Updated: Nov 9
Every time you start a new project you have many things on your plate, from managing costs, timelines, and changing orders to keeping the project on course. All of these are a challenge, how you manage them determines directly your company’s profit and the ability to bid on larger projects in the future. One of the most daunting issues is underbillings. Overall, underbillings happen because of your poor management, and it has a negative impact on cash flow.
In this article, we’ll take you through the definition of underbillings, how it affects your financial statement. Additionally, we’ll show you proven tips to improve your business management practice that help eliminate the risk of underbillings.
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What are Underbillings?
Underbilling is the opposite of overbilling and occurs when a contractor performs a certain amount of work in a billing period but does not invoice their customer for the full amount of completed work.
For example, in the billing period of March 2022, a contractor completed 45% of a project, but by sending to the customer a progressing invoice for just 30% of the overall contract, the contractor has underbilled by 15%.
>> Read More: What are overbillings?
How underbillings can hurt your cash flow
From the perspective of CPAs and bookkeepers, your performance could look completely different: Your cash flow could be in the negative, making it difficult to cover payroll and other expenses.
And most importantly, your construction company's uneven financial statements will make you a less attractive candidate when you need financial support to bid on larger projects.
How bad project management contributes to underbillings
One of the most common reasons why construction companies are stuck in underbilling situations is not completing the progress invoicing on time. If a contractor and customer agree to set up a fixed time to send an invoice and make payment, the contractor can not get up-to-date costs to be paid. For example, the contractor is expected to get his progressing invoice on the 1st of every month and get paid around the 10th, he can not have costs occurring from 2nd to 10th paid. That leads to an underbilling period.
Another reason for this circumstance is that the contractor got a bad project management accounting. Unlike not completing the progressing invoice on time, which might not affect your overall revenue, bad project management could turn into unrecoverable losses. Let’s go through some bad practices why a contractor is underbilled on a project:
Underestimate project costs
For example, the contractor estimated that the Concrete phase just needs 5 workers with $200 per one to be completed. So, the whole-time contractor thinks it’s going to cost about $10,000 to complete the concrete phase. However, they have to hire 2 more workers to get the work completed on time and the work ends up costing $14,000 in the end. As a result, the contractor could never get paid the extra amount of $4,000. The amount of money they have to pay is always larger than the amount they could get.
Accept to pay vendors for work not completed
If the contractor agrees to pay his subcontractor $20,000 on 03/25/2020 for the window installation which can not be finished at the end of April, he has underbilled his customer in the period from 03/01/2020 to 03/31/2020. The reason is that he can not make an invoice for the work that he has not completed yet.
Not having updated bills from vendors
A list of vendors paid in a billing period could be a bonus point. For example, per the contractor’s calculation, he has been charged up to 355 of the total project costs, which he can discuss with the customer in order to create an invoice with a matching percentage.
Perform unsigned/unapproved Change Orders
A change order is a giant construction industry bugaboo that could cause major problems if it does not perform properly. Without signing or approval, a contractor could not be paid by customers. That means permanent, unrecoverable underbillings. The contractor spent money to complete the change order, but never got revenue to recover all costs for the Change Orders.
How you can take to eliminate underbillings
Underbillings are inevitable when doing business in the construction industry, but how you can manage it makes all the difference in the world. Here are some tips, along with the support of Professional Construction Bookkeeping services to help you overcome under billings and maintain a healthy financial position:
Keep accurate, detailed financial records
Accurately estimate and adjust project costs
Send preliminary payment notices and use progress billings when possible
Prevent unapproved change orders by documenting everything in writing
Conclusion - Underbillings is not a good thing in common
Construction companies need to work and communicate with their customers and accounting staff for planning, controlling, and making decisions during the project. Keeping updated bills from your vendors and discussing with your customer whether you can create invoices and get paid on time. Make sure all of the change orders you performed have been signed and approved. Sometimes, it is alright to underbill your customer. At the end of the project, ensure that you have no net under billings or overbills in excess of 2% of total revenue.
There are many subtle nuances involved in contraction accounting, including the concepts of over and underbillings and work in progress. If you have more questions about these concepts or need help implementing them into your bookkeeping and accounting practices, please contact Irvine Bookkeeping at (949) 545-9980 or book a schedule here.