In Depth Review of WIP Report
Introduction:
As a Construction CFO, you
understand the critical role that Work in Progress (WIP) reporting plays in
your company's financial success by using the Percentage of Completion Method
(PCM) which is highly recommended by GAAP for long term contracts for Revenue Recognition.
GAAP requires that certain
elements be in place in order to use the PCM. These include the existence of a
binding contract with enforceable rights, such as the right of the contractor
to place a lien when the customer doesn't pay up. GAAP requires an assumption
that both the contractor and customer will fulfill their obligations. Another
essential element is the contractor’s ability to make dependable estimates
regarding the contract’s costs and progress. To measure progress towards
completion – in other words, the completion factor – under the PCM, the
contract can rely on the costs encountered, the efforts expended, or the units delivered.
Accurate and timely WIP reports not only help in decision-making but also
contribute to maintaining a strong financial standing. Projects typically span
multiple periods and organizations need a way to report Revenue and Costs
(according to GAAP) on a project that is not yet completed by the end of each fiscal
period(month).Why WIP
A
WIP report essentially makes sure everyone understands where a job stands, gets
everyone on the same page about billing progress, and proactively monitors for
profit fade, cash flow or loss-job issues. For CFOs, it's important to have a firm grasp
on the reporting process to ensure accurate and timely financial information.
This not only helps in decision-making but also enables the company to maintain
a strong financial standing.
WIP reports also calculate how
companies should adjust their financials to create an accurate picture while
jobs are still in progress. That means under billings or overbillings can have
an impact on your reported revenue.
The goal, then, is to be as
accurate as possible so that you can adjust for jobs encountering unexpected
difficulties and you’re not overreporting revenue, which can hurt job profit.
That requires companies to make
a pretty exact prediction of the future. Accounting can do that with numbers,
but some of those numbers must come from the knowledge, vision, and experience
of project managers.
A question often asked is, if
accounting can crunch the numbers, then why do they need information from
Project Managers (PM’s). Realistically, everyone understands that plans and
conditions change on the jobsite. It’s part of construction. Costs can go
up; weather delays might demand more labor; conditions can damage inventory; disputed
change orders influence the job long before they make it to accounting.
The temptation is to simply keep
managing the job to make everything work out in the end, but if the estimated
cost-to-complete isn’t true-to-life, the percent complete won’t
be accurate and neither will billing expectations. As a result, project
managers are critical for WIP reporting.
Project
managers possess the knowledge, vision, and experience needed for your finance
department to execute the most accurate WIP Analysis possible. PMs are
the experts in knowing the most accurate, real-time costs and what it’ll take
to top out. Where a spreadsheet might “think” the job should be 70% done, an
experienced PM might look at the whole situation and know there’s no
way. That’s an invaluable conversation for construction companies. By incorporating their expertise, construction companies
can avoid discrepancies in billing expectations and ensure the smooth operation
of their projects.Best Practices
The WIP report gives operations and
accounting a common goal, so achieving it requires a little cooperation and a
lot of understanding. There’s no one right process for completing good WIP
reports, but many contractors make best practices work for them.
To start, you have to make sure that your systems are
accurate, that the data is accurate and consistent, and that your approach is a
team approach including all of the people that are engaged in reviewing the job
cost and the Work In Process schedules. Having a consistent schedule for
WIP reporting is crucial.
Monthly reports are recommended, as they provide a
comprehensive view of the company's financial standing without overwhelming the
management team. Consistent reporting also helps in identifying trends and
addressing any issues that may arise in a timely manner.
Some common KPIs for construction companies include:
• Percentage
of Completion (JTD Cost/FCAC(or EAC{Estimate at Completion}))
-
This purpose is to recognize revenue that is
earned regardless of the amount billed based on JTD cost versus total cost.
This should always be confirmed by analyzing where you are at in the budget to
make sure it makes sense and no costs are on a project that don’t belong there.
-
When using this method, Revenue is earned and
should be recognized as the project is completed
• Forecasted
Cost at Completion (FCAC)
-
There’s always an estimate of what it will cost
to complete a project, and it requires stringent scrutiny for a logical and
specific solution. A best practice is to include approved change orders in the
final figures. This allows you to avoid situations where profits are overstated,
and revenues are incorrectly calculated.
• Earned
Revenue (Percentage of Completion * Contract Value)
• Over(+)/Under(-)
Billings (JTD Billings – Earned Revenue)
-
Underbillings (an asset on the balance sheet) could
represent poor billing practices, an inability to bill for work performed due
to a milestone not reached, incurred cost on an unapproved change order deemed
unbillable or an overstatement of estimated gross profit on the project.
-
Overbillings (a liability on the balance sheet) represents
potential front-end loading of profit in earlier project stages based on the
schedule of values, or deferred profit.
These KPIs can help identify problem areas
and measure the overall success of the project. This internal analysis is vital
for aiding in decision making for the organization and to ensure that the
organization maintains a strong financial standing (with banks and or bonding
companies).
By using Anterra software, CFOs can save time and effort
while generating accurate WIP reports. The software can also help identify
trends, enabling proactive decision-making as well as identify holes in their
organizations Processes and Procedures. WIP is not just an accounting tool for banks
and the bonding companies. I would suggest that you utilize this as an
informational tool to help drive your throughput and accuracy to help people,
equipment, and all of your resources, which will drive profits to the bottom line.
Anterra is a software
solution designed to streamline the reporting process for construction
companies, offering numerous benefits that optimize WIP reporting:
Pre-built
calculations: Anterra provides pre-built calculations, eliminating the
need to create formulas from scratch. This saves time and reduces the risk
of errors in your WIP reporting.
Cloud-based
storage: With Anterra, your WIP report lives in the cloud, ensuring
version control and preventing the confusion of managing multiple
spreadsheets. This improves collaboration between team members, granting
easy access to the most up-to-date information.
Seamless
integration with ERP systems: Anterra directly populates data from your
ERP system and your Project Managers' forecasts. This integration ensures
accurate and real-time information, making your WIP reports more reliable
and effective.
Access to
historical data: Anterra provides quick access to past month WIP reports,
allowing you to analyze trends, compare previous reports, and identify any
changes or issues that may require further investigation.
Export to
Excel: Anterra's ability to export WIP reports to Excel makes it easy for
you to manipulate, analyze, and share data. This flexibility ensures you
can present your WIP reports in the most effective way possible, catering
to various stakeholder preferences. Common Mistakes
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 a project of where the job
stands, including if it's been over or underbilled.
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 chasing invoices for payments or
re-evaluating 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. These need to be accurately tracked to ensure your
project remains profitable and the WIP report is accurate.
- Example:
Imagine
a construction company working on a project with a budget of $1 million.
They have spent $600,000 so far, but they haven't tracked $200,000 in
committed costs for materials and subcontractor services. By not
accounting for these committed costs, their WIP report will show that
they have spent only 60% of their budget, when, in reality, they have
committed 80% of the budget. This discrepancy can lead to financial
issues and an inaccurate assessment of the project's progress.
- Not
being Timely: An effective WIP schedule requires timely updates of
costs and billing details – ideally, this should be done Monthly at a
minimum. If the updates are in real-time and based on actual costs, the
WIP schedule is an insightful business tool for the contractors.
- Example:
A
construction company is working on a six-month project with a budget of
$500,000. They update their WIP report every three months instead of
monthly. By the third month, they have spent $350,000 (70% of the budget)
but only completed 50% of the work. If they had updated their WIP report
monthly, they could have identified the budget overrun earlier and made
adjustments to avoid further issues.
- 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.
- Example:
A
construction project has a budget of $2 million, and the company has
spent $1,000,000 to date. However, a data entry error results in the WIP
report showing that they have spent only $100,000. This error could lead
to overconfidence in the project's financial standing, causing potential
budget overruns and project delays. By the time the error is discovered,
the company may have already spent more than they planned, leading to a
negative impact on their profit margin and the project's overall success.
- 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.
- 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.
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