How Could Overbilling Become A Risk?
- Cost Construction Accounting
- Dec 30, 2020
- 3 min read
Updated: Oct 16
In the construction industry, effective project accounting is paramount to maintaining cash flow and financial stability. For contractors utilizing the Percentage-of-Completion (POC) method, two crucial financial terms are Overbilling and Underbilling. These dynamics typically emerge in projects with extended timelines that rely on progressive billing based on work completed. Understanding how to manage both is essential for the financial health of your construction business.
In this article:
Defining Overbilling (Billings in Excess)
Overbilling occurs when the cumulative amount a contractor bills the client exceeds the total costs incurred plus the estimated profit earned to date.
Simple Example: You have physically completed 25% of a project's work, but you invoice the customer for 35% of the total contract value. The resulting 10% difference is your overbilled amount.
This practice is often a deliberate cash flow strategy, particularly for contractors dealing with slow-paying clients. By strategically billing ahead of physical progress, you can secure working capital sooner, helping to cover immediate expenses like materials and payroll, and effectively self-finance the float time between issuing an invoice and receiving payment.
The Critical Risk of Job Borrow
While beneficial for cash flow, aggressive or uncontrolled overbilling introduces the serious risk known as Job Borrow or "running out of billing capacity."
Job Borrow happens when a contractor has been paid for work that has not yet been earned. The primary danger is not just a cash shortage; it is the fundamental error of using funds from unearned revenue to cover current job expenses. If this overbilled cash is spent before the project is complete, the contractor may:
Mask a Project Loss:
The job appears profitable on paper because the cash is in the bank, but the actual cost to complete the remaining work exceeds the remaining billing capacity.
Rob Other Projects:
The contractor is forced to use the cash flow from a different profitable job to finish the overbilled one, a practice that can quickly destabilize the entire business.
The Consequences of Underbilling
Underbilling is the inverse: the contractor has completed more work (incurred costs and earned profit) than they have invoiced the client for.
Chronic underbilling is detrimental because it forces your company to self-finance the project, effectively turning your construction business into a low-interest lender to your client. It unnecessarily ties up your capital, delaying cash intake and restricting your ability to invest in new equipment or take on additional projects.
The Financial Statement Impact
Understanding where these concepts appear is crucial for lenders and bonding companies:
Overbilling appears on your balance sheet as a Current Liability (Billings in Excess of Costs and Estimated Earnings). It represents an obligation to perform future work for which you have already been paid. A large liability here can sometimes be viewed favorably by lenders as a sign of strong cash positioning.
Underbilling appears as a Current Asset (Costs and Estimated Earnings in Excess of Billings). It represents earned but unbilled revenue. While it is an asset, a growing balance indicates a potential failure to collect earned revenue promptly.
Actionable Steps for Management Control
For Small to Mid-Sized Contractors, moving beyond awareness to proactive management requires strict discipline:
Accurate WIP Schedules:
Conduct frequent, precise reviews of your Work-in-Progress (WIP) reports to compare physical completion percentage against current billing. This is the single most important control mechanism.
Tight Cost Tracking:
Implement robust Job Costing to capture every dollar spent on a project in real-time. Without accurate costs, calculating the earned profit is impossible.
Use Industry-Specific Software:
Rely on accounting platforms that handle percentage-of-completion calculations correctly, such as Sage Accounting or construction-specific setups in QuickBooks. Generic software often fails to provide the detailed analytics required.
Regular Review of Variances:
Establish a system where any significant variance between the percentage billed and the percentage completed is flagged and immediately reviewed by project management and accounting teams.
Conclusion: Achieving Financial Control for Contractors
Successfully navigating construction finance means achieving a controlled, strategic overbilling position without succumbing to the risk of job borrow. It demands an integrated, real-time view of your project costs, physical progress, and billing schedule, a level of visibility that your accounting team must deliver.
Construction Cost Accounting (CCA) specializes in providing this essential financial control for Small to Mid-Sized Contractors (SMEs) in the US construction industry. We offer expert ensuring your billing practices maintain cash flow without introducing catastrophic risk.
Are you ready to stop guessing and start proactively managing your project finances?
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