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 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.
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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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.
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:
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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