Modelling: Construction WIP

Overview

Construction businesses present a unique forecasting challenge - revenue is earned progressively over the life of a project, costs are incurred throughout the build, and cash flow often occurs at entirely different points. 

Castaway can handle this through two complementary mechanics: accrued revenue recognition for the income side, and an Inventory Recovery Transfer to capitalise costs to a WIP balance on the balance sheet.

• Revenue is recognised progressively in the P&L as work is performed
• Costs are captured in cash flow when incurred but do not distort the P&L during the build period
• WIP balances accumulate on the balance sheet and are cleared at the point of sale
• COGS is matched to revenue at settlement

Reporting Outcome:

Area	Outcome
P&L	Revenue recognised progressively. Direct costs appear and are netted off via the Transfer Recovery. COGS recognised at point of sale.
Balance Sheet	Accrued revenue (WIP) accumulates and clears at invoicing. Inventory balance builds through the transfer and reduces at point of sale.
Cash Flow	Outflows occur at the time costs are incurred. Inflows occur at the time invoices are settled.

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Illustrative Example

A construction business contracts to build a house for $1.2M. The build takes 12 months.

• $100,000 of revenue is recognised in the P&L each month
• Construction costs are incurred monthly and captured in cash flow at the time of expenditure
• Accrued revenue (WIP) and capitalised costs accumulate on the balance sheet throughout the project
• At settlement, the invoice is raised, clearing WIP balance, and cash flow occurs off the back of the invoice
• COGS is recognised at the point of sale to match against the revenue

The steps below walk through how to set this up in Castaway.

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Element Setup Overview

The solution requires the following elements working together:

Element	Purpose
Sales Element	Progressive revenue recognition and accrued income (WIP) management
Direct Cost Elements	Record construction costs as they are incurred
Inventory Element	Receives capitalised costs via transfer and holds the WIP closing stock balance
Transfer Recovery (Cost Element)	Negates the P&L impact of direct costs and transfers them to the Inventory element

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Step 1: Sales Element (Revenue Recognition)

Option 1: Manual Entry

1. Open your Sales element and change both the Revenue Method and Invoice Method to Enter...
2. Enter the monthly revenue values you wish to recognise in the Enter Revenue line - for example, $100,000 per month for a 12-month build
3. Leave the Enter Invoices line blank during the build period. The accrued income (WIP) balance will grow on the balance sheet automatically without entry here
4. At the point of invoicing milestones or settlement, enter the expected invoice values in the Enter Invoices line for the relevant months. This reduces the accrued income balance and triggers the cash flow

Option 2: Driver Spread (Recommended)

For a more automated approach, use the Driver Spread revenue method to enter the contract value as a single Driver value and spread it automatically across the build period. For detailed setup guidance, refer to: Driver Spread

1. Create a Driver element and enter each contract value in the month it is signed.
2. Set the Revenue Method to Driver Spread and link it to the Driver element.
3. Configure the spread profile to distribute the contract value across the build period.
4. Manage invoice milestones and cash flow as per Option 1 above.

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Step 2: Direct Cost Elements

Model your Direct Costs relating to the project as you would any other cost line in Castaway. These costs will appear on the P&L initially but will be netted off by the Transfer Recovery. They remain visible in the P&L for reporting purposes.

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Step 3: Inventory Element - WIP Closing Stock

1. Create an Inventory Cost element either through your integration or as a new element. This automatically creates and connects to the Inventory asset partner element on the balance sheet.
2. Leave this element's data entry blank during the build period - it will receive values via the Transfer Recovery in Step 4.
3. At the point of sale, enter your COGS values in line with your invoicing milestones to wind down the inventory balance and match costs to revenue at settlement.

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Step 4: Transfer Recovery Element

This is the key step. The Transfer Recovery element negates the P&L impact of your direct costs and capitalises them to the Inventory element.

1. Create a new Cost element and name it 'Transfer Recovery'. Position this under a Transfer Recovery sub-heading beneath your direct cost lines.
2. Set the Expense Method to % of Expense.
3. In the Element Selector, tick the direct cost elements you wish to capitalise to inventory and click OK.
4. Set the Link % to -100% across all months. This nets off the direct cost values against the P&L, removing their impact while preserving the cash flow.
5. Add a Transfer by selecting Add Transfer above the element data table.
6. Choose Recover to Inventory as the transfer type, select the Inventory element as the target and set the transfer method.
7. Set the Transfer percentage to 100% across all months. (In the Inventory Cost element - you will see the Transfer Recovery values flowing into the Inventory balance on the balance sheet.

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Scaling the Principle

The example above uses a single project with even monthly revenue recognition and a single pool of direct costs. In practice, the same structure can be extended to accommodate more complexity.

Scenario	How to Extend the Structure
Multiple concurrent projects	Replicate the setup for each active project with separate Sales, Direct Cost and Inventory elements per project, allowing WIP, revenue and COGS to be tracked independently for each job.
Variable revenue recognition	Adjust the Enter Revenue line to reflect percentage of completion, milestone-based recognition or any other method that matches the contract terms.
Multiple cost pools	Where costs need to be tracked separately (for example, labour, materials and subcontractors), give each its own Direct Cost element and selectively include them in the Transfer Recovery via the Element Selector.
Stage-based invoicing	Where invoicing occurs at project milestones rather than final settlement, enter invoice values progressively in the Enter Invoices line to partially clear the WIP balance at each stage.

The core principle remains consistent across all variations: costs flow through cash flow at the time of expenditure, are capitalised to the balance sheet via the Transfer Recovery, and are matched to revenue at the point of sale.

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