“It’s a work in process,” I said, as my wife stared at the partially installed and therefore fully ineffective replacement shower door. Where she saw an incomplete Honey Do project, I saw progress—small though it may be.
I’ve run into similar situations when looking at some of my clients’ financial results. The owner will tell me, “We’ve been working like dogs! Everyone has been very productive, with lots of good output but no cash to show for it—yet.”
Where Did the Money Go?
That last word is important. The client spent considerable time and energy delivering services but hasn’t reached a point where they can bill customers for those efforts. They are stuck with work in process, or WIP as number guys like me call it.
Most businesses have some work in process built into the way they function. For a manufacturer, these would be partially finished goods awaiting completion. In that world, WIP is a key financial metric, so calculating its dollar value is common.
Not Just for Manufacturers Anymore
Service-based businesses generally pay less attention to WIP. That’s because there’s not too much time between when they provide the services and when they bill for them.
Here’s the problem with WIP for those businesses. It often sits invisibly in the corner, sucking up time, energy and cash. Sometimes it consumes so much cash that the business appears to be losing money, when it’s actually sitting on a large pile of incomplete but profitable work. After the project is completed, and we send the invoice, presto: profits improve and cash soon flows.
When to WIP
There are two instances when service businesses are really running blind by not paying attention to how much time, energy and cash is caught up in WIP.
#1: Contingency work – If you provide services and getting paid depends on a successful outcome, you should consider calculating WIP. Law firms, commercial real estate brokers, and property tax appeals are just a few examples.
When you are providing services and uncertainty looms over when, and maybe even if, you will get paid, huge dollars can get trapped in WIP. Money is going out to pay for the labor and material to provide the services, and those expenses likely show up immediately in your income statement. But they won’t be offset by any revenue. This distorts your profitability picture. It also makes it darn near impossible to re-evaluate and assess the worthiness of your contingency based services. Bringing WIP into the picture provides insight into the dollar size of your efforts and energy.
#2: Long time to completion – I have clients who build houses. Sometimes projects take a year or longer to complete. While intermittent billing may occur during construction, typically a large amount of money goes to pay for subcontractors and materials. This often overwhelms the income statement and distorts the project’s profitability. Calculating the value of WIP gives us clarity into how the project is going.
You may notice I didn’t include the recipe for WIP. That’s because the calculation—and the ingredients it includes—varies by type of business. What I can share is that if your company faces the two situations just mentioned, then getting your arms around WIP will remove a major blind spot in your financial picture.
If you are considering WIPping your business into shape, please contact me for some tips and advice on how to make that work. In the meantime, it’s time to get back to the process of installing that shower door …