Managing the financial operations of a construction company requires far more than securing accurate bids and completing projects on schedule. It demands precise, proactive financial oversight that can identify how underbilling and overbilling affect cash flow.
In the construction industry, the timing of your billing compared to the actual costs you have incurred dictates the financial health and longevity of your operations. NorthStar Bookkeeping serves construction firms across the United States, and we consistently see business owners struggle to balance their project inflows and outflows.
If you are a CEO or business owner in the construction sector, you know that managing cash flow is your most critical operational task. While CPAs and CFOs understand these financial metrics inherently, construction leaders need clear, accessible reporting to make strategic decisions. Even property management firms and law firms experience variations of billing discrepancies, but in construction, the stakes are directly tied to massive material and labor costs.
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“Revenue recognition in construction is uniquely complex because cash flow rarely aligns perfectly with project progress. Accurate financial health is only visible when business owners consistently measure their incurred costs against their billed amounts on a granular, project-by-project basis,” says Paul Yee, Co-Owner of NorthStar Bookkeeping.
To understand your true financial position, you must master the concepts of underbilling and overbilling.
The Mechanics of Construction Accounting
Before examining billing discrepancies, you must understand how revenue is recognized in your industry. Most construction companies utilize the percentage of completion method for their accounting. This method recognizes revenues and expenses based on the actual progress of a specific project, rather than waiting until the project is entirely finished to record the financial data.
For example, if you are working on a project with a total estimated cost of $100,000 and you have incurred $25,000 in costs to date, your project is 25 percent complete. Under the percentage of completion method, you should have recognized 25 percent of your total estimated revenue for that project.
Discrepancies arise when your actual billed amounts do not match this percentage of completion. This creates a variance on your Work in Progress (WIP) schedule, resulting in either underbilling or overbilling. Both scenarios provide critical information about your cash flow, but they impact your business in vastly different ways.
Costs in Excess of Billings: The Threat of Underbilling
Underbilling, technically referred to as “Costs in Excess of Billings,” occurs when you have incurred more costs on a project than you have invoiced to your client. Returning to the previous example, if your project is 25 percent complete, but you have only billed the client for 10 percent of the total project value, you are currently underbilled.
This scenario is highly detrimental to your operations. When you underbill, you are using your own working capital to pay for materials, equipment, and labor that are being used to build your client’s project. You are, effectively, financing the construction project for them.
“When a company continuously underbills, they serve as a primary financier for their clients. This operating model depletes working capital and severely limits a firm’s ability to take on new projects or negotiate favorable terms with material suppliers,” explains Heather Kirstein, Co-Owner of NorthStar Bookkeeping.
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Underbilling often stems from operational inefficiencies rather than a lack of actual work completed. Common causes include:
- Delayed Invoicing: Your field team completes the work, but the office delays sending the invoice to the client.
- Unapproved Change Orders: You perform additional work outside the original scope, but you fail to secure formal approval and invoice for that work promptly.
- Poor Communication: A disconnect between your project managers and your bookkeeping team prevents accurate tracking of project milestones.
When you allow underbilling to persist, your cash reserves diminish rapidly. You may find yourself unable to meet your own financial obligations, such as payroll or vendor payments, despite having a backlog of profitable work. It creates a false sense of failure, where your profit margins appear non-existent simply because you have not collected the revenue you have rightfully earned.
Billings in Excess of Costs: The Cash Flow Advantage
Overbilling, known as “Billings in Excess of Costs,” is the exact opposite scenario. This occurs when you have invoiced your client for a greater percentage of the project than you have actually completed based on incurred costs. If your project is 25 percent complete, but you have successfully billed for 40 percent of the total contract value, you are overbilled.
In the construction industry, overbilling is generally viewed as a highly positive cash flow indicator. It means that you have secured the capital necessary to fund the upcoming phases of the project. You are using the client’s money to purchase the required materials and pay your labor force, protecting your own working capital.
While running a project with underbillings can drain your cash reserves, maintaining a healthy state of Billings in Excess of Costs acts as an interest-free loan from your client, provided you manage that cash responsibly.
The Financial Discipline Required for Overbilling
While overbilling solves immediate cash flow concerns, it introduces a significant requirement for financial discipline. The surplus cash sitting in your operating account from an overbilled project is not pure profit. It is a liability, categorized as unearned revenue. You still owe the client the labor and materials required to earn that capital.
If you view this temporary cash surplus as profit and spend it on general overhead expenses, new equipment, or owner distributions, you will eventually face a severe cash shortage when it is time to complete the actual project work. This phenomenon is known as “job fade,” where the anticipated profit of a project vanishes because the funds were mismanaged before the costs were incurred.
“Recognizing unearned revenue as available capital is a critical error in construction financial management. Proper liability tracking ensures that cash reserves remain allocated to the specific project obligations they were intended to fund,” advises Yee.
To maintain discipline, you must rely heavily on your WIP schedule. A properly maintained WIP report will clearly define exactly how much of your current cash balance is unearned revenue and how much is true, realized profit.
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Leveraging QuickBooks Cloud Integration for WIP Reporting
Tracking underbilling and overbilling manually is highly prone to error. To maintain accurate financial oversight, you need immediate access to your financial data. NorthStar Bookkeeping specializes in QuickBooks cloud integration for on-demand cloud financial reporting and analysis.
By integrating your project management tools with cloud-based accounting software, you can automate much of the data entry required for job costing. This integration allows you to:
- Track labor and material costs in real-time as they are submitted from the field.
- Generate accurate WIP schedules at the end of every month, rather than waiting for quarterly or annual reviews.
- Identify underbilled projects immediately so you can issue invoices and correct your cash flow trajectory.
- Isolate overbilled funds so you do not accidentally spend unearned revenue on unrelated operational expenses.
Accurate bookkeeping processes allow you to move away from reactive financial management. Instead of waiting to see what your bank balance is at the end of the month, you can project your cash flow needs based on accurate percentage of completion data.
“A proactive financial strategy requires moving away from reactive invoicing. By aligning project milestones with real-time financial reporting, business owners can maintain liquidity and protect their profit margins from unexpected cash shortages,” notes Kirstein.
Establish Healthy Cash Flow Today
NorthStar Bookkeeping serves construction firms in Orange County, CA, and across the United States. We understand the specific nuances of construction accounting, from complex job costing requirements to detailed WIP schedules. We can help you implement the systems necessary to eliminate underbilling and manage your overbilling with strict financial discipline.
Contact us today to talk about outsourced bookkeeping for your business.