Understanding Revenue and WIP: A Deep Dive

In the ever-evolving world of business finance, understanding the nuances of revenue and Work in Progress (WIP) can be a game-changer. In this video titled Tom delves into these concepts, shedding light on the challenges businesses often face when managing projects that span multiple months but are invoiced only at the end.

The Challenge

Imagine a scenario where a business undertakes a project that stretches across May, June, and July. However, the invoice for the project is only raised in August. This common practice can lead to inaccurate monthly management reporting. Why? Because while the costs associated with the project are recorded in the months they are incurred, the revenue is only recognized in August when the invoice is raised.

Breaking It Down With An Example

We use a straightforward example to elucidate this concept:

Project Value: $100 plus GST
Labor and Materials Cost: 7% of the project’s total cost

When the invoice is raised in August, the accounting system recognizes the entire $100 as profit for August. An additional $10 is set aside as a GST liability. However, the work was done across May, June, and July. So, while the costs are recorded in these months, the revenue isn’t, leading to a reported loss.

For instance:

In May, if 10% of the work was completed, that’s a value of $10. But, based on the 7% cost assumption, there would be an invoice from suppliers amounting to $7 for May. This means, in the books, May shows a revenue of zero but a cost of $7, resulting in a loss for the month.

The Implication

Such a scenario not only results in inaccurate financial reporting but can also be misleading. Businesses might perceive a loss in the months the work is done and a sudden profit in the month the invoice is raised. This can impact decision-making, budget allocations, and overall financial strategy.

The Solution

The goal is to find a method to allocate revenue to the appropriate months based on the work done, rather than when the invoice is raised. This ensures a more accurate representation of a business’s financial health and performance.

In Conclusion

“Revenue WIP” is a must-watch for business owners, financial professionals, and anyone keen on understanding the intricacies of revenue recognition and WIP. It offers valuable insights and solutions to a common challenge, ensuring businesses can make informed decisions based on accurate financial data.