Clean and accurate accounting isn’t easy in the construction industry, but there are plenty of tools contractors can use to take some of the burden off. That’s why I’m always shocked when veteran business owners come to me having never used work in progress accounting. From my vantage point, WIP reports are one of the most valuable tools available to get real-time information on the financial health of your projects. Yet all too often, contractors misunderstand how to use them (or don’t think they’re worth the effort).
My goal today is to convince you that work in progress accounting isn’t just a nice-to-have, but a necessity for your business. I’ll walk through how to implement WIPs strategically in your day-to-day system and cover how to navigate some of the most common mistakes I see.
Key Takeaways
- When done well and approached consistently, work in progress accounting is one of the most powerful tools you have at your disposal as a contractor. Not only does it ensure accurate project accounting, it’s a vital part of cash flow forecasting.
- To get the most out of WIP accounting, it should ideally be a part of everyone’s job, not just something you hand off to your CPA or bookkeeper.
- One of the most common mistakes contractors make when building WIP reports is forgetting to include the project’s start and end date. This data is critical, because anything impacting these dates impacts when you’ll be paid, which then influences your ability to build accurate forecasts.
Why Should You Be Using Work in Progress Accounting?
Construction projects are long, expensive, and unpredictable, which is why you need something to give you a clear line of sight into how they’re performing at any given moment. This is where WIP reports come in. WIP reports show the financial status of all your projects, individually and in aggregate.
At a high level, WIP accounting is about tracking work in process. Not just from a completion perspective, but from a cost, revenue, and profitability perspective. This allows you to capture two key benefits:
Accurate accounting: At any given point on a job, you’re either in an overbilled or underbilled position. This impacts your GAAP accounting and means you’ll need to adjust your position at the end of every accounting period. The WIP report tells you exactly how this accounting entry should be made, so you can keep your numbers as accurate as possible.
Better decision-making: Above and beyond making sure your accounting is accurate, WIP reporting is one of the best decision-making tools you have access to as a contractor. When implemented well, it should give you a real-time overview of:
- The total cost you’ve incurred on any given job to date
- How much cost you have left to incur on a job
- How much you’ve invoiced the customer
- How much you have left to invoice
When you’re doing this for every job you’re working on, you can pull together some pretty meaningful information. For example, the WIP will tell you how much revenue you have left to bill, which is an important part of cash flow forecasting. You can also see how much of that revenue is profit vs. cash owed to subcontractors, etc. The more profit you’re left with, the more funds you have to cover your business’s overhead costs over the next year.
WIP Reporting Is a Diagnostic Tool
Another huge benefit of WIP accounting is that it allows you to diagnose and treat profitability issues at the source. If your profitability isn’t where you want it to be, you can drill down to exactly which jobs (or other elements of your business) are the problem.
Say you’re a remodeler who does bathroom, kitchen, and full-home remodels. With accurate WIP accounting, you can see which types of jobs are actually hitting your profitability goals, and which aren’t. Maybe bathroom remodels are consistently underperforming and you need to pivot away from them. Or, maybe the problem is that one of your estimators is submitting bad bids on bathroom remodel jobs. Either way, you can’t get to the bottom of it without the WIP report.
How to Implement WIP Accounting in Your Construction Company
If you think about it, WIP accounting is just math. But for all that math to produce accurate, meaningful results, you need to start with some key inputs, including:
- A project identifier/project number
- Estimated project start and end date (this is almost always missing!)
- Project status
- Project type
- The team member who did the bid
- Customer name
- Estimated original cost
- Original bid amount
- Change order tracker - cost and additional revenue
- Cost incurred to date
- How much you’ve billed to date
- Final actual cost and revenue
Once you have this data, the formulas should take care of themselves, especially if you have a dedicated construction accounting software. Because timeliness and accuracy are so important with work in progress accounting, I don’t recommend manually entering this data into an Excel spreadsheet. Whenever possible, let accounting software do the heavy lifting for you. A small investment into quality, construction-specific software pays for itself super fast.
WIP Accounting is Everyone’s Job
Ideally, you’ll have a team of project managers, estimators, superintendents, and other folks around you to help implement WIP reporting consistently. If not, you can still make WIP reporting work, you’ll just have to be diligent about entering data in a timely manner.
To get the most value out of work in progress accounting, data entry has to be timely, complete, and accurate. This means you can’t just assign WIPs to your bookkeeper - you need full buy-in from everyone on your team. Everyone has a role in getting updated WIP reports across the finish line each month, from updating change orders to submitting vendor invoices to accounts payable. It’s not just busy work, it’s a mission-critical part of everyone’s job.
I’ve had a lot of CEOs tell me they can’t implement WIP accounting because there’s no buy-in. Because this is such a critical business function, I advise my clients to tie WIP metrics to their bonus structure and performance KPIs. If this is what it takes to get everyone on board, it’s worth it.
4 Common Mistakes Contractors Make With WIP Reporting
Because WIP accounting is so misunderstood, I see a lot of companies get tripped up on the basics. The good news is, most of these are pretty simple fixes:
1. Not including job start/end date in the WIP
This is the #1 issue I see contractors make, and I understand why. People don’t want to enter these dates because they’re not 100% sure. We’re not looking for perfection here though. We’re just looking for a general idea of the project’s timespan. Check back in monthly and update your dates as needed.
Aside from helping you visualize the lifecycle of the project, start and end dates capture when you can expect to be paid. If something impacts those dates, it’s going to take longer to collect revenue. This also drastically impacts your ability to forecast accurately, which is critical to cash flow management. Set yourself up for success by including these dates from the get go.
2. Not including the estimated cost remaining to completed
Every single WIP report I’ve seen does this wrong, and it can really skew your numbers more favorably than they might be. For example, you estimated $100k to get a job done. To date, you’ve incurred 50k in direct costs. Every WIP report will tell you that your estimated cost to complete is 50k. Simple math, right?
There’s a massive problem here though. Let’s say you have ten vendors who are each charging you $10k to get the job done. You’re at $50k in costs though, not because five vendors have billed you, but because three of them billed you $10k, and one of them billed you $20k. Your estimated cost to complete is not $50k anymore - it’s $60k, because you still have six vendors left who are going to charge you $10k.
Your typical estimated cost to complete calculation will never show you that though, because it doesn’t give you the opportunity to show cost overrun. Now you’re $10k over budget on a $100k job, and that’s a huge deal. If you don’t want to spend your days playing catch-up, make sure your WIP report is designed to get in front of these cost overages.
3. Not entering bids into your accounting software
The easiest way to approach WIP accounting is to keep all your data in the same ecosystem. This is why I tell my clients to build their bids directly in their construction accounting software. Be as detailed as possible, and list everything out directly in the software.
When you get an invoice from a vendor, you can then easily tag that invoice to the job number and original quote. Let’s say they quoted $10k but invoiced you $20k. By keeping everything in your software, you can see that invoice on a line item and ideally adjust your WIP report’s estimated cost to complete with that new info in mind.
4. Not doing a final project review each month
Every month, take some time to review projects that have closed out that month. What was our final margin, and how much money did we actually make? If you didn’t meet your minimum required standard, what went wrong, and what can you do to fix it moving forward? These are the kinds of questions that keep your business from stagnating.
Wrapping Up
A good work in progress accounting system, as with any good financial reporting, isn’t something you can build overnight. With consistent work and communication from your team though, it can become an incredibly valuable decision-making tool for your business. My challenge to you this year? See what steps you can take today to implement accurate WIP reporting into your accounting system.
Not sure where to start? My team at Cruzumi can help