Why WIP and debtors decide more of the price than the multiple does
In a professional services firm — legal, accounting, architecture, engineering, consulting, financial planning — work in progress and debtors are frequently the largest asset class in the deal, sometimes larger than goodwill itself, so WIP is priced separately rather than folded into the earnings multiple. In a trading business, working capital is usually a balance sheet adjustment made after enterprise value is set; in a people-and-time business the order of operations is different. A buyer does not price WIP as an afterthought; they price it as a separate, heavily scrutinised asset with its own recoverability risk, and the outcome of that pricing exercise can move total consideration well away from what the headline EBITDA number alone would suggest. Sellers who focus their preparation on maintainable earnings and the multiple, and leave the WIP schedule and debtors ledger untouched until due diligence starts, are consistently surprised by how much the lock-up conversation costs them. This is not a working-capital footnote — in a people-and-time business, WIP and lock-up are close to being the valuation.
Lock-up as a valuation quality metric, not just a cash-flow metric
Lock-up is the combined cycle from time recorded (or cost incurred) to cash collected — conventionally measured as WIP days plus debtor days. WIP days measure how long unbilled time and disbursements sit before they are invoiced; debtor days measure how long invoiced fees sit before they are paid. Firms quote lock-up in days because it is comparable across different revenue sizes, and because it is a proxy for something a multiple cannot see directly: how disciplined the practice's billing and collection function actually is. A firm with the same normalised earnings as a competitor but materially fewer lock-up days is a different asset — it converts profit to cash faster, it needs less working capital to fund growth, and its WIP balance carries less realisation risk simply because it is younger. For that reason lock-up is not treated as a side issue in a professional firm valuation; it is read alongside the earnings figure as evidence of billing discipline, file management and partner behaviour, and it directly informs both the recoverability discount applied to WIP and, more subtly, the multiple selected for the earnings themselves. A buyer's advisers will benchmark lock-up days against sector norms — professional services practices with efficient billing cycles typically run materially tighter than firms with entrenched delay in getting matters to invoice — and a lock-up figure well outside the normal range for the practice type is treated as a risk flag requiring explanation, not a rounding error.
How is WIP valued? Recoverability discounts and aged-WIP writedowns
WIP is valued by testing recorded time or cost down from face value for recoverability risk, not by taking the balance sheet figure as given. WIP on the balance sheet is time recorded at standard billing rates, or cost incurred not yet invoiced. That figure is a ceiling, not a value. A valuer or a buyer's accountant tests it down through a series of questions before it is treated as worth anything close to face value: is the matter substantially complete or still open-ended; will the client accept the bill as recorded, or has scope crept beyond what was quoted or agreed; does the file and the client relationship actually transfer to the buyer, or does it leave with a departing principal; and how old is the unbilled time. Age is usually the single biggest driver of the discount. WIP billed promptly after the work is done tends to realise close to its recorded value, because the client remembers the work and the file is fresh. WIP that has sat unbilled for several months carries compounding risk — the client query it, the firm writes it down rather than fight over it, or the matter simply stalls and the time is never recovered at all. Firms and their advisers commonly apply a banded ageing schedule to WIP for this reason: recent WIP close to full recoverable value, WIP in the middle bands at a meaningful discount, and WIP beyond a firm-specific threshold treated as largely or wholly unrecoverable unless there is specific evidence to the contrary. The discount schedule is not generic — it is set from the practice's own billing and write-off history wherever that evidence exists, because a firm that has historically billed and collected its aged WIP in full deserves a lighter discount than one with a track record of writing it off. Debtors are tested the same way: an aged trial balance, a review of what is genuinely collectable versus what should already have been provided against, and a discount to face value that reflects the practice's own collection history rather than an assumed industry rate. This evidence-based approach to recoverability is consistent with the market-value standard set out in IVS 104 and with the evidence and documentation expectations in APES 225 for valuation engagements — an asserted WIP figure without supporting ageing and billing-history evidence does not meet that standard.
Is WIP taxed the same way as goodwill when a practice is sold?
No — WIP transferred on the sale of a professional practice is taxed as ordinary assessable income to the seller, not as a capital gain the way goodwill usually is, and sellers who assume otherwise are frequently caught out late in the process. Under s 15-50 of the ITAA 1997, a work in progress amount received by the outgoing practitioner or firm is included in assessable income; the corresponding provision, s 25-95, allows the payer (the buyer) a deduction for a WIP amount paid, but only to the extent that a recoverable debt has arisen — or can reasonably be expected to arise within 12 months after the amount is paid — in respect of the work to which that amount relates, with any remaining balance deductible in the following income year. The practical effect is that WIP consideration is treated on revenue account for the seller, not capital account — it is ordinary assessable income in the year received, separate from any CGT treatment applying to goodwill or other capital assets sold in the same transaction. This matters for two reasons a valuation file needs to make explicit. First, the allocation of total consideration between goodwill (generally capital) and WIP/debtors (generally revenue) is not an arbitrary split the parties can set for convenience — it needs an evidenced value behind each component, because the allocation drives materially different tax outcomes for the seller and the buyer's own deduction timing depends on the recoverable-debt condition being met. Second, because the WIP amount is assessable to the seller as ordinary income rather than a capital gain, it does not attract the CGT discount or access small business CGT concessions the way a capital gain on goodwill might — a seller expecting concessional treatment across the whole sale price can be surprised to find the WIP component taxed in full at marginal rates in the year of receipt. None of this is a matter a valuation report resolves; the sale agreement's consideration allocation and its tax consequences are matters for the vendor's and purchaser's own tax advisers, working from a valuation that has separately and defensibly valued WIP and debtors as their own asset class rather than lumping them into an undifferentiated goodwill figure. Prismi is not a registered tax agent and does not provide tax advice — what a valuation contributes is a supportable, evidenced value for WIP as a discrete component, so that whatever allocation the parties and their advisers ultimately adopt has a documented basis behind it.
Does WIP risk look different in a fixed-fee practice than a time-billing practice?
Yes — the billing model a practice runs changes what WIP actually represents, and a valuation that treats all professional-firm WIP the same way is missing the more important question. In a time-billing practice, WIP is recorded time at standard rates on open matters — its recoverability risk is realisation risk: will the client accept and pay the bill as recorded, and will scope overruns be written off. In a fixed-fee practice, there is typically little or no conventional WIP on the balance sheet in the time-billing sense, but the risk has not disappeared — it has moved into unbilled or under-billed delivery risk, where the firm has committed to deliver a scope of work for an agreed fee and the cost of completing it may exceed what has already been invoiced under a milestone or staged-payment schedule. A fixed-fee firm with a large book of long-dated engagements partway through delivery carries a form of lock-up risk that never shows up as a WIP balance at all — it shows up as engagements where cost-to-complete has not been properly provisioned, and a buyer's diligence needs to test committed-but-uncompleted fixed-fee work with the same rigour a time-billing firm's WIP ageing receives. The practical implication for valuation is that the methodology used to test WIP recoverability has to match the billing model: ageing and recoverability-discount analysis for time-billing practices, and cost-to-complete and margin-erosion analysis on open fixed-fee engagements for practices that have moved to value-based or fixed-fee pricing. A hybrid practice running both models needs both tests applied to the relevant portion of the book, and the valuation file should say which test was applied to which revenue stream and why.
How can a firm reduce lock-up before a sale?
Lock-up is one of the more tractable value levers available to a firm in the run-up to a sale or partner transition, because unlike goodwill it responds directly to operational changes rather than market conditions. Because lock-up is read as evidence of billing discipline as much as a working-capital number, the practical steps below are not exotic, but they require sustained partner-level discipline rather than a one-off clean-up immediately before due diligence begins — a buyer's advisers will look at the trend in lock-up days over several periods, not just the balance on settlement day.
- ·Bill more frequently on time-based matters — moving from irregular or completion-only billing to a regular monthly or milestone cycle shortens WIP age directly and gives the firm an earlier read on client pushback
- ·Set and enforce WIP-age escalation triggers — matters with unbilled time beyond a defined threshold should be reviewed by a partner, not left to accumulate silently in the practice management system
- ·Tighten scope and variation discipline — agree scope changes and additional fees in writing as they arise, rather than absorbing them into WIP that later proves hard to bill in full
- ·Review and provision aged debtors actively rather than carrying them at face value — a debtors ledger that already reflects realistic collectability is more credible to a buyer than one relying on the buyer to find the problem
- ·Reconcile practice management WIP reports against actual billing history — where the system-recorded WIP has historically been written down materially at billing time, that gap needs to be understood and addressed before it becomes a due-diligence finding
- ·For fixed-fee engagements, tighten cost-to-complete tracking on open matters so delivery risk is visible internally before a buyer's diligence team finds it first
What this means for the valuation file
A professional firm valuation that treats WIP and debtors as a rounded-up working capital line, rather than as a separately tested asset class with its own recoverability evidence, understates the analysis a buyer's accountant will actually run — and a value built that way tends to move materially once real due diligence starts. A supportable position states the lock-up days observed against the practice's own history and, where available, sector benchmarks; sets out the ageing bands and recoverability discount applied to WIP and debtors, with the basis for each band explained; identifies which billing model applies to which part of the revenue and tests recoverability or delivery risk accordingly; and treats WIP and debtors as a discrete component of consideration, separate from goodwill, so the tax treatment under s 15-50 and s 25-95 has an evidenced value to attach to rather than an arbitrary allocation. Prismi prepares this analysis as part of Comprehensive (from $3,995 + GST, 15–25 business days) and Defensible Valuation File (from $8,995 + GST, 25–35 business days) engagements for professional practices — normalised earnings and the WIP/lock-up analysis sit alongside each other in the file, senior-reviewer signed under an independence statement, prepared with reference to the ATO's market valuation guidance, APES 225 and IVS 104 so the position is defensible if reviewed, and documented to the standard a buyer's or a reviewer's own accountant will test it against. Fees are fixed at engagement and never contingent on the outcome, and where a party wants the WIP figure set to suit the negotiation rather than the evidence, we will say so and decline the engagement on those terms.