Underbillings: What is it? How can it hurt your cash flow?

Underbillings Bookkeeping

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When you start a new project, you have a lot on your plate, from managing prices, timetables, and changing orders to staying on track. All of these are difficult challenges, and how you manage them directly affects your company’s profit and capacity to bid on larger contracts in the future. Underbilling is one of the most difficult challenges. Underbillings occur as a result of poor management and have a negative influence on cash flow.

In this article, we’ll define underbillings and explain how it affects your financial statements. In addition, we’ll show you tried-and-true ways to strengthen your company management practices and reduce the danger of underbilling.

What are Underbillings?

Underbilling is the inverse of overbilling and occurs when a contractor completes a particular amount of work during a billing period but does not bill their customer for the entire amount of finished labor.

For example, a contractor completed 45% of a project in March 2022, but by providing the customer a progressive invoice for just 30% of the whole contract, the contractor underbilled by 15%.

Read more: Underbillings Definition | Law Insider

How underbillings can hurt your cash flow

CPAs and bookkeepers may see your performance in an entirely different light: Your cash flow may be negative, making salaries and other expenses difficult to cover.

Most significantly, your construction company’s erratic financial records will make you a less appealing choice when it comes time to bid on larger projects.

How underbillings can hurt your cash flow

How bad project management contributes to underbillings

One of the most prevalent reasons for construction companies to be underbilling is a failure to complete progress invoicing on schedule. If a contractor and a customer agree on a predetermined time for sending an invoice and receiving payment, the contractor will not be able to obtain up-to-date charges paid. For example, if the contractor is expected to receive his advancing invoice on the first of each month and be paid on the tenth, he cannot have costs happening from the second to the tenth paid. This results in an underbilling period.

Another reason for this situation is that the contractor received poor project management accounting. In contrast to not completing the advancing invoice on time, which may not effect your overall revenue, poor project management may result in irrecoverable losses. Let’s look at some of the reasons why a contractor underbills on a project:

Underestimate project costs

For example, the contractor anticipated that the Concrete phase would only require 5 workers at $200 per person to finish. As a result, the full-time contractor estimates that the concrete phase will cost around $10,000. However, in order to complete the work on time, they must recruit two more workers, and the work ultimately costs $14,000. As a result, the extra $4,000 could never be paid to the contractor. The amount they must pay is always greater than the amount they could receive.

Accept to pay vendors for work not completed

If the contractor agrees to pay his subcontractor $20,000 on 03/25/2020 for window installation that will not be completed by the end of April, he has underbilled his customer from 03/01/2020 to 03/31/2020. The reason for this is that he cannot issue an invoice for work that he has not yet performed.

Not having updated bills from vendors

A list of vendors paid throughout a billing period could be useful. For example, the contractor’s calculation shows that he has been charged up to 355 percent of the overall project costs, which he can discuss with the customer to construct an invoice with a corresponding percentage.

Perform unsigned/unapproved Change Orders

A change order is a major construction industry stumbling block that can lead to major problems if not handled appropriately. Customers could not pay a contractor without signature or consent. That entails perpetual, irreversible underbilling. The contractor spent money to complete the change order but never received revenue to satisfy all costs.

How you can take to eliminate underbillings

Underbillings are unavoidable in the construction industry, but how you handle them makes all the difference in the world. Here are some pointers to help you fight underbilling and preserve a good financial situation, combined with the assistance of Professional Construction Bookkeeping services:

  • Keep accurate, detailed financial records
  • Accurately estimate and adjust project costs
  • Control expenses
  • 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 businesses must collaborate and communicate with their clients and accounting staff to plan, control, and make choices during the project. Keeping up with vendor bills and negotiating with customers whether you can issue invoices and get paid on time. Check that all of the change orders you completed were signed and approved. It is sometimes acceptable to underbill your consumer. At the end of the project, make sure there are no net underbills or overbills that exceed 2% of total income.

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 XOA TAX Bookkeeping or book a schedule here.

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