How to Calculate Work In Progress (WIP) Days
Mastering Work In Progress (WIP) is essential to operational efficiency, and consequently having sufficient cashflow in the business. WIP for Service businesses represents direct costs such as staffing, subcontractor, and/or material costs that have not yet been invoiced.
Calculating WIP Days is the simplest way to control your WIP:
WIP Days = (Total Current WIP / Direct Costs) × Time Period Days
Here's an example:
Carlie's Consulting has $100,000 WIP at the end of the month
Direct Costs for the month of April were $250,000
WIP Days are ($100,000/$250,000) x 30 days = 12 Days
Here's Carlie's main competitor:
Chris's Consulting has $250,000 WIP at the end of the month
Direct Costs for the month of April were $125,000
WIP Days are ($250,000/$125,000) x 30 days = 60 Days
This means that for every dollar in direct costs invested by Carlie, she has to wait an average of 12 days to invoice them to her clients. Not bad!
Chris however has to wait 60 days to invoice his direct costs to his clients ... which is too long.
This has a direct impact on Cashflow - Chris has to finance his direct costs for an additional 48 days!
How to reduce WIP Days
There is one simple way to reduce WIP Days: Get Your Jobs Invoiced Earlier:
1. Review client contracts
Review invoicing terms in your client contracts and reduce the time to invoice as much as possible. For example if you currently invoice monthly, reduce this to weekly for new contracts and update for existing clients at contract renewal. If you work with long-term contracts (longer than 1 month) with invoicing on completion, build "stage of completion" clauses into the agreements.
2. Job Management Systems
Move on from managing your jobs via email, sms, and Excel!
A good job management system allows you to:
Quote/Estimate jobs
Schedule work
Purchasing - issue Purchase Orders to help with cost tracking
Track labour, materials and subcontractor costs on each job
Invoicing
Reporting: Quote vs Actual costs, invoicing, and profit
Reporting: Work In Progress for jobs started by not yet complete
3. Review WIP regularly
The backbone of managing WIP is to review it regularly. This is an operational management task that often includes Finance staff, who together aim to:
Review project progress against original planned timeline with relevant Project Manager/s
Calculate the actual pattern of costs and invoices against original project budget to determine if the Margin Burn is on track
If either of those is running behind the project plan, determine what actions need to be taken to bring the project/s back on track
4. Report WIP progress
WIP Days should be included on Management reports and where applicable, Board reports. Slippages in project timeframes should be queried and the action plans justified.
Remember: WIP is one of the biggest investments a growing business makes. If costs are spent earlier than expected (or they blow out) it can take a long time to recover them, depending on your contract terms. So, stay on top of it!
Conclusion
The pulse of WIP Days resonates deeply with cash flow dynamics, serving as a delicate yet potent lever. Any elevation in this metric can significantly strain financial resources, whereas optimization thereof can considerably ease cash-flow pressures. Particularly in service businesses, where working capital is predominantly tied to labour, materials, and other job-related expenditures, a profound comprehension of WIP Days and its implications is paramount.
When your service business is growing, your fastest growing investment will be in WIP - that's why it's essential that you get it under control. If you don't, it can starve your business of cash.
This is one of many articles on Cashflow, Working Capital Management, and Growth. Find out more in our blog.