Successful building contractors understand the importance of maintaining constant cash flow. They also know that their billing practices largely impact cash coming into the business and how it can negatively impact the cash required to operate their business and complete a project. A common invoicing mistake on construction jobs that can lead to financial instability and project delays is underbilling. Continue reading to learn what underbilling in construction means, what causes it, what the consequences are, and discover tips for avoiding the negative impacts associated with the practice.
In This Article
What is Underbilling in Construction?
In simplest terms, underbilling is the failure to invoice for the total value of work completed within a given billing cycle. On most construction projects, AIA billings are generally structured based on the percentage of work completed and any associated costs during a given billing cycle. An example of underbilling is finishing 90% of the work in a pay period but invoicing just 60%, resulting in a 30% underbilling. Underbilling in construction is the opposite of overbilling, which occurs when a contractor invoices in excess of the work that has been put in place. Successful contractors understand the pitfalls associated with both billing practices. For more information, be sure to check out our full guide to percent completion billing.
Why Does Underbilling in Construction Happen?
In many cases, underbilling is accidental and can happen for a variety of reasons. Common causes include miscalculations in cost estimating, missing the billing cycle, problems with change orders, and other administrative delays. Contractors who fail to track their jobs properly find that they frequently underbill, as well. Regardless of the cause, underbilling in construction often leads to serious consequences, financial and otherwise, and General Contractors typically want their subcontractors to avoid such problems. A good General Contractor understands the importance of helping their subcontractors invoice properly in order to maintain healthy cash flow throughout the life of the project. After all, no General Contractor ever wants to be in the position of having to bail out underfunded subs for the sake of pushing a job across the finish line.
What Are the Consequences of Underbilling in Construction?
Among the many ramifications of underbilling in construction is the significant strain the practice can put on a contractor’s financial resources, leading to potential problems paying for labor, materials, equipment, subcontractors, and other related costs. Cash flow issues due to underbilling can also cause project delays, increase backlog, and impact cash flow on other jobs. Ultimately, failure to bill in full on a project can result in a contractor being unable to take on additional work.
Though underbilling might look nice to the client at first glance, the practice can negatively impact relationships and reputations. Progress payment requests for less than the full amount owed are akin to “kicking the can down the road.” Eventually, contractors who regularly underbill are forced to issue larger-than-expected invoices in later billing cycles to recoup the difference, a practice that risks creating confusion for the client and a potential loss of trust with all stakeholders.
How Can You Avoid Underbilling in Construction?
Avoiding underbilling in construction is generally not a complicated endeavor. Following are some tips and best practices to help 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. Conduct such 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.
- Review work-in-progress reports on all open jobs to ensure minimal or zero underbilling has occurred. If significant underbilling has taken placeon a job, return to step one above and reevaluate the project costs with the PM team for that project.
- If underbilling is found to have taken place, be sure to address the issue immediately, adjusting the next month’s invoicing to nip 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. And be sure to make use of available technology. Construction management and accounting tools like CrewCost are designed to help make the billing process easier. And integrated software features like SOV cost and progress tracking aid contractors in reducing their risk of underbilling.
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. In short, knowing how and why to avoid billing issues helps ensure your project’s success. Having the right tools at your disposal is also beneficial. Smart contractors know that CrewCost delivers one of the construction industry’s best accounting and job management software packages, helping them avoid the pitfalls of underbilling and allowing them to concentrate on their core business. Try CrewCost for free today and discover how easy it can be to stay within budget, improve profits, and simplify the AIA billing process.
Yancy Lassiter, a CPA with a degree from the University of Texas, has 12 years under his belt as a Controller and CFO in the construction industry; he’s your go-to guy for finance in the building industry.
