When you run your monthly Profit & Loss (P&L) report (you do run one, right?) do you find that both the dollar value and the profit percentage varies wildly and you start to doubt the accuracy of the report? If so, maybe it’s because you are not adjusting the figures to take account of Work in Progress, or WIP. This is especially important for builders who are running multiple projects over multiple months. Timing differences between job costs being incurred and invoicing the client can result in big shifts in apparent profitability from one month to the next.
So what is WIP and how should you allow for it in the P&L report?
Looking to Wikipedia, it says: Work-In-Process in construction accounting identifies the value of construction projects which are currently being worked on by the construction firm. To properly account for each project, FOUR values are needed for each project at the end of any given month (or period):1. the Sales Price for the project, the Sales Price for the project,
- the Sales Price for the project,
- the total Cost Estimate for the project,
- the Costs-To-Date,
- the Billed-To-Date.
By taking the Costs-To-Date divided by the Cost Estimate, the “percentage complete” for the project is calculated. For example:
- Assume a project is estimated to cost $70,000 by the time the work is complete
- Assume at the end of December, $35,000 has been spent to date for the project
- $35,000 divided by $70,000 is 50%, therefore, the project can be considered 50% complete at December 31.
Calculation of the Percentage complete is a valuable tool in determining how much the client should be billed – it is important that invoicing, and even collection of these invoices, is greater than the costs expended to do the work. This ensures that the client is directly funding the construction work, and that the contracting firm minimizes its borrowings.
Too much over-billing can distort the P&L however. For more accurate MANAGEMENT figures the monthly FINANCIAL P&L should be adjusted downward for over-billings and upwards for under-billings. In my opinion this will provide a more realistic P&L and show the underlying profit percentages being consistently achieved by the company.
As they say, more accurate information results in better decisions.
NB. If you are making this adjustment in your financial accounting system, remember to reverse the entry at that start of the new month so your accounting system is not corrupted.
Contact me here if you want some help understanding your financial numbers a bit better.
Andy Burrows – The Trades Coach