In a study of thousands of construction company audited financial statements testing the profit projected on work in progress (WIP) reports over five years to the final reports of completed project profits, I found the average difference to be a little over 1% profit bleed. This suggests that industry-wide reported annual profits in any given year were likely overstated by more than a percent, which is huge when you consider that construction industry profits are low to begin with. 

This "profit differential (bleed)" is one of the main causes of the frequent, sudden, catastrophic failure of construction concerns large and small, old, and new. The exaggeration of WIP profits is unfortunately too common and, for the most part, caused by misplaced optimism, unaware management and, in rare cases, deliberate deception. I probably don’t have to tell you that it is almost impossible for outside auditors to test WIP because they are not construction estimators, and by the time they are conducting an audit the projects are two or three months further along, making it just about impossible to verify the claimed percentage complete in prior months. To rectify this exposure, the responsibility for accurate timely WIP reporting should be assigned to the CFO who can then organize the reporting process to prevent the overstatement of WIP reporting which can, and often does, lead to fatal self-deception.

An Accurate Guide Not a Comfortable Cushion

The Work in Progress reports determine whether we are over-billed or under-billed on the jobs under way. This is an important piece of information that, if inaccurate, can make bank accounts looks good when most of the jobs are halfway to completion only to have profitability falls apart when several of the jobs simultaneously near completion. This can also explain why some projects run out of money before they get to the punch list. Not knowing where we stand on costs during progress creates cash flow problems that research shows often prove fatal.

Accounting for WIP

Accurate construction accounting depends on the correct calculation of over/under billings. On the balance sheet, over-billing is a short-term liability and under-billing is a short-term asset and if they are wrong the information is misleading.