One of the fundamental outcomes any construction company wants to achieve is an increased ability to take on additional work.
With the correct enterprise resource planning system in place (see construction software [link to Construction Software article below*]), your company will know where it has improved productivity, where it has reduced its costs and, at the touch of a button, be able to access accurate and timely financial information, creating a “portfolio” approach to projects.
Without these systems in place, data integrity, the ability to manage risk, and having a clear and accurate understanding of the value of Work In Progress (WIP) is both challenging and can put the company’s financial performance at risk.
Why is valuation of work in progress important for small and medium project based enterprise resource planning?
Accurate valuation of work in progress, and the processes that support it, is a normal function of the financial reporting cycles of larger contractors. There are considerable benefits for SME contractors to adopt these practices and procedures. The risks of not valuing WIP will be reflected in a distorted view of both the financial performance and position of the business. These distortions may include:
• An incomplete understanding of a project’s financial performance as a result of inaccurate forecasting processes;
• Over-stating or under-stating profits – resulting in an inaccurate view of the business’ overall profitability and the project’s capability to drive this further; and
• Working capital – incorrect disclosure on the balance sheet of assets and liabilities providing a distorted view of the financial strength of the business.
The benefits of correctly valuing WIP are:
• Managing project financial performance – disciplined procedures to forecast, update and document project costs and variations as well as managing employee performance;
• Managing company financial performance – by reflecting the movements of WIP you can provide accurate revenue, gross margin and net profit results monthly;
• Understanding the financial position of the company – accurate monthly WIP valuations and analysis aids management with respect to working capital and ultimately Return On Capital Employed (ROCE); and
• External stakeholders eg. banks – many SMEs use banking facilities to fund working capital and to provide bank guarantees for project performance.
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