Why do Businesses get caught out by Long Term Work in Progress?

Why do Businesses get caught out by Long Term Work in Progress?

Work in progress (WIP) is inventory that has begun the manufacturing process and is no longer included in raw materials inventory, but is not yet a completed product. On a balance sheet, work in progress is considered to be an asset because money has been spent towards a completed product.

If you do not know your progress on long term projects and contracts, it can be hard to know how much profit you are making or what losses you may be incurring.

Whilst long term work in progress is something your accountant should work out for you with your year end, end of year accounts are produced 6 to 9 months after the year end, so you may get unexpected corporation tax bills or worse, have spent money that you shouldn’t have.

What is short term work in progress?

Short Term Work in Progress is partially finished goods or services awaiting completion that have not been fully invoiced to the customer, and is measured at a period end, usually with the year end or management accounts if these are prepared. 

It includes the direct costs used in the product or service and possibly an element of attributable overhead, but is usually made up of the cost of materials, labour, transportation and any other direct costs. 

It must not include any profit element and if the Short Term Work in Progress cost exceeds the anticipated income, then it is written down to its net realisable value.

What is long term work in progress?

Long Term Work in Progress is, by its nature, work in progress that takes longer than 12 months to complete.  

As it takes a long time to produce/ finish, then it is a more complicated calculation, where it includes not only all the direct costs, it should include a proportion of overheads and also a proportion of your anticipated profit or the full amount of your anticipated loss.

However, this is complicated as you would likely have had some stage or interim invoices and payments .

At the end of your accounting year or period end, you have to work out how much you have spent on the contract, say 40%, then look at what you have invoiced to date, then anticipate all future costs.

If that shows a loss then you have to account for the total anticipated loss on that contact or job. If it shows a profit then you take a proportion of the profit. 

It is important to note that work in progress can be a different figure dependent on how long the contract or job is for. 

Long term work in progress
Long term work in progress

What do business owners need to do now?

Work in Progress can be complicated so if you’re struggling, get expert help to look at it and set up the right systems to measure it. 

Make sure you are regularly checking work in progress with your regular management accounts. Otherwise, you could be in for some surprises, like unexpected tax bills or worse,  thinking you have made lots of profit to find out that you have incurred losses instead. 

So often monies dry up towards the end of contracts, so make sure you know where you stand, as you need to protect your cash. No business goes bust if it’s got cash, but many have despite being profitable.

If this issue resonates with you and you want to have a no-obligation chat with Graham on a 1 to 1 basis, email Graham at chatwithgraham@wessexcommercial.com

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