Imagine steering a massive ship through treacherous waters. The journey has been carefully mapped out, and everyone relies on you to safely navigate to the destination.
Suddenly the ship starts veering off course and barrels toward an iceberg.
Fortunately there is a lifeline: an advanced radar system that identifies the obstacle in real time and provides the exact adjustments needed to dodge it.
In the volatile seas of construction accounting, the Work-in-Progress (WIP) report is this advanced radar system.
Without WIP reports, construction firms can face a variety of challenges, some fatal to the company’s financial health. Below are three critical ways in which the WIP supports construction companies and contractors.
1. Maintaining Project Budgets: The WIP calculates the progress of all ongoing work as it relates to estimated costs, incurred costs, and billings to date. This information allows the user to determine the percentage of completion (POC) on each job. If the ratio of total costs incurred to estimated costs is 50%, this indicates how “complete” the job is. However, if the job is half complete and only 25% of the total contract value is billed, it’s essential to catch up on billing so money from another job’s budget isn’t spent on this one.
2. Profitability Blind Spots: In any project-based business, the company could have tens, if not hundreds of jobs going at one time. These jobs can be considered products with a much longer time horizon than a retail product. Every business owner wants and needs to know their margin. The WIP is a comprehensive and effective tool for estimating and monitoring the profit margin of each project. Future bids and bonding capacity hinge on the performance metrics of past and current projects. Without access to real-time data from the WIP report, a business risks underbidding on a job—which could lead to tight profit margins or even financial losses, or overbidding—potentially resulting in fewer contract opportunities.
3. Access to Surety Bonds: Surety bonds insure against disruption or financial losses due to a contractor’s failure to complete or meet the specifications of a contract. This reassurance is critical for investors in construction projects, as it reduces the risk of financial loss and delays caused by contractor default. By submitting a construction or surety bond, the contractor guarantees they have the financial means to manage and complete the project. The contractor purchases a construction bond from a surety, and the WIP report is the most critical element in approving these bonds. The elements of particular scrutiny include:
- Budgets or estimated costs: Bonding companies want to see that the estimated profit margin stays in line with the actual profit margin. The WIP can show if actual costs are in line with expected costs or if there is a history of under-budgeting.
- Underbilling: If profits are over-projected or costs are under-budgeted, a company may end up in a substantial state of underbilling (where costs exceed billings). This can not only lead to cash flow issues—because costs are incurred and paid well in advance of recouping them through billing—but it can also signal to the surety that profits are overstated and require further scrutiny.
- Overbilling: On the other hand, overbilling (billing more than the percent complete creates the risk of inadvertently using funds from an overbilled project for another job, potentially leaving insufficient funds to complete the overbilled job. The surety and the contractor are liable if the contractor fails to abide by the contract’s conditions.
Let’s ground this with a tangible example from our hypothetical WIP report. Consider Contract D. With 55.05% of the project completed, its incurred costs are $300,000—nearly matching the projected costs of $545,000 for this stage. Yet, the gap between the Revenue Earned to Date and the Billed to Date signals a potential cash flow concern, emphasizing the need for vigilant monitoring to prevent future issues. Contrastingly, Contract E has been overbilled by about $146,760 relative to its progress. While this can boost short-term cash flow, it raises concerns about inadvertently diverting funds and potentially jeopardizing Contract E’s completion.
The WIP report is a cornerstone in construction finance management. It’s not just about having the data but discerning its story and acting swiftly. For construction businesses, effectively utilizing the WIP report is a pathway to enhanced financial clarity, optimized operational efficiency, and sustained profitability.