A PSO can appear to be highly profitable, but may still go out of business if it lacks the cash to sustain its operations.
There is, in the end, no substitute for cash. Work in Progress (WIP) is a pale stand-in for invoice value. Invoice value is a pale stand-in for cash. Without cash, you can’t pay your professional staff. Therefore, if you allow yourself to celebrate apparent profit, based on the value of Work in Progress, without regard for cash, your business will be at risk.
Many PSOs have only informal mechanisms for determining the value of WIP, especially if realisation is less than 100% or if projects are fixed price, or milestone dependent. However, assuming that WIP can be calculated it is vital to keep track of how it grows in relation to revenue and cost.
This is why it is essential to keep Work in Progress under control and to ensure that invoices are so arranged that cash will arrive in sufficient time to cover expenses that must be paid on time, such as salary. It is very likely that salary and other direct expenses (as for most PSOs) will represent towards 80% of your costs, when ‘overhead’ salaries (administrators, etc.) are also included.
WIP Days is a good measure of how well your WIP is under control.
WIP Days can be defined in this way:
WIP Days is the number of days’ services revenue represented by your Work in Progress value (after provisions).
How is it calculated?
WIP Days = ((WIP – WIP Provisions) / (Average Monthly Revenue * 12)) * 365
Average Monthly Revenue may be calculated based on the previous six or more months’ revenue.
Suppose average monthly revenue of 200,000.
Suppose WIP of 350,000.
Suppose WIP Provisions of 41,000.
WIP Days = ((350,000 – 41,000) / (200,000 * 12)) * 365 = 46.99
Obstacles to Invoicing
Rising WIP Days is often an indicator of underlying ills. It might indicate, amongst other things:
- A general deterioration in relationships with your clients. You find yourself deferring invoices because you don’t expect your clients to accept the value you’ve placed on the work you’ve done
- Structural weaknesses in the contracts you have with your clients, in that these do not permit you to invoice.This can happen when invoicing depends upon reaching a milestone. However, if the milestone is not reached because the client has temporarily halted the project you can find yourself exposed. You must make sure that your contract allows you to invoice after a defined time has elapsed especially if the project is suspended for reasons beyond your control.
- An increase in the number of fixed price contracts, and their size Large fixed price projects are likely to be invoiced in larger ‘lumps’ which means that WIP is more likely to accumulate to higher values. Try to avoid large ‘lumps’ even if you are managing larger projects.
- Projects have extended beyond original scope without control. If you have performed services which you regard as beyond project scope, but without agreement with your client, it is likely that your client will be unwilling retrospectively to agree charges. In these cases, WIP balances are often ‘suspended’ until negotiations have concluded. And more often than not, such WIP is written off.
- Project Managers are deferring invoicing or write off to boost realisation figures. Realisation measures the relationship between invoice or WIP value and the value of the work that is related to it. When managers are judged on realisation they will consciously or unconsciously show reluctance either to write off or calculate provisions for work that they may never invoice.
Previously on this blog:
Measure No. 1 – Utilisation
Measure No. 2 – Standard Fee Variance
Measure No. 3 – Activity Variance
Measure No. 4 – Realisation
Measure No. 5 – Standard Cost Variance