Updated: Jul 29, 2020
In the Percentage of Completion Project Accounting, 2 terms are frequently used: over-billing and under-billing. Underbilling represents the practice of not billing fully for all of the labour, materials and services provided in a billing cycle.
What is Underbilling?
Underbilling is the opposite of overbilling and occurs when a contractor performs a certain amount of work in a billing period but does not make invoice their customer for the full amount of completed work. For example, in the billing period March 2020, a contractor completed 45% of a project, but sending to customer a progressing invoice for just 30% of the overall contract, the contractor has underbilled by 15%.
So, why does a contractor underbill?
One of the most common reasons why construction companies stuck in underbilling situation is not to complete the progress invoicing on time. If contractor and customer agree to set up a fixed time to send invoice and make payment, contractor can not get up-to-date cost to be paid. For example, the contractor is expected to get his progressing invoice on the 1st of every month, and get paid around 10th, he can not have costs occurring from 2nd to 10th paid. That leads to a underbilling period.
Another reason for this circumstance is that contractor got a bad project management accounting. Unlike not completing the progressing invoice on time, which might not affect your overall revenue, bad project management could turn into unrecoverable losses. Let’s go through some bad practices following:
Underestimate project costs. For example, contractor estimated that Concrete phase just needs 5 workers with $200 per one to be completed. So, the whole-time contractor thinks it’s going to cost about $10,000 to complete the concrete phase. However, they have to hire 2 more workers to get the work completed on time and the work ends up costing $14,000 at the end. As a result, contractor could never get paid the extra amount $4,000. The amount of money they have to pay is always larger than the amount they could get payment.
Accept to pay vendors for work not completed. If contractor agree to pay his subcontractor $20,000 on 03/25/2020 for the window installation which can not be finished at the end of April, he has underbilled his customer in the period from 03/01/2020 to 03/31/2020. The reason is that he can not make invoice for the work that he has not completed yet.
Not have updated bills from vendors. A list of vendors paid in a billing period could be a bonus point. For example, per contractor’s calculation, he has been charged up to 355 of the total project costs, he can discuss with customer in order to create an invoice with matching percentage.
Perform unsigned/unapproved Change Orders. Chang order is a giant construction industry bugaboo which could cause major problem if it does not perform properly. Without signing or approving, contractor could not be paid by customers. That means permanent, unrecoverable underbillings. The contractor spent money to complete the change order, but never get revenue to recover all cost for the Chang Orders.
Conclusion – Underbilling is not a good thing in common
Construction companies need to work and communicate with their customers and accounting staff for planning, controlling and making decisions during the project. Keeping updated bills from your vendors and discussing with your customer whether you can create invoice and get paid on time. Make sure all of change orders you performed has been signed and approved. Sometimes, it is alright to underbill your customer. At the end of the project, ensure that you have no net under billings or overbills in excess of 2% of total revenue.