places to take risks that will keep the bank and other lenders comfortable. Your CFO or controller can work with you to choose the best strategy based on this information.
Tip 3: Make Your Business More Profitable
At the end of the day, business owners need to know if their jobs are making money. The WIP enables management to see the profitability of each job every month and allows the team to see if the actual profits are consistent with their estimates when the project was awarded.
Profits are calculated and reported based on each job’s completion percentage. An updated WIP provides a timely view of actual profits earned on a job compared to the expected initial profits. It allows you to evaluate the remaining cost to complete each assignment and adjust strategies more timely – which could be the difference between making or losing money on a job.
The WIP will not only provide the risk information discussed above, but it also enables leadership to use the remaining work that hasn’t yet been completed or backlog to analyze future cash flows and perform earnings forecasting, which are critically important to managing any business.
A WIP integrated with financial statements and forecasts will raise the company’s credibility with banks and sureties, which gives creditors more confidence in the reliability of the financial information and the financial state of your business.
A work-in-process schedule creates a complete picture of the projects companies are performing and offers a better lens into how to make more strategic business decisions based on outstanding change orders, the cost to complete the projects, and billing needs on each project. Working closely with your CFO or controller to use and understand the WIP will make it an indispensable tool to help your company track its expenses and make more informed business decisions.