Work in Progress in the Construction Industry
Work in progress is a method of valuing inventory or projects in progress at the end of a reporting period. In the construction industry, this calculation allows you to monitor the progress of your jobs and the cash flow relevant to them, provides a method for more accurately ensuring your costs remain on track through the life of the job, and ensure costs and revenues are adequately matched, which provides a consistency in financial statements that will provide a sense of comfort to banks and lenders.
A work in progress report compares the costs incurred, the costs anticipated, and the contract value, allowing the business owner to monitor his project and know immediately if his project is incurring major cost overruns, figure out why, and correct the issue before the project becomes a major money drain. The larger the project, the more difficult these cost overruns can be to spot – and the more likelihood of them becoming major disasters.
A work in progress report allows a business owner to analyze his billing practices, ensuring he is not underbilling and causing cash flow shortages for himself. Similarly, during negotiations with the contractors who, in an effort to keep their cash flow healthy, will often dispute the completed portions on a progress invoice a work in progress can allow a subcontractor to confidently support his billing position.
Because a work in progress provides a method for allocating revenues to the months the costs are incurred it eliminates wild swings in profitability. This consistency keeps lenders comfortable – which can be important when you’re trying to finance a major project.
Without a work in progress, it is virtually impossible to be certain of your margins or your profitability. Large material purchases at the start of a project that have not been used can drastically reduce profit margins. Consistent inadvertent overbilling can lead business owners to believe they are far more profitable than they turn out to be when the project is done. This misinformation can lead to decisions that cause stress on a business.
And, finally, at tax time a work in progress calculation can prevent the business owner, who is in an overbilled state, from paying taxes on a profit that he doesn’t really have.
Work in progress is critical to the informed decision making of any construction professional, especially the business owner trying to expand his market – as most of us are.