If you don’t always quite get what your CPA is talking about when it comes time to discuss your Work-In-Progress (WIP) schedule, you’re not alone. Many construction contractors are hesitant to dig deep into the subject, but those that do have access to a powerful tool for assessing project profitability.
The basic premise of the WIP schedule is identifying and assessing the rate of completion for each project currently underway and comparing that assessment to your original expectations for the project. Measuring that comparison in financial terms seems to be what gives contractors the most trouble.
What the WIP Schedule Offers
As a construction contractor, you should be able to immediately determine how much progress you’ve made on any project you’re working on, at any time. But can you determine how your current progress on a project affects your bottom line? Can you project how the project will continue to affect your bottom line come tax season?
These are important questions that you should not ignore if you’re looking to turn healthy profits consistently. Additionally, they are questions your bond agent is going to want thorough answers to before increasing bonding capacity sufficiently for you to take on large projects.
Understanding the Percentage of Completion Method
First, an example: You’re in the middle of a $400,000 construction project when the financial cutoff date occurs and you’ve estimated that your cost to complete the job $280,000. You report according to the percentage of revenue billed so far to determine how complete the job is. If you had billed $140,000 by the cutoff point, you would claim the job is 50% complete and recognize $200,000 in earned revenue. How does this work?
First, the difference between your cost to complete the job and the price of the contract is $120,000. If you already billed for 50% of the project’s completion, you would recognize revenue that includes 50% of the profit you are expecting to earn. Thus, you would have $140,000 billing to date + $60,000 profit = $200,000.
This method doesn’t rely on whether you have billed your customer in advance, or whether you received money for the job in question. It simply matches your revenue to the expenses as they occur.
What are Underwriters Looking For?
This example was simplified – in practice, you’ll find that your expected profits change over time, as does the actual amount of money billed for each step of the project. These are the differences that your surety underwriters are looking at to determine your bond worthiness. Long-term contracts will undergo changes that should be addressed in the WIP schedule.