Overbilling and underbilling explained

Start with earned revenue, which is the contract amount times percent complete. Compare it to what you have billed to date on the same job.

• Billed more than earned: the job is overbilled. The difference is billings in excess of costs and estimated earnings.
• Earned more than billed: the job is underbilled. The difference is costs and estimated earnings in excess of billings.

A quick example. A $1,000,000 contract is 40% complete, so earned revenue is $400,000. If you have billed $450,000, the job is overbilled by $50,000. If you have billed $350,000, it is underbilled by $50,000.

Overbillings are a liability. You have been paid, or can bill, for work you have not yet done, and you owe that work to the customer. Underbillings are an asset. You have done work you have not yet billed for.

Those two balance sheet lines should equal the totals on your WIP schedule. When they do not, either the WIP or the books are wrong, and that mismatch is one of the most common problems found when a contractor's financials are reviewed. The monthly entry that keeps them in sync is covered in the percent complete adjustment.

Contractors who bill on a schedule of values with front-loaded line items, mobilization, or stored materials will run modestly overbilled on most jobs. That is the operating norm, and it helps cash flow.

The risk is treating overbilling cash as profit. That money is already committed to finishing the work. A company that spends its overbillings to cover overhead or other jobs can look healthy right up until the back half of its projects need funding.

Underbilling can be innocent. A change order is approved but not yet billed, or the billing cycle simply falls before month end. But a job that stays underbilled, or grows more underbilled month after month, usually points to something else:

• Costs are running over the estimate, so the cost-to-cost percent complete races ahead of what the work actually supports.
• Unapproved change order work is being done and carried as if it will be paid.
• Billing is lagging because nobody owns it.

Sureties and lenders read persistent underbilling as possible unrecognized losses. It is the line they ask about first.

Look at overbilling and underbilling by job, not just in total. A small net figure can hide one badly underbilled job offset by several overbilled ones. Review the trend each month alongside estimated gross profit, and ask the project manager about any job whose underbilling grew.

That review only works if the WIP is updated every month. See the monthly close checklist for where it fits.