Glossary
Work in Progress (WIP)
Work in progress is the gap between the work a contractor has performed and the amount it has billed for that work. Where those two move together, WIP is unremarkable. Where they separate, it creates a contract asset or a contract liability on the balance sheet, and it becomes the single most common reason a construction business fails a revenue test in diligence. In our experience the failures are rarely deliberate. The work is being done and the money is being earned. It is simply not being recorded in the period it belongs to.
Why WIP is where construction deals go wrong
Under percentage of completion, revenue is recognised as the work is performed rather than as it is invoiced. That is the correct treatment and it is also an estimate, which is what makes it worth testing.
Two things separate:
Overbilling
, where billings run ahead of the work performed. The balance sheet carries a liability, because the company owes work it has already been paid for.
Underbilling
, where work performed runs ahead of billings. The balance sheet carries an asset, because the company is owed money for work already done.
The risk that actually matters is overbilling
Underbilling costs a contractor cash flow. Overbilling costs a buyer real money, and it is the one we test hardest.
If a business bills aggressively against percentage of completion, it is recognising revenue for work it has not yet done. Eventually the customer notices. A developer who believes it has been billed ahead of progress simply declines to pay, and the revenue that looked recognised turns into a dispute.
How we check it, which is not where people expect
The useful test for aggressive percentage of completion billing is not in the revenue workings. It is in the accounts receivable aging.
A business billing ahead of its work produces a distinctive pattern: invoices that sit unpaid for a long time, drawn-out disputes over what was billed and why, and write-downs against invoices that should have been routine. Where we look at an aging and see invoices outstanding well beyond normal terms, we ask about each one specifically. Is it a liquidity problem at the customer, something the contractor has not delivered, or something the customer is waiting on?
What we do not want to see is a large historical accumulation. Aged balances carried for years are not receivables in any meaningful sense, and where a ledger holds invoices from several years back that nobody expects to collect, that tells you more about the revenue recognition than any schedule will.
Retainage is the deliberate exception and gets treated separately. It is long by design, sometimes running well over a year, and it inflates days sales outstanding in a way that is not a collection problem at all. See retainage for why it belongs in its own bucket.
Billing frequency changes the entire risk profile
This is the most useful single thing a contractor can know, and it is rarely discussed.
A business that bills monthly against progress carries much less WIP risk than one billing at milestones. With monthly billing, variances between work performed and work billed shake out quickly and evenly, and any given month’s error is small and self-correcting. With milestone billing, say half at a point and the balance on completion, the gap between billing events can run many months, and everything that accumulated in between has to be caught up at once. That is where large over and under billing positions come from.
| Monthly progress billing | Milestone or completion billing | |
|---|---|---|
| WIP position | Small, self-correcting | Can accumulate substantially |
| Variance between periods | Low | High |
| Ease of tracking | Straightforward | Requires deliberate tracking |
| Diligence scrutiny | Lighter | Heavier |
If you run a contracting business and have a choice, monthly is materially easier to track and materially easier to defend.
What a WIP analysis actually contains
We build the schedule separately rather than relying on the company’s, and across several fiscal years rather than a single date, because a point-in-time WIP position tells you very little.
For each contract: the total contract value, cost incurred to date, percentage complete, revenue recognised, amounts billed to date, and the resulting position in either costs in excess of billings or billings in excess of costs. Then that gets compared against the billing records to see whether revenue is being accumulated ahead of the cost side of the business.
We also sample contracts for two specific things. First, accelerated billings: has an unusual proportion of a contract been invoiced relative to the work done? Second, change orders and remaining value. If a large contract is already substantially burned through, there is less revenue left in it than the run rate suggests, and a buyer needs to know that before pricing the business on trailing figures.
Adjacent risks that travel with WIP
Deposits recognised as revenue
Businesses that take money up front and recognise it immediately rather than as a liability create a real problem, because that revenue is owed as future work. A contractor that takes no deposits is genuinely de-risked on this front. See deferred revenue.
Billing late rather than early
The opposite finding and a real one. On a time and materials business we reviewed, the pattern was consistently billing behind rather than ahead, with work occasionally going uninvoiced for a couple of months before somebody caught it. That understates revenue and receivables rather than overstating them, which is a different conversation, but it is still a control weakness.
Different divisions, different profiles
Commercial and residential work inside one business behave nothing alike. Commercial contracts run longer, so WIP is higher and working capital is heavier, but collectability tends to be better and bad debt lower. Residential work brings more one-off customers, more chasing, and more bad debt. A business with both needs them looked at separately, because a blended view describes neither.
Materials stored but not installed
Many contracts permit billing for materials delivered to site ahead of installation. That is legitimate and it does need to be understood, because it changes what billing ahead of installation actually means on that contract.
Frequently asked questions
What is the difference between WIP and retainage?
WIP is the timing difference between work performed and work billed. Retainage is an agreed portion of an invoice the customer withholds until completion, on work already properly billed. They sit in different places and behave differently, and combining them makes both unreadable.
Is an underbilled position a red flag?
Not by itself, and it is very common. It means the company is financing work ahead of payment, which is a working capital question rather than an earnings question. It becomes a concern when it grows steadily without explanation, which can indicate work that is not being billed at all.
Why does a buyer care about our billing schedule?
Because it determines how much error can accumulate between billing events, and therefore how reliable your reported revenue is between them. Monthly billing produces small, self-correcting variances. Long gaps do not.
We do not have a formal WIP schedule. Is that a problem?
It is workable but it will slow things down, because the schedule then has to be reconstructed from contracts, job costs and billing records. Any internal tracking mechanism, even an informal one, helps considerably. If a transaction is on your horizon, building a proper WIP schedule is one of the highest-value preparations available to a contractor.
How far back will a buyer look at WIP?
Usually several fiscal years, because the point is the pattern rather than the balance. A single date shows a position; a run of years shows whether billing consistently leads or lags the work.
Does this affect the price or the working capital peg?
Both, and separately. Misstated percentage of completion changes reported earnings. The contract asset and liability positions sit in working capital and affect what the buyer funds at closing. See the working capital peg.
Where to next
If you run a contracting business and expect to transact, a multi-year WIP schedule you can stand behind, a clean receivables aging with retainage separated out, and a clear statement of your billing practice will do more for the process than almost anything else. Our transaction advisory services team builds this analysis on every construction engagement. Read quality of earnings for construction for how the wider engagement runs, and revenue recognition in due diligence for how the revenue side gets tested. To talk through a specific business, email Avnit Sekhon at avnit.sekhon@treewalk.com.
