This article introduces the reader to the three groups of reports and their associated goals and presentation formats. In addition I’ll explain in general how to read them. The follow-up articles cover in detail each group.
The following introduces the three groups of project reports.
Balance Sheet Set
The balance sheet set is read straight from the balance sheet and includes four distinct accounts:
- Contracts Receivable – found in the current assets section, it reflects the amount of contract revenue invoiced to customers that has not been paid at the time of the report.
- Work in Progress – also a current assets account, this account reflects the total dollar value of expenses incurred to date for all active projects
- Suppliers/Vendors Payable – a current liabilities account, it is strictly limited to those amounts owed to vendors/subcontractors/and suppliers of materials or labor for all projects. Another payables account is used and reflects non project based expenses such as rent, utilities, office supplies and so on. Typically these are your overhead based expenses.
- Progress Billings – also a current liabilities account, this account reflects earned income from the projects. When an invoice is generated for a customer related to a progress billing on a contract, the credit is assigned here. The corresponding debit is recorded in Contracts Receivable attached to this customer.
Notice that two of the accounts are asset based and the other two are liabilities based. In general the comparison between the four different accounts inform management of the overall financial status of the company related to the projects taken in the aggregate. The following is a short summation of this comparison review.
The receivables balance identifies cash that is currently owed to the company. Most owners will pull a receivables aging report and based on their knowledge of the customers, identify the most likely dates of payment of the invoice and via summation understand how much is going to be received this week, next week and the total over the next 30 days. Any customers with balances older than 30 days are given notice of potential project suspension in accordance with well drafted contract agreements.
The Work in Progress (WIP or CIP) reflects the total debits for all active projects. As some piece of material or labor is incurred on the project the transaction is recorded to this account. These dollar values accumulate over a period of time or throughout the lifetime of the project. Depending on whether management uses completed project or percentage of completion methods of accounting, the account values for a particular project are then transferred to the Cost of Sales section of the Profit and Loss Statement. The balance in this account fluctuates in differing values depending on circumstances.
Many owners confuse the total investment into project accounting by adding the contract receivables balance with the WIP balance. This is wrong. Receivables balance reflects how much is owed to the company from contracts. WIP reflects the current total investment in active projects.
Vendor/Supplier payables identify the total amount of money owed to material suppliers and subcontractors. It also includes other project related accounts such as the local government for permits or fees, debris removal, onsite utilities, and in some situations specific insurance amounts.
This account value also has an aging schedule as payables are traditionally control accounts and come with various vendor reports. The primary goal is to determine cash requirements over a given period of time. Proper management compares the cash flow from receivables to the cash needs of payables. Constant monitoring is essential to execute project coordination and final outcomes.
The fourth account is used to identify the total amount of billings to date for active projects. As a project is completed, the dollar value is transferred to the profit and loss statement’s revenue section reducing the value in this particular account. In general, management compares the total amount progress billed to date against the aggregate value in WIP. When WIP’s value exceeds progress billings by a preset sum; management reviews the various projects to determine amounts to be invoiced to customers. Overall, progress billings will generally exceed WIP as project billings include indirect, overhead and profit and WIP only identifies actual costs incurred to date.
Notice that the balance sheet set of reports has no detail of a respective project or summations of existing projects. It is strictly taken in the aggregate for all active projects. The next set of reports breaks out these two accounts (progress billings and WIP) into values per project.
Project Summation and Comparison
Most businesses that use project accounting or utilize project reporting have multiple projects underway. In evaluating these projects a summary set of reports is needed listing all the projects and their corresponding accumulated costs and progress billings to date. A good model of a report identifies the respective project, accumulated WIP and then the corresponding Progress Billings. In addition, the report includes the estimated total contract value and percentage of completion. The following is an example:
Progress Billings WIP Contract $ % of Completion
141108 $243,200 $203,841 $381,400 82%
150112 192,800 197,405 409,750 71%
150117 307,500 301,979 841,350 58%
150216 147,000 182,719 305,000 91%
In a project summation report like this a reader can discern a lot of information. For the novice the key is to understand that there is a relationship that exists between all four columns. The relationship exists in the aggregate and between the respective columns. As an example, take a look at Project # 141108. Notice that the project is 82% complete. If the contract value is $381,400 and we are 82% complete, this would mean that we have earned $312,748 of the contract. But, look at the progress billings to date. It is only $243,200 invoiced to date with the customer. Therefore, we have an earned amount of $312,748 and only billed $243,200 leaving us with an unbilled balance of $69,548 or around 18.23% of the contract value. Why is this important?
Often well written contracts have an indicator of the incremental stages of invoicing the customer for payment. Suppose this particular contract requires not less than 20% for invoicing purposes. Technically, we are 1.77% shy of the next opportunity or right to invoice this contract. As an owner, you may push the project manager to get that project to 84% completion for the right to generate the next invoice and get some cash into the company’s bank account.
Another example is Project # 150112. Are we on budget? Well to know this you would need to know your estimated profit margin for the respective project. Assume for this example it is 39%. The contract’s value is 409,750, therefore the cost of the contract is 61%. If we are 71% complete then we can calculate if we are on budget:
Step 1 – Determine the value of the contract earned to date: $409,750 X .71 = $290,923
Step 2 – Calculate the expected costs to date based on the percentage earned: $290,923 X .61 = $177,463 of expected costs to date
Step 3 – Via simple subtraction, determine over or under budget for costs accrued to date: WIP to date of $197,405 less expected of $177,463 means we are over budget by $19,942
If you are over budget, then the question is: ‘What is driving this cost overrun?’ The answer gets into the details of the project which is the next set of reports.
My goal here is to explain to you that there is a relationship that exists between these four columns. Other relationships include determining the backlog of available work; this is simply the value of the contract that remains to be completed. With Project # 150117, the open balance is 42% (100 – 58% completed to date) which means there is an uncompleted amount of $353,367 of work. If you add up the entire balance the company has an aggregated value. This is important because this backlog needs to be at a minimum threshold in order to maintain operational stability. If there isn’t enough work available then management should find out what is going on over in the sales department. Are there more contracts in the pipeline that will be signed soon? If not, do we consider laying off some personnel or slowing down production?
Sometimes senior management can compare project management skills by comparing similar projects. Suppose Project #150117 and 141108 are similar in nature with a different scale of volume ($381,400 contract vs. $841,350 contract). But each has a different project manager. Which project manager is performing at a higher standard? Well, I would imagine there are several standards but let’s assume for this issue we are basing are decision on costs of the contract to the actual expected costs. With Project #141108 we are expecting a cost of $200,159 with actual costs of $203,841. Not bad, the project manager is obviously on budget.
With Project #150117 we are expecting a cost of $312,309 and actual costs of $302,000. Again, not bad; the project manager is nearly on budget. By the way, I used a cost ratio of 64% to calculate the outcomes. Are our managers doing well? I would say yes, give them a pat on the back and let them know they are on budget and keep up the good work.
This is just one example of a project summation report and how it is used for comparison purposes. Other summation reports include:
- Individual Project Phase Costs to Estimated Costs
- Summation of Projects by Class or Divisions of Revenue
- Project Managers Summation Report
- Quarterly Comparison and Year to Year Comparison
Now that you understand your operation in the form of summation of the projects and are able to compare projects and management it is time to gain an understanding of the details for a particular project.
Now for the really good stuff! I’ve always believed that the real value for accounting comes in evaluating the details. This clearly separates the successful operations from the average business. With detail project reports and owner can distinguish what is working well and where there are issues.
Most projects have phases of creation. As an example, suppose Project #150112 is a radio tower. This company designs, fabricates, installs and tests radio towers. They use a seven phase breakout for the tower project. The phases are as follows:
Phase 01 – Contract Negotiations/Permits/Other
Phase 02 – Engineering/Design
Phase 03 – Software Coding/Testing
Phase 04 – Tower Fabrication
Phase 05 – Site Development/Foundation
Phase 06 – Installation/Erection/Mounting Hardware
Phase 07 – Testing/Analysis/Adjustments
In this example, the project is actually onsite and partially installed; the crane is still there raising the respective sections; thus we are only 71% complete. In my summation analysis above I have calculated that we are $19,000 over budget. The question right now is: ‘What is driving this cost overrun?’
To figure this out, we have to know how much we estimated as the cost for each phase and the actual costs incurred for each phase to date. Here is the report:
Project #150112 – Radio Tower #2015009 Seaward Orientation, Site 83-710098547A
May 31, 2015
Phase Estimated Costs Actual Costs
01 $22,700 $20,687
02 35,000 32,203
03 21,300 18,441
04 46,840 42,716
05 76,250 79,632
06 21,700 3,417
07 26,210 309
Totals To Date: $250,000 $197,405
It doesn’t appear that any particular phase is out of whack does it? Well this is where experience by the owner comes in handy. He immediately goes to Phase 05 and knows that more costs will trickle in from the various subs that he uses to prep the site for the tower. Experience has taught him that each phase has some outstanding unrecorded bills that will come in the mail soon. For example, the engineering firm he uses bills monthly and he gets his bills on the 10th. As of May 31, he has not received his bill for May from the engineers for the balance of Phase 02. He expects that bill to come in around $2,500 more but he just doesn’t know the exact amount. The same goes for other phases.
But for Phase 05 Site Development he knows that there are a lot more dollars coming into the accounting department due to the nature of how his vendors and suppliers bill him. He knows he is 71% complete and expects more costs to get recorded to each phase. However, Phase 05 already indicates over budget and it is likely to go higher. He now wants to know, what happened in Site Development that is driving the costs higher?
Now he can pull a detail report out of this project specifically identifying each cost incurred for Phase 05. How much was spent on site clearing and compare that to the estimate? How about costs for the foundation, the four pillars, any retaining walls/deadmen (foundation retention devices), etc. The key is that the detail reports identify the particular cost overrun and now he has to use subjective questioning to determine the cost driver.
By the way for this particular case, the soil condition was too soft and required a significantly larger and deeper footprint to prevent shifting of the tower in high winds; thus more concrete and rebar and associated foundation materials. Over a period of years he noticed that this particular phase generally had cost overruns and he modified his contracts to shift this risk back to the customer.
Other detail reports include:
- Cost of in-house labor for each phase
- Material costs for each phase
- Subcontractor costs for each phase
- Margins by phase
- Production time per phase
The key is that each phase of construction can be evaluated separately or the project can be evaluated as a whole. By grouping projects based on functions, a future estimate can be generated more accurately by comparing the details of prior similar projects with the initial estimates. Any deviations can be questioned and analyzed for adjustments. This entire process generates a feedback loop of information allowing for greater and greater profit margins for the business. Act on Knowledge.