Work in Progress Reports are vital to surety bond underwriting. Without good reports, it is impossible to accurately predict where a contractor stands currently and forecast the company’s future. Unfortunately, many contractors and surety bond agents do not know how to read these reports or understand the importance of them. You can read an abbreviated version here, but this article discusses in detail how Work in Progress Reports are put together, how they affect a contractor’s financial statements and how they can be used by surety bond underwriters. Having a better understanding of these statements will help contractors run their business better and obtain contract surety bonds easier.
Long Form and Short Form Contractor Work in Progress Reports
There are many ways to prepare a contractor work in progress report. Usually the format depends on factors such as the contractor’s internal accounting staff, software system or CPA firm. Some systems can even generate short form work in progress reports. However, these require more manual calculations from the contractor, surety bond underwriters and other stakeholders. Therefore, they should be avoided by most. However, a short form is still better than no work in progress schedule at all. For purposes of this article, we are going to focus on a long form work in progress report. We are also going to assume for the purposes of this article that a contractor’s financial statements are prepared on a percentage of completion basis. Not only is the required for many contractors, but it is also the most accurate way to account for construction projects.
Elements of a Proper Long Form Contractor Work in Progress Report
A contractor’s work in progress report should be through and useful to the construction company’s ownership, as well as other stake holders such as surety bond underwriters and lenders. Below is MG Surety Bond’s Work in Progress Report which is available for contractors to use. It can be downloaded here. We will use it as an example for the elements we need.
A proper contractor work in progress statement should contain the following items:
The Date of The Work in Progress Report
The date of the report is important. Normally, it should correspond to the date of the other financial statements being evaluated such as the balance sheet, income statement and statement of cash flows. Without having the same reporting date, a surety bond underwriter cannot properly evaluate the information and may have to make improper estimates.
Job Number (Column 1) and or Job Name (Column 2)
These items speak for themselves. Each project should have a unique identifier to distinguish it from other projects. We include both Job Number and Job name in ours, but many reports combine these two items. Just keep in mind that surety bond underwriters need a way to identify projects and often project numbers alone are not sufficient.
Contract Price (Column 3)
Contract Price is normally the first column of the report after the Project Name, Project Number, or Project Description. You will notice that in our report, we have a separate column for change orders. Often these two items are group together. Just make sure that if they are not separated, the Contract Price includes approved change orders and contract modifications to arrive at a Total Contract Price (Column 5)
Cost to Date (Column 6)
The Cost to Date field includes all costs incurred on a project up to the date of the contractor’s work in progress report. The information comes directly from the contractor’s job cost records and is one of the most important items a contractor can track. Contractors often fail when they lose track of costs and cash. A good system should be able to track job costs at least monthly. Failure to be able to pull accurate job cost information is a major red flag to surety bonds underwriters and a strong predictor of contractor failure.
Estimated Cost to Complete (Column 7)
The Estimated Cost to Complete is the contractor’s own estimate on what costs are remaining on the project. It does not take into effect what has already been spent on the project. It is one of the most difficult estimates a contractor must make because it the contractor must be realistic about what costs remain, regardless of the contractor’s initial estimates. Without an accurate Estimated Cost to Complete number, the contractor’s work in progress report will not be accurate and useful.
Estimated Total Cost (Column 8)
Estimated Total Cost is the contractor’s estimated total cost on the project. This is simply the sum of Cost to Date and Estimated Cost to Complete. Our work in progress schedule adds these together for the contractor.
Estimated Total Costs = Cost to Date + Estimated Cost to Complete
At the beginning of the project the Estimated Cost to Complete is the same as the contractor’s Total Estimated Cost for the project. However, as the project progresses, this estimate may increase or decrease.
Percent Complete (Column 9)
Percent Complete is a measure of the project’s progress. There are a few different ways to calculate a project’s percentage of completion for contractors.
Cost to Cost Method
The cost to cost method is the most widely used method and the method appropriate for most contractors. This method is calculated by dividing Cost to Date by the Estimated Total Cost. The equation looks like this:
Cost to Date/Estimated Total Cost = Percent Complete.
The Billings Method
For some contractors, the Cost to Cost Method may not be appropriate. Another alternative is The Billings Method. The Billings Method is calculated by dividing Billings to Date by Total Estimated Billings.
Billing Method = Billings to Date/Total Estimated Billings
The Gross Profit Method
A third method when the others are unavailable is the Gross Profit Method. This method is calculated by taking the Gross Profit Earned to Date and dividing it by the Estimated Total Gross Profit on a project.
Gross Profit Method = Gross Profit to Date/Estimated Total Gross Profit
Estimated Gross Profit or Loss (Column 10)
Estimated Gross Profit or Loss is simply the Total Contract Price minus Total Estimated Costs.
Estimated Gross Profit/Loss = Total Contract Price (including change orders) – Total Estimated Costs
As you can see, this is reliant on the contractor’s proper estimates of the cost to finish the project. Surety Bond Underwriters look closely at if a contractor’s projected profit holds up as the project progresses or if the projected profits go down (profit fade) as the project advances. Profit fades can happen to the best
of contractors. However, a history of profit fades may be a sign of bad estimating or bad supervision.
Gross Profit Earned to Date (Column 11)
This is the portion of the project’s profit that a contractor has earned at a given point in time. It is calculated by taking the Estimated Gross Profit and multiplying it by the Percent Complete.
Gross Profit Earned to Date = Estimated Gross Profit X Percent Complete
Alternatively, it can be calculated as The Total Contract Price multiplies by Percent Complete and the subtracting Cost to Date. Both methods are acceptable. It is important for both contractors and surety bond underwriters to know how much of the project’s total gross profit the contractor has earned at any given point in time.
Billings to Date (Column 12)
Billings to Date is the cumulative amount the contractor has billed the Owner or General Contractor on a project from the beginning of the project to the date of the reporting. This information comes from the contractor’s records and usually their accounting system. Good billing practices are vitally important to contractors and should be done as quickly as possible.
Overbillings and Underbillings (Column 13)
Overbillings are when a contractor’s billings exceed their earned revenue on a given project. They usually show up on a balance sheet under the Title, “Billings in Excess of Costs and Estimated Earnings on Uncompleted Contracts”. To calculate Overbillings, you take The Billings to Date (Column 12) and subtract the sum of Cost to Date (Column 6) and The Gross Profit Earned to Date (Column 11). This is the amount of the Overbilling on the project if there is one.
Overbillings = Billings to Date – (Cost to Date + Gross Profit Earned to Date)
Let us give a simple example. If a project is 50% complete and the contractor has billed 60%, the project is 10% over billed. Overbillings show up as a current liability on a contractor’s balance sheet. This is because a contractor has billed for work that they have not earned yet. The rationale is that they will incur costs later in the project that they cannot bill for again. You can see this on our sample balance sheet below. If Column 13 has overbillings on our work in progress, this amount gets transfer to our balance sheet as follows:
Slight overbillings are considered a good practice in construction, especially early on in a project. Early overbillings help cover things like mobilization, surety bond premium and builder’s risk insurance premiums that must be paid upfront. Slight overbillings can keep a contractor from having to tap into bank lines and other forms of credit. However, keep in mind that overbillings must be paid back throughout the project so too much over billing can still be a bad thing. Surety Bond Underwriters will look for cash or accounts receivable balances that will offset overbillings to make sure the contractor has the resources to pay these back to the project. Sometimes, contractor get into a situation called “Job Borrow”. Job Borrow occurs when the contractor is over billed more than the remaining profit in the project.
A more in depth read on Overbillings can be found here.
Underbillings are just the opposite of Overbillings. They occur when a contractor’s billings are less than a contractor’s earned revenue for a given project. They typically show up on the balance sheet titled, “Costs and Estimated Earnings in Excess of Billings on Uncompleted Contracts”. Underbillings are calculated by taking Cost to Date (Column 6) and adding Gross Profit Earned to Date (Column 11) and then subtracting Billings to Date (Column 13) from the total.
Underbillings = (Cost to Date + Gross Profit Earned to Date) – Billings to Date
Let us use a simple example. If a contractor if 50% complete on a project but only billed for 40%, the contract is 10% under billed. Underbillings show up on the balance sheet as a current asset and directly affect a contractor’s working capital. In theory, this is an asset because a contractor has performed and earned revenue that they have not yet billed for. If Column 13 of our contractor work in progress have Underbillings, they will show up on the current asset portion of our balance sheet as show below.
Having more assets and working capital may sound like a good thing. However, surety bond underwriters are very skeptical of underbillings. A contractor should bill for work they have performed, and the best contractors are able to get a head the project and be slightly over billed. Therefore, underbillings are often a sign of problems. These are usually where contractors hide job losses either knowingly or unknowingly. For example, unapproved change orders often show up as underbillings. Contractors perform the work but cannot bill for it.
Another issue with underbillings is that they may be a sign of poor accounting practices or internal controls. Again, not billing for earned revenue is a bad practice and should be avoided. You can read more about underbillings here.
Gross Profit Remaining (Column 14)
Gross Profit Remaining is the estimate of how much profit is left to earn on the projects a contractor has under contract or “backlog”. The calculation is Estimated Gross Profit (Column 10) minus Gross Profit Earned to Date (Column 11).
Gross Profit Remaining or Backlog Profit = Estimated Gross Profit – Gross Profit Earned to Date
This is an important ratio because a surety bond underwriter can determine if a contractor already has enough profit in their backlog to cover overhead expenses and make a company wide profit on the year or if they will need additional work to do so.
Scheduled Completion Date
Scheduled Completion Date is not a common item to see on a contractor’s work in progress report, but it is very useful. It is included on the SBA work in progress report for contractor using that program. By providing an estimated completion date, it allows surety bond brokers to calculate a contractor’s runoff and potentially get them more surety credit.
Underwriting contractor financial statements is a challenge and quality financial statements are important. Contractor must make estimates that constantly change throughout the course of a project. Having an accurate work in progress report is vital to surety bond underwriters and other lenders. These reports are normally a requirement for contractor seeking contract bonds such as bid bonds, performance bonds and payment bonds. Additionally, having an accurate report can help contractors catch project issues before they become a larger problem. Contractor should take time to make sure they have the systems in place to put together timely contractor work in progress reports. They should then be viewed and managed regularly to make sure projects are performing as expected.