It’s hard for us to overstate the importance of accurate billing on construction projects. When managed well, progress billings should help you maintain a healthy cash flow and a good relationship with project stakeholders. Overbilling is one way contractors keep their cash flow consistent on projects. Like anything though, it’s best done in moderation. Whether intentional or not, significant overbillings are one of the fastest ways to erode the contractor-customer relationship if they become too egregious over time.
Of course, most owners understand that it’s not the contractor’s responsibility to fund the project. The problem happens when contractors aren’t transparent about billing. Thankfully, it’s possible to keep a good cash flow while staying in an owner’s or general contractor’s good graces. Read on to learn more about overbilling and how to avoid any unintended consequences.
Key Takeaways
- Overbilling happens when contractors bill in excess of costs, i.e. when the amount invoiced is more than the value of the work completed.
- While overbilling can compensate for slow payments, excessive overbilling can erode trust, especially if you’re not upfront with project stakeholders about your billing practices. Overbilling is a part of our industry, but it should be managed intentionally.
- Detailed planning, clear communication, and consistent updates can help you avoid the unintended consequences of overbilling.
What is Overbilling in Construction?
Over/under billing are both common bookkeeping issues in the construction industry. Underbilling happens when contractors invoice for less than the value of work done. On the other hand, overbilling is when contractors bill for more than the value of work they’ve completed.
In construction companies, overbilling usually happens when a contractor invoices labor and materials before the actual work is completed, as described in the Schedule of Values (SOV).
Like most things, it’s best in moderation. For instance, it’s important to charge for upfront costs like mobilization, material purchased and stored onsite, and general conditions per the construction contract.
Overbilling becomes a problem when contractors try to use it to solve immediate cash flow issues. No one wants to work with a negative cash flow, but this type of overbilling often leads to inadvertent headaches later in the project, including payment delays if invoices get flagged for review or otherwise declined. Trades that consistently overbill often find themselves in hot water with general contractors and owners when it comes to future finances.
Why Does Overbilling in Construction Happen?
More often than not, overbilling is the unintentional result of trades trying to avoid having to fund jobs out of their own pockets. Overbilling can also be caused by:
- Billing for unapproved work, like change orders
- Disproportionately high-margin line items resulting in an overbilled amount
- Disproportionately high estimated costs in the early stages of a job
- Contractors charging for mobilization
- To compensate for retainage on longer jobs
The best contractors understand the importance of staying cash-neutral on jobs and remain aware of their current cash position on every project. Instead of leaning on overbilling, they invoice appropriately to avoid falling behind because of underbilling.
The Consequences of Overbilling in Construction
Usually, if a contractor gets overbilled, they’re able to maintain the overbilling throughout the job until it gets closer to the finish line. One tricky situation that can happen though, is when a contractor gets overbilled and then realizes they’ve overspent toward the end of a job. Now they’re cash-neutral, and have to attempt to overbill other jobs to get to the end of this job. Cash is a contractor’s lifeblood, and falling behind is almost always detrimental to a project’s success.
It should go without saying that your business relationships can also suffer from excessive overbilling. Invoicing outside the parameters of the Schedule of Values runs the risk of destroying trust between the general contractors, subcontractors, and owners by the end of the project. Over time, this breakdown of trust can cause irreversible harm to your business relationships, making it harder to win future work.
How Can You Avoid Excessive Overbilling?
Accurate invoicing is essential to more than just a contractor’s financial health. Avoiding overbilling throughout a project will keep your business relationships and reputation intact. Follow these best practices to avoid unintentional overbilling on the job.
Detailed Planning
Detailed planning is essential. At the beginning of every project, creating an accurate and comprehensive Schedule of Values is critical. This provides a breakdown of all work to be performed and the associated values for each step in the project. With a solid SOV, unintended billing errors can often be avoided.
Staying Funded
If you keep your company properly funded, you won’t have to overbill to stay afloat. When you’re starting out small, it’s important to build up enough working capital over time so a situation where you can’t overbill doesn’t put you in a financial bind. Find a balance between funding your company at the level you want, and paying yourselves over time from those profits. It’s much easier to sleep well at night knowing you have the money to fund yourself for a few months whether you get paid timely or not.
Regular Updates
Providing stakeholders with regular updates is equally important. Construction budgets and related work-in-progress reports should be updated regularly to reflect project costs and progress. You should also double-check actual costs against project SOV amounts to find potential discrepancies as early as possible. When you send in a billing, keep in mind that the owner might ask for a backup (which could show them exactly how much you’ve overbilled).
Remember standard construction project billing dates like the 15th and 25th of each month, and always make sure payment requests are made by the general contractor’s monthly deadlines to avoid falling behind.
Clear and Open Communication with all Stakeholders
Good communication with project stakeholders keeps everyone up to speed on anything that might impact pricing. If adjustments to the contracted costs need to be made, a consistent and comprehensive change order process will help maintain transparency.
Along with agreeing with the client on any project changes, all updates should be reflected across the construction contract, corresponding WIP reports, and relevant AIA payment applications.
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Resource Management
Finally, do your best to take full advantage of all available resources at your disposal. Construction accounting and financial management tools like CrewCost can help track project spending and automatically update budgets and WIP reports, so you can worry less about accurate billing.
Accurate Billing Practices = Good Financial Management
A healthy billing cycle will keep your construction business flush with cash and help you forge strong relationships. Instead of relying on overbilling as a quick fix, you can move forward on projects with confidence.
Ready to stop wasting so much time tracking down all the numbers? Sign up for CrewCost today and get back the time to do what you do best: building!