The WIP Report: Your Job Profit Crystal Ball
A Work In Progress report is a powerful tool: it can increase your bonding capacity, help you manage costs, and give you an accurate picture of both your working capital and the status of your current jobs. This week, we’re talking about why the WIP is crucial and how to do it right.
Topics we cover in this episode include:
- How a WIP report affects your bonding capacity
- The importance of consistency when tracking job costs and why WIP numbers are not always intuitive
- Common mistakes contractors make on their first WIP report
- Addressing stored materials on the WIP report
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Rob Williams, Profit Strategist | IronGateESS.com
Wade Carpenter, CPA, CGMA | CarpenterCPAs.com
Stephen Brown, Bonding Expert | McWins.com
Rob Williams: Welcome to the Contractor Success Forum! Today, our subject is the importance of a Work In Progress Report and how it’s your job profit crystal ball.
Here on the Contractor Success Forum, we discuss financial strategies for running a more profitable, successful construction business.
Our hosts, us, we have Stephen Brown with McDaniel-Whitley bonding and insurance company. All right, Stephen. And we have Wade Carpenter with Carpenter and Company CPAs and I’m Rob Williams with IronGate Entrepreneurial Support Systems.
So how is the WIP report our job profit crystal ball? This
Stephen Brown: Here’s the thing, you know, WIP reports are different and unique to contractors. And it’s important that a contractor know what that report is and how it’ll help you [00:01:00] in a million different ways. It is your profit crystal ball. So a WIP report is usually a module that’s part of your accounting software. And it’s always something that your construction oriented CPA does with your, your fiscal year end for you to give to your bankers and your bonding company. But the WIP, most importantly, shows how the jobs being financed. And whether you’re having to borrow money from one job to another, to get the job finished.
And it shows so many things that it’s just a great subject matter. And, and we were talking about this before the show and we really could do five different series on this. And I I’m hoping it wouldn’t bore our listeners, but a WIP report can give you so much power in so many ways, as far as managing your costs and your profit. Wade?
Wade Carpenter: Well, I absolutely agree. From an accounting standpoint, a WIP schedule is essentially [00:02:00] trying to figure out a percentage of completion. And what you were saying about whether you got cash or accrual, either one of those could very easily be manipulated, by, say in accrual, you could send the bill out on the end of the year, but you may not have earned all that money. You could hold off on payables or things like that. There’s a lot of ways to manipulate a financial statement for contractors and the WIP report or the percentage of completion calculation is designed to kind of even it up and give a truer picture of where you really are on your jobs and where your working capital should be, your equity should be.
Rob Williams: One thing Stephen said a minute ago is the WIP being in the software. I think with us, our WIP report wasn’t ever in the software, our software didn’t do it. We always had spreadsheets. And I didn’t really understand it because I had a manufacturing plant, which we had WIP. So I thought I knew WIP, which was so different than the WIP in construction. And [00:03:00] I don’t think I ever understood it because we didn’t do it on our monthly reports. We just did it for you, Stephen, for the bonding and for the banks or something for their statements. So it’s so interesting.
The main elements of a WIP report
Stephen Brown: Well, and WIP reports look different too. But the basic headings that a WIP report have, element in the WIP report are important to know because of what the report will show you and how to interpret it. It shows the contract price, plus any changes to the contract price. Amount billed to date. Cost to date. Excess of billings over cost, excess of cost over billings. Estimated cost to complete, and then estimated gross profit or loss on the job. That’s the fundamental categories.
How a WIP report affects your bonding capacity
Stephen Brown: And then to make it even better, from my perspective, as a bonding company you would add a column that showed projected time of completion date, because we use that WIP to do runoff, to show the bonding company that this is how much work has been [00:04:00] run off since we last talked, and this is what they need.
So we need you to analyze this and increase our bonding capacity because we need this particular job. It’s the number one tool that helps us get that done. And our customers that don’t have that in place and don’t understand it, it really hurts their ability to get these bigger bonds that they need.
Rob Williams: Just made a great point, Stephen, that I hadn’t thought about. So if you’re getting these WIPs, if you’re in the middle of a job, say it’s a two-year job and you’ve completed part of that. Can that go off of your bonding?
Stephen Brown: It’s a way of replenishing your working capital and that’s what drives bonds. So when you see that the working capital is being replaced, that’s what gets you more bonds. And as you see the work’s done, then you see, well, all of these elements are going into place. So they’re either projecting to lose money or make money on a job. And I always tell my contractors, don’t underestimate your profits, [00:05:00] and don’t overestimate it. Just try to be reasonable. Because a contract underwriter likes to look at those reports and see, there’s a profit fade on a job, let’s just talk about it.
It’s not the end of the world. You may lose money. You may break even. You may not hit your profit margins. That is not the end of the world. The end of the world is when it happens and we haven’t talked about it, I think.
Importance of cosistency with job costs
Wade Carpenter: There’s a whole bunch of the conversations in what you just said there, Stephen. So, if I can just kind of start back at the cost that goes into it. Well, number one problem with a lot of contractors when they’re trying to do a WIP schedule is they don’t have any idea what their job costs really are.
Being consistent where, if you do a WIP report internally for the bonding company, it’s direct costs only, but your CPA gives them a end of year statement that has overhead allocated to the jobs and that kind of stuff. It’s not apples to apples. So, number one, getting the costs in there in a consistent [00:06:00] basis is a huge factor.
Why the WIP numbers are not always intuitive
Wade Carpenter: Number two, getting the costs in there, it is not intuitive. And I know Rob talked about manufacturing and I started jumping in a minute ago, but you know, if you increase costs on a manufacturing, you’re increasing inventory. If you’re increasing costs on a profitable job, as long as you’ve got a profitable job, it may not make sense, but if you get that accounts payable in there, it’s going to increase expenses, yes. But it’s also going to increase your percentage of completion, which also bumps up your revenue. In which case it’s going to bump up your top line and your bottom line, because you’ve increased your profit and it’s going to increase your working capital.
You may have added accounts payable to your balance sheet, but you’re also going to either increase your under-billing, which is an asset, or decrease your over-billing, which is a current liability. So it helps your working capital on the balance sheet and also helps your equity.
Stephen Brown: That makes perfect sense. You know, we’ve talked in the past about accounting systems [00:07:00] and we probably ought to do another show on them. We know we don’t plug one accounting system over another, but at the same time, the data that goes into that accounting system is what produces the accuracy of these reports.
For example, you put a contract price in there and you don’t put change orders over there and you’ve incurred more costs. Then it looks like the job is losing money. And also, you were saying earlier, Wade, you forget to put retainage in your schedule then that throws everything out of whack.
You want to do it right. And if you have a good construction oriented CPA, they can help you do this. And you want to learn how to do them yourself. There’s always tweaking to be done. It is complicated, but a good WIP is a tool that you will really enjoy using, I think.
Rob Williams: One observation of what Wade just said. My thought as the contractor, when I have those accounts payable increase, I’m just thinking of not the working capital, but my cash flow. It’s [00:08:00] not intuitive that by having that cashflow go out, it lowers my cash, but my working capital has actually increased because of the book thing, not the cash. So we really just think about our cash if we’re not advanced on accounting, when we’re thinking about that. In working capital, we think about the cash part. And we don’t typically think about, hey, we’ve got the balance sheet going up because we have more assets that are part of working capital.
So that was a great point because I had to think about that a minute when you were talking, Wade. So I think our intuition is backwards on what the bonding company will see.
Wade Carpenter: It’s not intuitive and it doesn’t make sense unless you walk through the calculation, but that is one of the pet peeves I’ve got. I’m not going to try to go on a rant here, but you know, if accounts payable is sitting there on a project manager’s desk and they didn’t get into accounting, then it didn’t get into that bill for that month end, then it didn’t get charged to your general contractor, your owner. [00:09:00] So you’re shooting yourself in the foot, which doesn’t make sense unless you understand the calculation and what it really does to your financial statement.
Rob Williams: Yeah. Stephen, I’m actually thinking about maybe that’s why you actually bonded me because the psychology of me saying, oh gosh, I was nervous going to get a bond. My working capital was alright even though my cash might’ve been low a lot of the time because I was actually really slow in billing. Well, we billed it. Collecting and receiving. But so it was on my working capital. So that’s probably why I looked good to you guys. Cause you were looking at that, but I’m thinking, gosh, I’m like trying to get the money in because I had so many receivables that went way–
Stephen Brown: Well, you did. And your good credit. Yes.
Rob Williams: Those government jobs. Geez. So this is helping it make sense. Yeah. Yeah. So,
Stephen Brown: That’s a really good point. That’s a great
Rob Williams: –come in and where sometimes I wasn’t feeling that you didn’t have any cash in the bank. So anyway, back to the WIP suject. But [00:10:00] this is, this is really enlightening to me. Just thinking about this.
Stephen Brown: And one thing too. And I know Wade, I want to hear more from you because you’re the expert, but this WIP report shows your gross profits. So you don’t put your overhead costs and things in there. That’s your gross profit predictor. And so your gross profit of course, should be a little higher than what you hope your final profit is. Your net profit on the project. But, tell us what you see in WIP reports, and what are important to you?
Wade Carpenter: Can I make a distinction on what you said about overhead? There are certain things that are actually a component of jobs, like workers’ comp insurance, general liability insurance. Those directly affect the costs. So those kinds of things that can be allocated or should be allocated to the job, things like equipment that you own. We have to take that into account.
True overhead would be things like your rent and your office supplies and that kind of stuff. So I would [00:11:00] say, number one, if your CPA gives you a true GAAP statement versus, you, that’s what I was the point I was making before about the direct costs. Just be consistent. Number one.
Mistakes contractors make on their first WIP report
Wade Carpenter: One of the other things that you mentioned awhile ago about when people are trying to do the WIP schedule for the first time. Maybe we should at some point back up and walk through the mechanics of it. But you know, when they do the revenues, or the billing side, they should be, but they don’t include the retainage.
They don’t put it in there on their books and they don’t understand why it helps, number one, your working capital. But number two, it makes it look like you’re underbilled if you’re not including it. And I see that all the time.
I also see contractors trying to do it the first time and they have no idea what their job cost is. So they say, well, 38% gone, or they make up something, but it may have absolutely no relevance as to where they really are. Because they have no idea.
Rob Williams: I know on our home building, which is not commercial, but we still [00:12:00] had to do those reports. We had a percent for each phase. The slab was 20% and the framing was 20%. So it was 20, 20, 20, 20. Our cost was not that. That was not what our cost was. So we just sort of, okay, this is done. And the banks were fine with that. So we were banking, not bonding. So it was a little bit different.
Wade Carpenter: Yeah, the banker definitely looks at things differently from bond underwriting.
Rob Williams: A lot simpler. So.
Stored materials on the WIP report
Wade Carpenter: I could go into other things like stored materials. If you’ve ever done an AIA pay app, it’s right there in the calculation, they’re going to pull out store materials. You’re not supposed to pick up profit on store materials until you have them work in place. And I mentioned that for most people, it wouldn’t make that big a difference, but I did have one situation a long time ago where a water sewer pipeline guy had bought a million dollars of pipe at the beginning of a job. If he had recognized the profit on that, it would be, you know. These schedules that the bonding [00:13:00] company ask you to turn in are not necessarily GAAP. Same thing with, I hate to say it, but a lot of CPA firms that do this, they don’t understand that you’re supposed to back store materials out of your gross profit calculation.
Rob Williams: Yeah knew we had all those wall panels and trusses that we built ourselves. So we had months where it’s sitting out on the job, so we had that. I don’t know what we did with it, to be honest on our balance sheet, but that would have been a big example or that would throw it off.
Stephen Brown: Well, you know, accurate data just gives anyone you do business with that looks at your financials besides you accurate data. Allows them to interpret it, especially your CPA, and give you advice.
They look at this and they say, this job appears out of whack. What’s going on with that? Oh, it’s losing money. We had weather delays. We had this, we had that. There’s always a reason for it. But you know, you got to know what those reasons are and that report helps you do it. And it helps communicate to [00:14:00] others what’s going on with the job. That’s why we call this your crystal ball for profit. It predicts the future.
Rob Williams: With these crazy pricing increases, this stored material is probably one of the most important things to a contractor right now, you know how they’re going to buy this and bill it and what they’re going to do. Probably more important right now than I can remember in my history. of doing that. I can’t remember prices being this crazy.
Wade Carpenter: Right.
Stephen Brown: And we’re seeing a lot of private owners require bonds just because of. They want to make sure those prices are locked in.
Be upfront about losses
Wade Carpenter: And going back to one thing that Stephen just said about losing money on a job and being upfront with them, GAAP actually says that you’re supposed to recognize a loss on a job as soon as you recognize you’re going to have it.
I can tell another story where argued with the partners at a top twenty-five Atlanta CPA firm. They did not know the rules on that. They put it in a component of revenue versus cost. But you [00:15:00] know, if you’re going to lose money on a job, you need to go ahead and put that out there in your WIP schedule.
Some of the other things that I would say you were talking, they don’t want to come back and see that you’ve had a huge fade. Sometimes it happens, something goes wrong on a job, but there’s other times where you should’ve seen it coming. And that’s when I think, Stephen probably would back me up on this, is if you have a consistent track history of you say it’s going to come in really great, but then they’re always losing money, well, they lose faith in you.
Is that not right, Stephen?
Stephen Brown: That’s true. And also consistently underestimating what your profit is, and making more. Then you’re selling yourself short on the additional credits you could be getting for bonding. Talk about Generally Accepted Accounting Principles, Wade, I want our listeners to remember, well who are they to say I can’t do this? Well, you know, you got to put on your financial statement that you are abiding by a generally accepted accounting [00:16:00] principles. Otherwise the bank or the bonding company won’t accept it. So that’s just kind of a side. I mean, I think most people know that anyway, but that’s so important to know because you gotta adjust it according to the rules. And that way everybody understands.
Wade Carpenter: I mean, that’s true, but, I would also point out the fact that, there are rules like what backlog is for Generally Accepted Accounting Principles is not the same way that a bonding company would look at backlog. In a GAAP financial statement, backlog would be contract price minus revenue earned.
For a bonding company, exactly what you were saying while it goes, Stephen. Contract price minus what you’ve billed to date. Is that not right? That’s what you’re talking about on the bonding credit.
Stephen Brown: Right. Yeah.
Wade Carpenter: So that’s just a quick example, but you know, a bonding company is going to look at it a lot more stringently than a banker. I guess this is probably a topic for another day, but you know, things that you know, a bonding company probably would throw out like loans to [00:17:00] shareholders and prepaids and some of those things, you know, you probably should know or at least have somebody working with you that understands how they’re going to look at it. It can make a big difference.
Stephen Brown: That’s absolutely true.
Calculating your percentage of completion
Wade Carpenter: One other thing, I we didn’t really walk through the calculation of it. And typically it’s a cost to date divided by a total estimated cost. So that’s how you get your percentage. And GAAP does normally say, we say total estimated cost versus total cost to date on that job.
There are situations where, and I’ve done this a few times over the career where something is completely labor driven. So there are allowances if you wanted to make allowances like labor to labor, if it’s more relevant, but you know, generally it’s like total cost to date on that job, including true applied overhead, indirect costs, I should say. Versus [00:18:00] a fully burdened estimated cost at the end. So that’s how you get the percentage of completion. Multiply that by the total contract price.
What you said while ago, Stephen, about the change orders, getting the change order into the contract price, making sure that’s updated is another key thing.
But another place where a contractor dropped the ball, is the fact that, well, maybe they increased their contract price for that, but they don’t increase their total estimated cost because they added, another $40,000 worth of costs with that change order.
So it’s trying to make it consistent, trying to be upfront with the bonding company, underwriters. Building trust, I guess I would say, in the fact that that you’re giving them good numbers. I think that goes a long way. And understanding how they are going to look at things like backlog and if you’ve got enough work or too much work, or if you’re way overbilled versus way under billed and I’ll, I’ll [00:19:00] stop there cause I’m rambling at this point, but there’s a lot of points that could make all of those things.
Rob Williams: One of the big things for me listening to this is as a contractor, if you could understand this, and get these reports– because I honestly feel like most contractors don’t understand the reports, unless maybe they’ve really been in this a long time. But the amount of information you can get as a contractor and your efficiency of your knowledge of knowing how this works would be really important to get that information.
I was doing what Stephen said a minute ago when he said the contractor says, who are they to tell me how to do it? Well, that was me cause I was doing it my way. And then the CPA would have to unravel and do it because I wanted to see it the way I wanted to see it. So if I had learned this, the efficiencies and what I was paying to not be doing books and undoing and unraveling, and to understand that and all be on the same page would have been a [00:20:00] really valuable for me as a contractor. So I think the contractor could really get in his groove and his flow if they were to understand this.
Stephen Brown: Right. In General Accepted Accounting Principles, Wade, they tell others, we are adopting the same principles that are in the rules. So you know our data is accurate based on this information. But to me, every customer, unless they really have a good accounting system in place and they’re really keeping their billings and their costs posted and current, these reports are very difficult to get.
They have to involve their construction CPA, and it’s two or three months out to get this report. And when you really need the report is when you’re pushing the edge of the envelope on your bond program and you want the bond underwriter to realize how much backlog gross profits you have. And then they can give you credit for that.
And if it’s legitimate and the report is accurate, then it’s [00:21:00] worth its weight in gold. Literally, it’s money. It is money. It is your money. It is your money that’s coming in.
And then they might always look at your 30, 60, 90s of receivables and payables scheduled to see if you got a bad customer, or a bunch of bad customers. But even if they tweak that and discount it a little bit, it’s cash money in the bank. And we’ve talked about this before. Cash is king. Cash is king.
Last night, I was with a buddy of mine, Mike Fulton. he said, make sure your contractors understand that cash is king. And . I’m like, I got you. We’ve discussed that many times. So your WIP report is cash, right Wade?
What does it mean to be under-billed or over-billed?
Wade Carpenter: Absolutely. And you’re kind of making one other point I wanted to make. What does it mean that you’re under-billed or over-billed? Well to a bonding company, if you’re too far one way or the other, it could spell trouble. So if you’re too far underbilled, [00:22:00] are you actually billing like you should be? You’re messing up your cashflow if you’re not able to bill, so that’s probably hindering your working capital.
By the same token, if you get too far over-billed that’s saying, you’ve already taken a bunch of the billing out of this contract, but you haven’t actually earned it yet. So they want to make sure you’re not overextending yourself and then you disappear, you already got the cash and you disappear and don’t finish the job. So.
Stephen Brown: That’s why they like to see a balance sheet and income statement with that WIP, Wade. They want to see if you’re over-billed, what are you doing with that money? You’re not using it to buy equipment, or, if they want to give you proper credit for it, they got to know it’s there, right?
Wade Carpenter: Yeah. And sometimes there’s a point where you can put it in context. Cause I do have a large general contractor who works with schools. And this is kind of a longer story, but they get, typically four or $5 million over-billed. There a May year-end. And they get overbilled [00:23:00] because they’re billing ahead for the summer months. The county government won’t pay the bills during the summer months. That’s when they’re doing all these things ahead. So if you’re consistently way over-billed and you could put it in context, then it makes sense to the bonding company. If you looked at the ratios of over-billing and didn’t tell them what was happening and they have a consistent history of doing it, it doesn’t make sense. And somebody’s gonna say, is there a problem? And why have you done this?
Stephen Brown: That’s a good point. I have a lot of customers with a lot of stored materials right now on different jobs.
Rob Williams: Every time you tell a story, I think about it in my head oh, that’s what that Contractor was doing. I used to frame for a guy that built schools. I wasn’t building the schools, but I was doing the other work. I was like, oh, that’s, okay. So now I realize that’s why summer months were really tough on him because he wasn’t getting any cash! They weren’t paying him probably.
Stephen Brown: You know, this WIP report shows a bond underwriter so many good [00:24:00] things and potentially bad things. Let’s keep it positive. Go over your report with your agent and your construction CPA. Talk on the phone, get it worked out before you send it to the underwriter. And it’s a fantastic tool.
And also, if you can show that you’re not borrowing money from one job to finance another one, even though you may be thinking you’re making more profit on another job. That’s okay, but we have to explain it and it’s not a personal thing. It’s just how your working capital is analyzed for bond credit. That’s all.
So you can do what you want to do. It’s just how they look at it. And your bond underwriter and your construction CPA need to make sure that you’re putting your best foot forward on your WIP report. And then when you do the WIP report and you understand what they’re seeing from it, you understand what a profitable contractor looks like.
Rob Williams: Well this is the Contractor Success Forum! Today, the importance of our [00:25:00] Work In Progress reports and how that can be your job profit crystal ball. Especially now with the pricing fluctuations and increases, this is a great subject. So hopefully we hit this multiple times because I’m sure a lot of our contractors’ heads are spinning after this, but for me, I just have to hear it over and over again. And I have to think about it over and over again. It’s much more intuitive to me now than it was a while ago. So this is something you just have to listen to over and over again.
And I’d encourage the contractors, don’t just send this to your bonding agent. Look at it, understand this so you, you really get what’s happening. This report should be extremely helpful for us as contractors as well. Not just for the bonding agents. So we ought to look at it just like the bonding agent so we understand. I think it would actually reduce our stress dramatically as well if we could understand where we are, because all we look at is the cash. Understanding the working capital would be huge. So in [00:26:00] our work in progress report.
This is the Contractor Success Forum. Come back and listen to us again. We have Wade Carpenter, Carpenter and Company, CPAs. And we have Stephen Brown with McDaniel-Whitley bonding and insurance agency. And I’m Rob Williams with IronGate Entrepreneurial Support Systems.
We’ll see you on the next show.