Work in Progress in Construction: Why Accurate WIP Is Critical to Your Management Accounts

If you run a construction company, one of the most important numbers in your monthly management accounts is work in progress (WIP).

Get your WIP calculation wrong and you can get your profit wrong.

That can mean directors sitting around a boardroom table making decisions based on financial information that doesn’t accurately reflect what is happening in the business.

I know the importance of this from experience. Before running my accountancy practice, I worked as Finance Director for two large construction companies with turnover exceeding £100 million.

If I were sitting on the board of a construction company today, accurate WIP would be one of the first things I would want to understand.

What is work in progress in construction?

Construction businesses often have projects that run across several months or even years.

At any particular month end, you may therefore have:

• Work completed but not yet fully invoiced
• Costs already incurred on unfinished contracts
• Materials and subcontractor costs relating to ongoing jobs
• Revenue recognised against partially completed projects
• Further costs that will be required to complete each project

This means simply looking at invoices raised and costs entered into the accounting system doesn’t necessarily tell you how profitable the business was that month.

You need to understand where each contract actually stands.

That’s where WIP comes in.

Why does WIP affect your reported profit?

Imagine a construction company incurs significant costs on a project during March, but the corresponding value of the work isn’t invoiced until April.

If you simply looked at the March profit and loss account without an appropriate WIP adjustment, March could look considerably less profitable than it really was.

The reverse can also happen.

A business may have raised substantial invoices while significant costs are still to come. Without understanding the remaining costs, the accounts could give the impression that a contract — and potentially the whole company — is more profitable than it really is.

This is why inaccurate WIP can distort your monthly profit figures.

And once the profit figure is wrong, many of the numbers management relies upon become less useful.

Cost to date versus cost to complete

One of the fundamental disciplines in construction accounting is understanding two figures for each significant contract:

Cost to date – what have we spent on the project so far?

Cost to complete – what do we realistically expect to spend before the project is finished?

The first figure should be relatively straightforward if your accounting and job-costing systems are working properly.

The second requires judgement and good information from the people actually managing the contract.

You need a reliable estimate of what it will cost to finish the job.

That might include remaining labour, materials, subcontractors and other direct project costs.

If your estimated cost to complete is unrealistic, your assessment of the profitability of the contract can also be unrealistic.

You need systems, not guesswork

For a construction company of any meaningful size, WIP shouldn’t be a number somebody guesses at shortly before the monthly management accounts are prepared.

There should be a proper monthly process.

Your accounting, operational and project-management information needs to allow management to establish the financial position of individual contracts.

The finance team also needs information from contract managers and others responsible for delivering the work.

That information then needs to be reviewed critically.

If a project was originally expected to generate a healthy margin but costs are increasing, management needs to know.

Waiting until the project is finished to discover that the margin disappeared months earlier is far too late.

WIP is also a management tool

This is where WIP becomes about much more than accounting.

Good WIP reporting can help management identify:

Margin deterioration. Is a contract becoming less profitable than originally expected?

Cost overruns. Are labour, materials or subcontractor costs exceeding budget?

Problem contracts. Which jobs require management attention now?

Forecast profitability. What margin are we currently expecting when each contract is completed?

Quality of management information. Can the board actually rely on the monthly profit figure?

For me, that last question is crucial.

There is little point producing beautifully presented management accounts every month if one of the most significant numbers feeding into them isn’t reliable.

Review WIP at every board meeting

For a construction business, I would expect WIP to form part of the regular monthly financial review.

The board should understand not simply the overall WIP number but what is happening on the significant contracts underneath it.

Where have expected margins changed?

Why have they changed?

Have costs increased?

Has the expected completion date moved?

Are the remaining cost estimates still realistic?

Are there potential losses that need to be recognised?

These are commercial questions, not simply accounting questions.

Accurate numbers lead to better decisions

Management accounts should help you run your business.

If your WIP is inaccurate, your reported profit can be inaccurate. And if your profit is inaccurate, management may make decisions based on numbers that don’t reflect the true performance of the company.

For construction businesses, getting WIP right isn’t an accounting technicality. It’s fundamental financial management.

I’ve seen that first-hand from sitting on the other side of the table as a Finance Director.

If I were reviewing the monthly accounts of a construction company today, WIP would still be one of the first areas I would look at.

Need better financial information from your construction business?

At Paul Marks & Co Chartered Accountants, we help businesses improve their financial reporting and understand what their numbers are actually telling them.