In Percentage of Completion Project Accounting, two terms are frequently used – over-billing and under-billing. Both of these concepts are well known to construction industry accounting professionals, but may not be so well known to others. We want to take this opportunity to discuss one of them. Over-billings occur on projects that have some form of progress billings outlined in their contract.
What is over-billing?
Over-billing occurs when a contractor bills for contracted costs in excess of the work that has been completed to date. For example, a contractor has completed 20% of a project but bills the customer for 30%. That extra 10% is the over-billed amount.
The Rewards of Over-billing
In general, some over-billing can be a good thing. The construction industry is notorious for slow-paying. By occasionally over-billing, a contractor can try to stay ahead of the project cash flow. This, in turn, can help to offset any negative impact to cash flow caused by late-paying customers. Many contractors will attempt to over-bill on their projects if possible, especially if they’re dealing with some customers that are slow-paying.
The Risks of Over-billing
Contractors need to be careful however, because significant over-billing can become a problem and may lead to a scenario where you are borrowing from “Pete to pay Paul”, also called “job borrowing”. A company will have a job borrow scenario when, during the course of a project with an extended timeline, the company has gotten so far ahead on their progress billings that the estimated cash costs to complete the project exceed the amount of money remaining on the project still to be billed. It especially becomes an issue when any cash collected from previous over-billings was used to pay for costs on those other slow-paying projects. This can put a contractor in a financial bind.
Over-billing is only a problem when a contractor doesn’t realize that they’ve over-billed on a project and ends up blindsided towards the end of the project, forced to get through a period of negative cash flow in order to finish the project. As an example, a company has over-billed and collected $10,000 more on a project; they used this money to pay expenses to cover a shortfall that occurred because another customer has slowed paid them. The company is then going to have to find a way to come up with $10,000 in order to completely finish the project.
The best construction companies often boast strong financial and accounting teams that keep up with project costs, progress, and cash flow on a daily basis, and not just at the end of the month or on a project when it’s “time to close out the books.” Managing over-billing can be a useful component in a construction company’s financial toolbox to help mitigate the impact that the industry’s notoriously slow-payment practices has on cash flow. The key is to make sure to keep track of exactly where you are regarding project costs, project progress, and project billings.
If you would like more information on this topic, please contact Janet Stafiej, CPA at 314-576-1350 or firstname.lastname@example.org.