After a project is completed, it’s useful to perform a “postmortem” to not only analyze what went right and what went wrong, but also apply what you learned to improving performance on future projects. But what about current jobs? Using work-in-process (WIP) reports, you can monitor vital signs while jobs are in progress and then, if needed, look for ways to breathe new life into them.
Analyzing WIP for key indicators
WIP reports track key information about each of your jobs, such as:
- Contract price (including approved change orders and, possibly, unapproved change orders you’re confident you’ll collect),
- Estimated job costs (including change orders),
- Estimated gross profits (with and without change orders),
- Costs incurred to date (including accrued expenses not yet billed),
- Revenues recognized,
- Percentage of completion,
- Billings to date, and
- Billings to date in excess of revenues earned to date, or vice versa.
Regular WIP reports can help you spot problems and address them before they escalate out of control.
For example, the report may indicate that a job is underbilled — that is, revenues to date exceed billings to date. Underbilling may signal a variety of potential problems, such as management inefficiencies, lax billing practices, cost overruns or a risky number of unapproved change orders. Any of these problems can strain your cash flow or jeopardize your bonding capacity.
Underbilling isn’t always a bad sign, though. It may simply reflect significant front-loaded costs that will be recovered gradually over the remainder of the job. But if jobs are underbilled, you should investigate further and ascertain the causes.
Generally, on healthy jobs, you want to see billings to date that equal or exceed revenues to date. But it’s a good idea to examine high levels of overbilling. In most cases, overbilling means you’re doing a good job managing cash flow. But if overbilling results from some sort of management deficiency — unrecorded costs, for example — it can be a sign of trouble ahead.
Also, while sureties generally view overbilling as a positive, they’ll compare billings on all of your jobs to make sure you’re not “job borrowing” — that is, overbilling on some jobs to compensate for shrinking profits on others.
Comparing WIP reports and completed contract schedules over time can reveal dangerous trends, such as “profit fade.” As the name suggests, profit fade is a gradual decline in estimated gross profits over the life of a project. There are many possible causes, including poor estimating, inaccurate job costing, sloppy project management (particularly with regard to change orders) and unexpected job-site problems.
Understandably, sureties don’t like profit fade, so a pattern of declining profits can hurt your bonding capacity. To address this problem, evaluate your estimating procedures, job costing systems and management practices, and consider using more conservative estimates. A surety would prefer to see your estimated profits start at 4% and grow to 6% rather than start at 10% and shrink to 6%. But don’t be too conservative, or sureties may question your estimating abilities.
A powerful diagnostic tool
WIP reports can be a powerful diagnostic tool. But like any tool, they’re effective only if you use them properly. The reports should be prepared frequently — ideally, monthly — using accurate, timely information. And management should review the reports carefully and take prompt action to address any weaknesses or troublesome patterns they reveal.
Depending on the system you use to generate WIP reports, it may also be possible to organize WIP information by job type, location, contract size, and project manager or estimator, thus providing valuable insights into the factors that drive your construction company’s profitability.