work in process

Secrets of Bonding #57: (4 of 4) Work In Process Schedules – Own Them!

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WIP Schedule, Effect on Balance Sheet Analysis

Now we pull it all together.

Here again is our sample contract.

Contract Price / Original % GP  /   Billed    /     Costs to Date  / Remaining Costs

$1,100,000     /        10%            /$550,000 /    $350,000      /  $700,000

What did we determine so far?

  1. We found that the job is 33% complete.
  2. The profit % has slipped from 10% to 4.5%
  3. The contract is Overbilled by $187,000

In addition to generating some discussion (What’s going on with this project?), these facts have an effect on the financial analysis and bond worthiness of the account. They could result in the bonding line being reduced and future bonds being declined.

How does this happen?

Remember the Overbillings are dollars the contractor has in hand, but at this stage of the project they are undeserved.  The dollars are comprised of costs and profits, and the profits are unearned at this point.

So where are these “undeserved funds” on the balance sheet?  There is no entry by that name on the Balance Sheet.  These dollars are sitting in the cash account, along with other cash owned by the company.  These dollars are not yet earned or deserved, yet they are sitting in the account looking normal.

The solution is to reconcile (recognize) the undeserved funds by creating a corresponding liability that offsets the Overbilling cash asset. This Current Liability will be called Billings in Excess of Costs and Estimated Earnings. In short, this is referred to as Overbillings.

In this case, there will be a $187,000 Overbilling Current Liability to offset the undeserved funds in the cash account (Current Asset).  This removes the extent to which the Overbillings inflated the Working Capital calculation (Current Assets minus Current Liabilities).

In an Underbilled situation, a Current Asset called “Costs and Estimated Earnings in Excess of Billings” would appear.  (Notice that it sounds like the opposite of the Overbilling title.) This adds to Working Capital by reflecting the earned funds that have not been collected because the billings are not current.

Here are some CPA comments regarding WIP schedules and their importance:

http://www.reacpa.com/the-contract-schedule

Conclusion: The analysis described in this series is critically important for contractors and their surety.  However, the analysis is impossible if the contractor does not keep valid records of the costs attributed to each individual project and then periodically re-estimate the Remaining Costs to Complete based on the actual realities experienced.

Watch for #58 – a Bonus Edition!

FIA Surety is a NJ based bonding company (carrier) that has specialized in Site, Subdivision, Bid and Performance Bonds since 1979 – we’re good at it! 

Call us with your next one.

Steve Golia, Marketing Mgr.: 856-304-7348

First Indemnity of America Ins. Co.

 

 

 

Secrets of Bonding #55: (2 of 4) Work In Process Schedules – Own Them!

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Finding the Degree of Completion

When analyzing the financial condition of construction companies, the Work in Process schedule is always a required item.

Much of this evaluation keys into the degree or percentage of completion of each project. When you read a WIP schedule there may be no column heading for this number, but it is easy to calculate. Noteworthy: There are some inaccurate ways to determine this percentage, so you will want to figure it yourself in any event.

Formula to find the % of Completion:
Divide the Costs Incurred to Date into the Total Costs to Complete. The percentage of the total costs that have been incurred so far is the degree of completion for that project. If the Total Costs to Complete are not shown, you may need to add the Costs Incurred to Date to the Remaining Costs in order to find the Total Costs. The degree of completion is based on a cost analysis because until you incur your last cost, you are not finished – regardless of the status of the billings.bookkeeper2

Common misconceptions about the % of completion:

1. The % of completion is based on the degree of Billings. (No, it is based on an analysis of the costs.)
2. It is always based on the original contract amount. (No, the Current Revised contract amount is used if a plus or minus change occurred.)
3. It is based on the original estimate of total costs. (Incorrect, the Current Revised Estimate of Total Costs is always used.)

With all this in mind, what is the degree of completion on this contract?

Contract Price / Original % GP /      Billed    / Costs to Date / Remaining Costs
$1,100,000     /          10%          /$550,000 /  $350,000     /    $700,000

Raise your hand if you got 50%.

OK, that’s wrong… The typical short WIP schedule doesn’t show everything. It may not give you the Current Estimate of TOTAL Costs. First, you must find that.

So $350,000 + $700,000 = $1,050,000 Current Estimate of Total Costs

350,000 / 1,050,000 = .333 or 33.3% Did I hear someone say “Why didn’t I pay more attention in math class?!”

So the project is 33% complete based on the portion of the total costs that have been incurred so far.

Knowing the percentage of completion is important for a number of reasons. From a project management viewpoint, it is normal for the contractor to establish a projected timetable to assure on-time completion of the project. By periodically reviewing the degree of completion, the project manager can confirm they are on track. There may be financial rewards for early completion or a punishment, “liquidated damages,” if they’re late.

There are other important uses for the % of completion. We’ll go over them in the next segment… with the haunting title: “3 of 4!”

FIA Surety is a NJ based bonding company (carrier) that has specialized in Site, Subdivision, Bid and Performance Bonds since 1979 – we’re good at it! 

Call us with your next one.

Steve Golia, Marketing Mgr.: 856-304-7348

First Indemnity of America Ins. Co.

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Secrets of Bonding #54: (1 of 4) Work In Process Schedules – Own Them!

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Short Form WIP Schedules 

In the next few articles we will explore a somewhat complicated and often misunderstood element of the contractors file, the Work In Process or “WIP” schedule (also known as Work On Hand “WOH”).

Why is the WIP schedule important?

bookkeeper1

For Contractors
The WIP schedule is a critically important project management tool, or at least it should be.Contractors use this info to increase revenues and profits.
For Sureties
Underwriters use this form to manage the account and help avoid claims and losses.
For Agents
As the intermediary, the agent must appreciate both points of view and be the facilitator who creates the “win-win” strategy.

Before we explore the details of this subject, let’s review some of the key terms that are used.  For the purpose of this article, we are focusing on a “Short Form WIP schedule.”  There is a long version of the document (more columns of info) that may be too complicated for many contractors to complete without professional assistance.  Since you are likely to see the short form, that’s what we’ll discuss.

The following terms commonly appear on WIP schedules and on company financial statements.  There is a row of column headings across the top.  Download a blank form: FIA Surety WIP Sched. Let’s go over them:

  • Project Name: This is the name of each individual contract
  • Start Date: Date the contract commenced
  • Original/Revised Completion Date: This is the completion date required in the contract, or as subsequently changed by contract amendment.
  • On Time Completion Expected?
  • Bonded?
  • Current/Revised Contract Price: It is not uncommon for the contract price to be changed after the work has commenced.
  • Original Gross Profit Percentage: This ties into the performance bond request form.  In order to facilitate analysis of the contract going forward, this number must be expressed as a %, not a dollar amount.
  • Billed to Date (including retainage): This is the sum of all the amounts invoiced to the project owner (bond obligee) by the contractor.
  • Cost to Date (including approved change orders): These are labor and material costs incurred by the contractor in the performance of the project.  They are “direct costs” exclusively, and do not include any expenses considered Overhead.
  • Revised Remaining Costs to Complete: Current reevaluation of the project costs based on the current / revised contract price. This is a revised cost estimate for only the incomplete portion of the project.

From surety to surety, you will find slight variations in the column headings on a Short Form WIP.  For a more complete analysis, additional columns are needed.  When viewing a WIP schedule prepared by a CPA, you may see the longer version which we will discuss later in this series.

An Analytic Tool

Let’s talk about the nature of this document.  Like all businesses, construction companies are in business to generate revenues and produce a “bottom line” profit for the company owners (meaning after all expenses have been paid).

Construction companies engage in individual contracts or projects, and are paid periodically during the progression of the work.

These payments are normally monthly and are a result of an invoice, or “monthly requisition,” the contractor gives to the project owner for work completed in the preceding period. When the requisition is owed or outstanding, it is an asset on the Balance Sheet called accounts receivable (meaning it is billed but the funds have not come in.)  The dollars become part of revenues or sales (top line of Profit and Loss Statement) when the dollars are received.

The construction industry is highly competitive and often contractors must bid to acquire projects, and only win them if their prices are the lowest.  This means for many contractors, margins are thin.

From a management perspective, construction companies must know if their projects are proceeding as expected.  They need to monitor the progress to assure that the work goes as planned and yields the profit expected.  Contractors must be vigilant to protect the success of the project, and avoid unprofitable contracts that drain funds from the company. The WIP schedule is the document that shows the current status of all open (incomplete) contracts, including their past and future projected financial results.

Keep in mind that financial statements (FSs) of a construction company may be prepared on one or two set dates every year (such as 12/31 and 6/30, etc.,) but they  perform contracts all year – meaning that on 12/31, some projects are partially incomplete.  In order for the financial presentation to include everything worth knowing, there must be a way to show these open jobs. That is the relevance of the WIP schedule for bond underwriters and other grantors of credit.

In number 2 of this series we will go over some of the info that is revealed on the short form WIP schedule.  You’ll agree, this document is absolutely essential!

FIA Surety is a NJ based bonding company (carrier) that has specialized in Site, Subdivision, Bid and Performance Bonds since 1979 – we’re good at it! Call us with your next one.

Steve Golia, Marketing Mgr.: 856-304-7348

First Indemnity of America Ins. Co.

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