WIP Report - Over/Under Billing
Do you work or own a company in the construction industry? Maybe a general contractor or specialty trade? Chances are, you heard of ‘Work in Progress’, ‘Over/Under Billing’ or ‘Percentage of Completion’ and yes they are accounting terms. Your accountant may tell you what the numbers are and how to calculate them but do you know what it actually means and what it can tell about your projects and company?
If you haven’t seen my previous blog post on the overall WIP report, please check it out here. In that post, I talk about the various types of stakeholders that require the WIP report, why the WIP report is crucial for you as the business owner and the different components that make up this report.
In this blog, let’s go through 2 of the components:
Overbilling
Underbilling
Overbilling
There are a variety of other terms you might be familiar with or heard of when it comes to overbilling but they are interchangeable:
Deferred Revenue
Unearned Revenue
Billings in Excess of Costs and Earnings
The specific term used really depends on your stakeholders’ needs. Some terms are better understood by different parties than others.
What is this exactly?
In accounting terms, it means the amount you have billed the customer but haven’t earned yet. In business terms, it means the amount you have billed the customer net of the costs incurred for the period.
For example, you have billed the customer $20,000 of the contract this month and you have spent $15,000 of the costs in the same period. There is an overbilling of $5,000. This can also be expressed as a percentage (%). In the WIP report, it’s typically expressed in dollars ($).
What does this actually mean? Is this a good thing or not?
It will be both depending on how you look at it. Typically, projects with an overbilling is usually a positive sign because you have generated positive cash flow. In the example above, you have generated a positive cash flow of $5,000 this month. Cliché alert but cash is king. Some contracts may limit your ability to overbill and some may even indicate that you have billed for work that has not been completed yet. It’s usually accepted in the industry to overbill slightly.
On the flip side, overbilling indicates that you haven’t earned it yet. In my previous blogs, I go into depth into the Percentage of Completion and the different components of it but in summary, in order to earn, you need to incur. Since you haven’t earned it yet, it’s something that you owe (ie. You need to incur cost which means there might be an invoice payable or payroll you need to pay). Also, you can’t put anything you didn’t earn on your income statement or profit and loss statement and don’t worry, it’s only temporary.
Two Components of Overbilling
You might not know this but there are actually two components that make up the overbilling. Most companies only have one number for overall overbilling but separating these helps you understand why.
Unearned and Billed – this is the true amount that you haven’t earned yet
Job Borrow – the amount that estimated costs to complete exceeds the remaining unpaid contract balance
If you’re in the industry, you would try to have a slight overbilling because this helps with your cash flow (billing is more than the cost). You don’t want to finance the project with another project or with a loan you borrowed. On the other hand, you don’t want to overbill to a point that you have job borrow. This exactly describes the previous sentence. The remaining unpaid contract balance is actually lower than the estimated costs to complete. What does this mean? Negative cash flow until project completion. That means you’re financing the project with profits from another project or with a loan.
Overbilling Example
Contract Value $10,000
Contract Cost $8,000
Billed to Date $8,000
Costs Incurred to Date $5,000
Step 1: Percent complete = Costs incurred to date/Contract cost =$5,000/$8,000 =62.5%
Step 2: Overbilling = Billed to Date – Percent complete * Contract Value = $8,000-62.5%*$10,000 = $1,750 overbilling
Step 3: figure out what the ‘Job Borrow’ is = estimated costs to complete – remaining unpaid contract balance = $3,000 - $2,000 = $1,000
Step 4: figure out what the ‘Unearned and Billed’ is, this is just the difference between Job Borrow and Overbilling in Step 3. In this case, $1,750 - $1,000 = $750
What can we tell about this example?
You have $2,000 left on the contract to bill the client but have $3,000 in cost to be incurred. You will have negative cash flow of $1,000. The remaining billing isn’t enough to cover the cost remaining. This usually means you have received the money up front at the beginning of the project but the extra cash in the bank was used to pay for something else or another project (financing another project with this project)
How does this affect your revenue?
Unfortunately, your revenue will decrease by $1,750 due to the overbilling, not just $750. In accounting, revenue is earned and the only way it’s earned is by incurring cost. In this example above, if you spent an additional $1,000 and haven’t billed anything extra, you would only have $500 in overbilling with no job borrow. Not sure how I got that? Just repeat steps 1-4 above.
Underbilling
You will be glad to know that Underbilling is the complete opposite of Overbilling.
There are other terms you might be familiar with or heard of when it comes to underbilling but they are interchangeable:
Costs and Earnings in Excess of Billings
Unbilled receivables
What is this exactly?
In accounting terms, it means the amount you have incurred but haven’t billed the customer yet.
What does this actually mean? Is this a good thing or not?
It could be a good thing but most of the time, it’s not. Imagine this: you did the work but didn’t or couldn’t bill the customer. Between the two, hopefully it’s couldn’t bill, rather than didn’t bill but both is usually as a result of poor project management or a number of change directives where the contract says you can’t bill it. You have now financed that part of the project and you’re not even sure if you could recoup the cost. Negative cash flow territory.
Job borrow, as mentioned in Overbilling above, actually doesn’t apply to underbilling.
There are a couple of scenarios this could happen:
You have overbilled the project at the beginning but now your costs are catching up
There is a problem on your project
You were told to do the work even though no change order was issued (for example, Change Directives)
You incurred the cost but the contract says you can’t bill it yet (for example, contract says you can only bill if you installed the product but you have just delivered it to site)
Example
Let’s use the same example as above but tweak the numbers a bit.
Contract Value $10,000
Contract Cost $8,000
Billed to Date $5,000
Costs Incurred to Date $6,000
Step 1: Percent complete = Costs incurred to date/Contract cost =$6,000/$8,000 =75%
Step 2: Underbilling = Percent complete * Contract Value – Billed to Date = 75%*$10,000 - $5,000= $2,500 underbilling
What can we tell about this example?
You spent more than what you billed the client which means you have negative cash flow. Remember above, cash is king so if you keep pumping cash into the project, that means trouble for your company. Many construction companies go bankrupt because of cash flow issues.
How does this affect your revenue?
Since revenue is based on earnings and it’s earned when you incur cost, your revenue will increase by $2,500 which is great but your stakeholders will have questions. One of the areas they look at is working capital and underbillings means negative working capital.
Your Turn
If you use percentage of completion method, you will always have over and under billings except at the beginning before the project commences or at the end when project is completed. Projects can change between overbilling and underbilling since each component of the calculation will change depending on the circumstances. Spreadsheet software, your ERP software or simply Excel can help you quickly determine this so you can make decisions.
Both of the above is just an easy calculation but the inputs to get to the calculation is based on if you have a job cost system that is set up properly. Without this, you won’t have the visibility into the numbers and you won’t be able to make sound decisions. If you aren’t able to track what you’re buying, how much you’re buying and how much you have left to buy, how is the percent complete and your corresponding financials accurate?
If you would like to find out more about the different components of the WIP report, make sure to check out this article here.
At JTL CPA, our founder has just over nine years of experience in the construction industry (at the time of writing this article) with various general contractors and specialty trades, all the way to senior management. Our approach is unique because our solutions give you the ability to make sound decisions from good data. Check out our website here: www.jtlaccounting.com.
If you found this helpful and want to get notified of any new blogs, please sign up for our newsletter here.
Thank you for making it to the end of the blog post. If there are topics that you would like to learn more about in the future, please let us know down in the comments.
Until then, see you next time!
#accounting #data #construction #engineering #business #entrepreneurship #success
