Construction companies rely on a positive cash flow to fund projects, pay workers, and grow their businesses. However, slow-paying customers, unexpected supply costs, and other unpredictable events can set projects back and cause significant overbilling.
Effective communication, robust project management, and human oversight ensure accurate progress tracking and decrease the likelihood of overbilling.
Increased Risk of Delinquency
While over and underbilling may be just part of doing business on large construction projects, it can have serious ramifications. The issue is that a contractor can not earn payment for work they’ve performed until it is billed. That’s why it’s essential to have systems that monitor and ensure billing accuracy.
Overbilling often arises from accounting errors due to miscommunication or human error on project teams. It can also occur when a company’s revenue recognition process does not match up with actual construction progress.
In addition, the risk of overbilling is greater when federal dollars fund a project. This is because the False Claims Act can impose severe penalties on contractors who fraudulently claim payment on government contracts. This includes any fraudulent claims for labor, services, or materials that still need to be provided.
Increased Risk of Job Borrowing
Construction projects are long and complex, and payment cycles can vary. When a project is close to completion, contractors may need to borrow cash or accounts receivable from other projects to stay on schedule. This is referred to as “job borrowing,” it is an essential concept for construction companies to understand to manage their finances effectively.
To avoid job borrowing, it is essential to ensure the percentage of contract costs recognized reflects the percentage of work completed. This is accomplished through accurate cost accounting and comparing progress billings to actual costs. Muncy warns that even though some overbilling is acceptable and a good strategy for managing cash flow in an industry where payment is notoriously slow, contract bond underwriters and lenders can see significant overbilling negatively and trigger a red flag. A clear understanding of contract schedules and work-in-process (WIP) reporting is critical to avoiding financial problems on large-scale construction projects.
Decreased Cash Flow
Getting paid is one of the most critical aspects of construction project cash flow. The longer it takes to collect on an invoice, the less cash flow a company has to pay expenses and cover liabilities. In some cases, delayed payments can even threaten the financial viability of a construction business, forcing it to raise prices or reduce profit margins.
Many construction companies use “over-billing” to keep cash flowing during slow-payment projects. Overbilling is a great way to increase cash flow and keep your project going, but it can have drawbacks if you over-bill too much.
If you overbill too much and spend that money on other projects or supplies, it could prevent your company from running out of cash before the project is completed. This is known as “profit fade” and can be a huge red flag for sureties and lenders. Understanding the concept of over- and under-billings and accurately tracking work in progress (WIP) can help you avoid these problems.
Decreased Profitability
While a contractor should try to keep as much cash as possible, a significant amount of overbilling can have the opposite effect. Overbilling makes a construction company’s Profit and Loss Statement look like it has money to spend, so it may be tempting to use this extra cash to pay for something else instead of waiting to receive payments on a contract. This will ultimately result in a negative cash flow position on the project and could negatively impact its expected profitability and outcome.
Overbilling is common in the construction industry, often caused by slow payment turn-around times, miscommunication, or human error. It can be a valuable strategy for contractors to follow as it allows them to maintain their project timelines by staying ahead of the cash runway and avoiding costly time bottlenecks. However, it is essential to carefully consider the risks associated with overbilling and ensure adequate controls are in place to protect against this risk.
