Now that we have successfully measured our Negative Work In Progress (WIP) balance, how do we interpret it?
Our large negative WIP balance should remain relatively stable if not become slightly more negative throughout the year as we bring on more clients to these arrangements. If we have priced our services accurately we should find at the end of each engagement the total value of billable time incurred closely matches the total value of invoiced time. Provided we can meet our deadlines to deliver the work throughout the year we have successfully spread the cost of our services for our customer throughout the year, benefited from repeating reliable cash flow, and incurred no write-offs. Our negative WIP balance also represents the value of an overdraft we would have otherwise had to have with the bank.
One of the indicators of a dangerous negative WIP balance is when it is increasing rapidly. For an individual job this occurs where the invoiced value to date is much greater than the billable value of work done to date. This is okay if we’ve met all of our deadlines and obligations on the contract but it can be an indicator that we have a lot of work yet to do in an increasingly small space of time. On a practice level we can end up with a negative WIP crunch at the end of the financial year.
It is tempting for partners, job managers and staff to prioritise billable fee based work as it brings in cash immediately. Fixed-price agreement work has already been invoiced, so where a team member or job manager may be incentivised to increase their billable time or revenue contribution for a month this work can slip to the bottom of the pile.
Let’s look at an example:
Let’s say Aardvark & Aardvark CA are an Australian based accounting practice where most of their clients have a 1 July balance date. If they have a Negative WIP balance of ($400k) on the 30th of April, they potentially have $400k in billable work to deliver that they’ve already invoiced. If they have 10 billable team members that assumes $20k in billable time is added to these jobs by each of our billable team members for the next 2 months. That’s tight. The team at Aardvark & Aardvark CA cannot take on any other billable work for those two months without risking not meeting their deadlines on their fixed-price agreement agreements. That’s not a position you want to find yourself in.
So how do we avoid a negative WIP crunch?
Fortunately by organising our job categories to match our engagement types we are able to easily filter our total WIP balance found at Business > WIP into just our negative WIP balance. By looking at the ‘List’ view we can see which jobs we need to ensure we are able to hit our upcoming deadlines for. By running our negative WIP report for multiple months we are able to make sure the negative WIP in our practice is not getting out of control.
The easiest way to see how your negative WIP is tracking is to use the WIP Performance report in Link Reporting using the toggle to only show your negative WIP balances.