This article is an extract from the book 'Everything you need to know about Xero Practice Manager'
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Like an iceberg on a foggy night in the Atlantic, your total WIP balance in your practice can be misleading. For most practices, your total WIP balance contains two large numbers: a large positive billable WIP balance and a large negative WIP balance. In this section we’ll be discussing the submerged side of your WIP so you can steer clear of the hidden dangers that practices run into.
Negative WIP represents the value of work you’ve invoiced that you’ve yet to do. This is a current liability to your practice as you have a present obligation to deliver future services to your customers arising from a past transaction (the invoice).
The most common reason for a large negative WIP balance is fixed-price agreements. These were covered in Chapter 7: Setting Up Engagements. Fixed-price agreements typically involve a monthly recurring invoice that spreads the invoiced value of the work across the year. Each of these invoices causes a decrease in the WIP balance for a job.
Some of our in-period tasks like GST, payroll services etc occur throughout the year and may offset this decrease in a job’s WIP balance. The lion’s share of the work in an annual engagement, however, is completed in a single month, meaning that for most of the year our fixed-price agreement jobs will have a negative WIP balance. The billable value of time added to these jobs for 11 out of 12 months of the year will not offset the monthly invoiced value.
Why do we care? Due to the nature of a fixed-price agreement engagement, the time added to these jobs (although billable) is not used to determine the invoiced value of these jobs. We therefore want to exclude our fixed-price agreement jobs from our invoicing decisions. The invoicing for these jobs is independent of the time being put to them each month, and independent of their WIP balance. The aim of the game for our negative WIP balance is not to reduce it but to ensure we are able to meet our obligations on these jobs as they fall due. We are wearing the risk of the total annual billable time incurred in delivering this work being over and above the total annual invoiced value of the engagement. This makes budgets, time estimates and anticipated write-offs especially important for these jobs. Reducing our risk from fixed-price agreement jobs also relies on pricing our services accurately. If we undervalue our services, we are in for a world of pain as we are unable to invoice for any additional time required to deliver these services.
The best way to view the negative WIP balance as at the end of last month in XPM is to go to ‘Business > WIP’.
- Select the little blue triangle and ‘New Filter’
- Give this filter a name, such as ‘Negative WIP Balance’
- Add the condition ‘Job Category = Fixed-price Agreement’ or similar. Select all of your fixed-price agreement job categories where you may have more than one
- Hit ‘Save’
- Edit the date to be ‘As at’ the end of the previous month.
Note: If you do not have your job categories set up to match your engagement types, you are unable to filter your negative WIP from your total WIP. See Chapter 4: Practice Settings on how to set these up.
The ‘Overview’ tab will show you the total negative WIP balance for your practice as at the date selected. You will notice this negative balance creep closer to zero throughout the month as we add time to in-period tasks such as GST etc and jump suddenly into a deeper negative when our monthly fixed-price agreement invoices are generated.
There is no way to easily compare this value over time without rerunning the report for multiple dates. This makes it difficult to monitor and ensure that this balance is remaining stable and not becoming increasingly negative. The best way to monitor your negative WIP balance in your practice is by using the WIP Performance report in Link Reporting, which we will cover later in this section.
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 that 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:
Say Aardvark & Aardvark CA are an Australian-based accounting practice where most of their clients have a 1st July balance date. If they have a negative WIP balance of ($400,000) on 30th April, they potentially have $400,000 in billable work to deliver that they’ve already invoiced. If they have 10 billable team members that assumes $20,000 in billable time is added to these jobs by each of our billable team members for the next two 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 engagements. 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. You can help your team succeed by providing them the information they need at www.linkreporting.com
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