How to Choose the Right Construction Billing Method

Nothing in construction is easy, and that includes billing for your hard work. There’s no one standard billing method tied to the contract type you are using in the construction industry, so how and when you get paid varies from project to project. Naturally, this can be tough to keep up with, even for seasoned contractors. 

Because your billing practices can affect everything from your cash flow to your ability to complete jobs on time, it’s important to have a solid grasp of the most common construction billing methods out there, and when they’re most beneficial.  

To make things simple, here’s our quick breakdown of the 6 most common billing methods.

Key Takeaways

• Construction businesses can choose from several different contract methods and billing types when negotiating a construction contract. Each method has its own pros, cons, and best applications.
• Some construction billing methods, like Design-Build, require transparency and strong relationships with project stakeholders to be successful. It also requires a more collaborative approach to building.
• To avoid cash flow problems and maintain accurate billing, make sure your construction company’s operations team knows a job’s contract type so they can invoice properly.

The Most Common Construction Billing Methods

If you’re a general contractor, you’ll usually have some room to negotiate the contract type when signing onto a project, which can help you establish what billing method will be used. Keep in mind though that the larger the project, the smaller this option to negotiate becomes. 

Below are the most common types of construction contracts, their typical billing methods, and what kind of projects they’re best suited for. 

Lump Sum

Also known as fixed price, lump sum price contracts are the default most GCs and subcontractors start with. With lump sum, the contractor and owner agree to a fixed price upfront, then the contractor does the work. As the project progresses, the contractor invoices on a set timeline, usually by month or by project milestone. Depending on the value of the lump sum contract, you’ll likely need to meet AIA billing requirements for monthly progress billings. 

A lot of folks prefer fixed price billing because of the flexibility, freedom, and savings it can bring down the road. For example, say you’ve bid a job at $1 million, knowing your typical gross profit margin is 10%. On this job, you know you’ll be bringing in around $100k in profit if all goes as planned. 

Advantages of Lump Sum Contracts and Billing Options: 

• Potential for huge savings if you can finish the project for less than expected
• Less time spent on admin
• At least a monthly billing cadence.
• No need to provide back up with this contract type.
• One of the preferred contract types due to simplicity of billing.

Disadvantages of Lump Sum Contract and Billing: 

• You always assume the risk that the project will cost more than the amount agreed upon
• Your project management team has to be diligent in tracking any changes that go out of scope so you can maintain your margin.
• May require very complex billing schedules broken down by areas.
• AIA billing can be hard to understand for those newer to the industry.
• You’ll need to validate the numbers on the first sheet of an AIA to the schedule of values pages.

Time and Materials

Another more advantageous construction billing method is time and materials (T&M), which you’ll often see on very small projects or self-performed work. Here, contractors invoice for labor hours and the cost of materials, adding their profit margin (and sometimes overhead) to the total amount each billing period. Time and Material Billings can be billed much more frequently than other types of contracts. Monthly, weekly, or even daily billings are standard options.

Advantages of Time and Materials Billing: 

• Not much risk, especially for subcontractors, who can just focus on getting work done quickly.
• GCs can markup material and labor costs.
• Less incentive to be done in a certain amount of time.
• You can substantiate billings with hours worked and costs incurred by labor tickets and bills.

Disadvantages of Time and Materials Billing: 

• The project’s scope of work may not be well defined, creating the risk of costs rising beyond your initial estimate.
• Much more labor intensive to create T&M billings. Keeping track of expenses for some companies is more challenging when it comes time to bill. 

Guaranteed Maximum Price

Like with lump sum, the total project cost of guaranteed maximum price (GMP) jobs are agreed on before construction starts. Unlike lump sum jobs though, the owner - not the contractor - benefits from cost savings if the final cost is under the budget the owner had to build it. Occasionally, you may see a shared savings clause, but don’t bank on it with these types of projects. GMP contracts are best suited for contractors who are already familiar with the type of work/project to be completed.

GMP jobs are usually billed on a monthly cadence. If there is a shared savings clause, you’ll have more requirements around billings. If the savings are on the job overall though, you may have to go through and provide backup for all the costs associated with the project on a monthly basis (or all at once at the end).

Advantages of GMP:

• Because the project scope is usually clearly defined ahead of time, change orders are sometimes minimized.
• If it’s a normal GMP job, monthly billings are pretty straightforward, like on lump sum.

Disadvantages of GMP: 

• Any costs over the guaranteed maximum price ultimately fall on the contractor.
• Managing actual costs against budgeted costs requires a lot of diligence and oversight.
• GMP can require a lot of work to verify costs as you’re going with shared savings. 

Design-Build

For project teams that want a faster, more collaborative workflow, design-build contracts offer a good choice. The goal of these contracts is to align the architect, project owner, and general contractor to address design and construction at the same time. This way, each party can work together to come up with a solution that works best for everyone involved. 

Sometimes, D&B contracts still include a guaranteed maximum price, along with a shared savings clause that splits every dollar saved below the GMP among those three parties. 

On the billing side, Design-Build tends to get complicated because the architect and general contractor are working in unison from the start. Normally you’d bill on a monthly cadence, but during the early stages of the project, you’ll have to know your budget very well to make sure you’re not putting in more cost than you can recoup from the owner. In Design-Build jobs, the total project cost value is usually capped, and if the design can’t be worked through to arrive at a reasonable amount, your billings could get diminished later to get the project in line. However, you will occasionally not have a project get to construction because the costs can’t be reasonable in the design phase for construction. When billing in those early stages, you’ll also have to be aware of the time you’re using and make sure you’re charging a good rate for the design collaboration.

Advantages of Design-Build:

• Everyone becomes part of the process before the project is designed
• More transparent, open billing method.
• A lot more control when large items for mobilization need to be ordered, which usually means quicker upfront payments.
• Depending on the needs of your organization you could bill more frequently in the design and construction phases.

Disadvantages of Design-Build: 

• Hard to make work if there’s a lack of trust.
• Risks mainly fall on contractors for any unforeseen mistakes or costs.
• If the design doesn’t work out within the owner’s budget, the contractor will have a lot of pressure to reduce scope to help the project out. This will put a lot of billing strain on the contractor. 

Unit Pricing

Just like the name suggests, unit price contracts outline a specific price per unit created. Unit price billing is typically used when a contractor can build an easily-measured product, like a certain amount of road, for example. Oftentimes, contractors decide to bundle their material, labor, overhead, and profit together and charge per unit.

Advantages of Unit Pricing:

• Unit pricing can be used along with other construction billing methods to add extra transparency.
• Since each variable is a fixed cost, tracking and billing is much easier than in other types of contracts.
• Useful for jobs that have an unknown duration or scope.
• Very similar to Time and Material from a billing perspective
• You may have to validate your unit pricing to the owner or general contractor beforehand with the costs you will incur per unit. 

Disadvantages of Unit Pricing: 

• Project owners might be hesitant because they won’t know the full project scope until project completion and can’t accurately run a declining budget

Cost-Plus

Cost-plus contracts allow contractors to get reimbursed for all of their costs plus markup, making them a good choice for projects with uncertain expenses and/or scope. They aren’t a blank check though - cost-plus jobs usually require a detailed estimate at the beginning so the owner knows what to expect. From a billing standpoint, it’s very similar to Time and Material projects - you have to show or submit your costs for reimbursement.

Advantages of Cost-Plus Billing:

• Even if unexpected costs pop up, you can charge for them

Disadvantages of Cost-Plus Billing: 

• Because the owner is assuming more risk, you’ll need to provide detailed invoices and documentation when you submit payment applications
• Some cost-plus contracts include a “not to exceed” clause, which can limit your spending

Billing for Retainage

Once a job has been “substantially completed”, you’ll put in your retainage billings. This can get tricky on larger jobs, especially if you were one of the first contractors to start work. In cases like these, you could potentially wait for years to get that withheld cash back.

This is why we recommend getting a retainage reduction rider included in your contract. This reduces the amount of retainage withheld as project completion milestones are hit based on the amount of work completed.

Typically, retainage is billed separately from a progress billing, and will be submitted on the same dates as a progress billing (or after a job is over). In our experience, retainage billings can be some of the hardest billings to get submitted to close out a project, because punch lists and other items often delay the final retainage billing, we recommend working on your close out documents long before a project is complete to help them get in.

Construction Billing Best Practices 

So, how can you keep cash flowing, no matter which billing method you go with? Here are our best practices:

1. Make sure your operations team knows the contract type so they can bill properly from the get go. In that same vein, make sure you’re on the same page as everyone else on the project. Everyone should know the date when your billing has to be submitted and accepted. As well, if there are other contractors below you then you need to have them submit their billings to you with enough time to get your billing ready.
2. Whatever payment terms you get (30, 60, 90, etc) should ideally be mirrored with your subs. If you expect to get your progress billings paid every 60 days, having to pay your subcontractor every 30 will make it harder to stay cash neutral. If you receive a late payment, having that extra buffer is helpful. This will also help you understand what your cash flow could be on the job. Pay when clauses are a good way to keep billings synced up.
3. Sometimes you’ll see a combination of contract types on both the main project and change orders. If you can, try to negotiate change orders to be a time and materials contract. This is the least risky for you as a contractor. Still, situations like these can lead to more complex billings, so be prepared if your contract calls for this.
4. If you’re really looking to maximize savings, the best type of contract to look for are lump sum contracts. They provide one of the easiest ways to bill on a monthly cadence. 

Wrapping Up

The construction billing process can be tricky, but a little bit of preparation can go a long way as you take on new construction projects. The more familiar you are with how different types of contracts relate to billing methods - and how these billing methods impact jobs’ financial management, the better you’ll be able to choose the right method for your business. Don’t just stop here though. Take things up a notch with our complete guide to construction accounting.

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