Making a loss at the end of the year due to a bad evaluation of the work in progress is damaging for a company. Revenues and profits can be artificially created during the year, but reality always catches up with us.
What Is Work in Progress?
How do you define work in progress? It is the work done that has not been invoiced. In the context of a project billed by the hour to a client, the estimation is quite simple, we know the number of hours completed and the rate billed to the client. However, for a fixed price project, things get more complicated. Here are the important parameters of fixed prices:
1) The Initial Estimate
When calculating a fixed price, the work is estimated in quantity and multiplied by a unit price.
The obtained amount becomes our budget. But we must revise our calculation if the amount differs after negotiation with the client. We can adjust the hours (more risky) or the unit price (more conservative).
3) The Amount Billed
As the project progresses, an invoice is sent to the client, often reflecting a percentage of the budget or a contractual milestone.
4) The estimate to complete the project
This is usually the step that is left undone. The quantities required to complete the project must be estimated multiplied by the unit price.
How to Calculate the Work in Progress?
To calculate the work in progress at the end of a period, the following formula should be used:
Budget – Billed to date – Estimated to complete the project
If the work in progress is negative, it means that the project was less successful than expected and that there is more work to be done than the available budget. Therefore, a loss must be recognized.
The Importance of Revising Progress
If the work in progress is not reassessed monthly, your income is artificially inflated and does not give you a true picture of your financial situation. You think you are making more profit than you actually are. The impact on cash flow will be felt at some point, as these revenues will not be billed, but the costs are actually incurred.
Advice from an Accounting Expert
- Take the time to evaluate the work in progress by project and on a monthly basis
- Do not underestimate the number of hours required to complete the project
- Make sure you have a reliable calculation tool, many systems work well for hourly projects, but not so well for fixed price projects
- Make sure you do not recognize more revenue than the budget and negotiate riders before recognizing revenue for additional work
- Periodically review the unit price used, if different rates per resource are used in the estimate, it makes the calculation of work in progress even more complex
Have You Considered the Benefits of Outsourced Accounting for Your Business?
Are you a business owner? Are you considering starting a business? If the answer to any of these questions is yes, you should keep in mind that in addition to the main activity of your business, you will have to deal with many activities in its daily operation: administrative, technical, social and financial among others.
Because of this large number of tasks, many companies decide to outsource their accounting. Outsourcing accounting offers several benefits such as:
- Reducing overall costs
- Improved data security
- Access to a variety of services
- Minimize risk
- Helps you save time and focus on expansion
- Helps you retain projects and clients
- Helps you make better decisions faster
If you have any questions or would like to know more about our services, please contact us. We will be happy to help you.
Marie-Andrée Giroux, FCPA, FCMA