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Underbillings, Overbillings and Contract Bonds

March 12, 2022

Underbillings and Overbillings are important to all contractors and contract Surety Bond underwriters. Learn more about what they are and what underwriters look for in determining a contractor’s bond capacity.

 

Percentage of Completion Accounting

 

Most contractors should be using the Percentage of Completion (POC) method of accounting. This is the most accurate method of construction accounting and creates both Underbillings and Overbillings. You can read more about the Different types of financial statements here.

 

What is an Underbilling?

 

Underbillings are an industry name for Costs In Excess of Billings on Uncompleted Contracts. Simply put, they are revenue that a contractor has theoretically earned but not yet billed. For example, if a project is 50% complete but a contractor has only billed for 40%, the project is 10% underbilled.

 

Underbillings show up on a contractor’s Work in Progress Report. This report should tie back to a Contractor's balance sheet where Underbillings appear as a current asset. Underbillings are a Current Asset because in theory, they should be revenue that the contractor can bill for and collect in the future.

 

Many contract surety bond companies base a contractor’s bond capacity as a multiple of working capital. Working Capital is calculated by taking Current Assets and subtracting Current Liabilities.

 

In theory, because it's a Current Asset, more underbillings should increase working capital and therefore bond capacity. However, this is almost never the case.

 

Underbillings and Bond Companies 

 

Contract Surety Bond companies are skeptical of underbillings because they often turn into losses. From a practical standpoint, underbillings often appear when there is a project dispute, a poor estimate, or bad billing practices.

 

Disputes

 

Underbillings often happen when there is a dispute. The contractor submits a change order for work that has been done but cannot bill for it. This creates an underbilling. Contractors should ALWAYS have a signed change order in hand before doing work outside the contract.

 

For this reason, contract bond underwriters will closely monitor underbillings on a particular project. If the Underbilling remains for more than a billing cycle or two, most bond underwriters will assume it's a loss and remove it from their analysis.

 

Poor Estimate 

 

Underbillings can also occur when a project was estimated improperly. For example a contractor may realize they have significantly more coats but unable to bill for those costs under the contract.

 

Bad Billing Practices

 

Underbillings also show up when a contractor has bad billing practices. If a contractor has earned revenue that is not in dispute, the contractor should be billing for it. 

 

Constant underbillings are a sign that a contractor has poor accounting systems in place and are a major red flag. Contractors often create Bonds claims and go bankrupt when they have bad systems in place.

 

When are Underbillings Acceptable?

 

There are situations when Underbillings are justified. One example is when a contractor is not allowed to bill for material or equipment until it is installed. 

 

Certain trades also tend to have more underbillings. However, these underbillings should generally be small and Billed quickly.

 

What are Overbillings?

 

Overbillings are an industry term for Billings in Excess of Costs on Uncompleted Contracts. Simply put, these are revenues that a contractor has Billed for, but that they have not yet earned. For example, if a contract is 50% complete and the contractor has billed for 60%, the project is 10% overbilled.

 

Overbillings also show up on a contractor’s Work In Progress Report and should tie back to the Contractor's balance sheet as a Current Liability. Overbillings are a Current Liability because the contractor has billed for work they have not done. This will lead to a future cost that they cannot bill for.

 

Overbillings and Bond Companies

 

Most contract surety bond companies view some Overbilling as a positive. It is a best practice to stay slightly ahead of Billings on a project. In fact, an accepted industry practice is to "front load" a contract to cover mobilization, insurance and performance bond costs, etc. 

 

Overbillings can be a problem for contractors though. Bond underwriters will want to make sure that a contractor has enough cash and account receivables to offset Overbillings. This is because the contractor will have a cash outflow later in the project. Not having enough cash and receivables to offset Overbillings is a sign of cash flow troubles to come.

 

Job Borrow

 

While being slightly overbilled on a project is acceptable, job borrow is not. Job borrow occurs when a contractor uses Billings from one project to cash flow another project. 

 

Pure Job Borrow occurs when a project is overbilled by more than the project's remaining Gross profit. Job Borrow is often a sign of cash flow issues to contract bond underwriters and other lenders.

 

Every contractor should Understand Underbillings and Overbillings. Accurate accounting and billing guidelines practices is vital to the success of any construction company. These practices are also essential to contractors needing contract bonds such as bid bonds, performance bonds and payment bonds

 

Contact Axcess Surety anytime for best practices and help with all bond needs.

 

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