Cash is king in construction and one of the biggest culprits of cash flow is underbilling. When you don’t bill enough throughout the course of a job, you end up short on operating cash. That can mean trouble for finishing the work on time and keeping your construction business financially stable.
In this article, we’ll break down what underbilling is, common reasons it happens, and how it can hurt your construction company. We’ll also share some best practices to avoid underbilling in the first place. That way, you can keep cash flow steady and projects on track. Let’s get into it.
Key Takeaways
- Underbilling happens when you invoice for less than the total value of work completed in a billing cycle.
- Common causes of underbilling include miscalculations, missing billing cycles, unapproved change orders, and lack of organization.
- To avoid underbilling, do monthly cost reviews, compare job costs to schedule of values when invoicing, review work-in-progress reports, address underbilling immediately, and communicate transparently with stakeholders.
What is Underbilling in Construction?
Underbilling happens when you invoice for less than the total value of work completed within a given billing cycle. Remember, most construction projects that use AIA billings are structured based on the percentage of work completed along with any associated costs during a given billing cycle.
Let’s say you’ve completed 90% of the work this pay period but you only sent a progress bill for 60%. That means you underbilled by 30%. This is the opposite of overbilling, which happens when you invoice for more than the work that has been put in place. When billing correctly, you would accurately calculate how much work has been done and then bill for that percentage of the total contract price.
Why Does Underbilling Happen?
At face value, it seems like underbilling shouldn’t ever happen. After all, why would you ever bill for less work than you did? Though rare, underbilling does happen. Most times, it’s accidental and is caused by miscalculations in cost estimating, missing the billing cycle, unapproved change orders, or other administrative delays. It can also be caused by a lack of overall organization because you don’t have a firm grasp on how much work has actually been completed. General contractors are even more at risk because they have to make sure that each of their subs is billing properly so they can bill the owner at the proper amount.
Regardless of why it happens, it can have serious consequences and cause tons of cash flow problems. A good general contractor will help their subcontractors invoice accurately so everyone can maintain healthy cash flow throughout the life of the project. After all, no general contractor wants to have to bail out underfunded subs for the sake of pushing a job across the finish line.
Much of this comes back to properly calculating your percentage of completion (POC) which is a method that used to be used for revenue recognition by larger construction companies. Though guidelines from the IASB and FASB have changed the way companies with more than $30M in revenue can recognize revenue, the percent complete method is still used as a stepping stone by many companies.
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What Are the Consequences of Underbilling for Your Construction Company?
There are many things that can happen when underbilling occurs but at the core of it, it puts significant strain on your financial resources, leading to profit fade and problems paying for labor, materials, equipment, subcontractors, and other related costs. Underbilling causes cash flow issues which can cause project delays, increase backlog, and impact other jobs. Ultimately, the failure to bill in full on a project can result leave you unable to take on additional work.
It can also have a negative impact on your relationship with the owner and your reputation. Though underbilling might look nice to the client at first glance, progress payment requests for less than the full amount owed are akin to “kicking the can down the road.” Eventually, you will be forced to issue larger invoices in later billing cycles to recoup the difference, a billing practice that risks creating confusion for the client and a potential loss of trust with all stakeholders.
Tips for Avoiding Underbilling
The good news is, it’s usually not hard to correct the practices that cause underbilling. Let’s walk through a few tips that will help you steer clear of the financial and operational difficulties that frequently result from underbilling:
- Perform monthly cost reviews with the project management team on every job to ensure an accurate accounting of all expenses in each billing cycle. Do these checks a week before invoices are due to owners or GCs, and accurately estimate any unknown values through the end of the period.
- Compare the job cost report with the Schedule of Values when invoicing to be certain the project is not underbilled and to maintain a better understanding of cash flow and financial position throughout the job.
- Make a habit of comparing your actual costs against your estimated costs throughout and at the end of a job (job cost reviews), ideally on a monthly basis. If there is a large gap, dig deeper to find out why the gap exists. You may find ways to make your process more efficient and save money, or if your actuals were much lower than estimated, you’ll have more flexibility to compete on price.
- Review work-in-progress (WIP) reports on all open jobs to ensure minimal or zero underbilling has occurred. If significant underbilling has taken place on a job, return to step one above and reevaluate the project costs with the PM team for that project.
- If you find that the project has been underbilled, address the issue immediately, adjusting the next month’s invoicing to stop any ongoing related problems.
- Maintain transparent communication with project stakeholders, providing regular updates regarding job progress and any potential changes to the Schedule of Values.
Understanding the causes and consequences of underbilling in construction is vital to your project’s cash flow and the overall financial well-being of your company. If you consistently underbill on jobs you are going to start affecting your financial ratios, like working capital, which banks, bonding companies, and others in the construction industry look at to evaluate items like credit lines and if you have the resources to bond work.
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