Overbilling and Under billing in construction is 2 common terminologies for people using the Percentage of Completion Project Accounting. Both happen primarily on projects that have extended timelines and have some form of incremental billing or progressing invoices prescribed in the project contract.
So, What is an overbilling in construction?
Overbilling occurs when the contractor bills for labor and materials before the work actually is being completed. For example, during the billing cycle, the contractor completes 25% of the project but bills their customer for 35%. The 10% extra is the overbilled amount.
How could it be a risk?
First, let’s talk about its positive side.
In general, overbilling can be a good thing, especially for people working in the construction industry which is notorious for slow payment. Being in the practice of overbilling helps contractors stay on top of the project cash flow. Besides, it supports them to offset the potential negative impact caused by late-paying customers. Most contractors would try to overbill their customers if it is possible, especially when they are working with a slow-payment customer.
What about its risks? Overbilling can become an issue and may lead to a situation called “job borrow”, also known as “running out of billing". It occurs when the company has gone so far from the progress invoicing and they cannot bill for the remaining actual cost to complete the project,
This is a simple example of the job borrow concept:
PMLC company has a $50,000 construction contract for 12 months
In the 11th month, they decided to progress the final invoice for $5,000. When the customer pays that amount of $5,000, they will have paid in full of $50,000.
However, PMLC still has $8,000 of cash costs to complete the project. Therefore, with just only $5,000 more coming in, PMLC is going to have a NEGATIVE cash flow for the remainder of the project, to the tune of $3,000.
Conclusion
In the comparison with underbilling, the situation that the contractor does not bill fully for all the labor, materials, and services provided in a billing cycle, overbilling is a good thing. It only becomes a problem when the contractor does not realize that they overbilled on their project and expenses all the money they gained during the billing period. In the example above, the PMLC is still fine if the amount of $3,000 is still sitting in the bank and they could use it for the extra cost. If not, they are going to have a negative billing period to finish the project. Managing to overbill is not a difficult task, as well as contractors could keep track of exactly where they are regarding project costs, project progress, and project billings.
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