Published October 17, 2023 . 3 mins read

Assessing Project Health: Understanding the Root Causes of Over/Underbillings in Construction

In the dynamic world of construction, the heartbeat of a project’s vitality is encapsulated in its over/underbilling status. But mere identification of overbilling or underbilling only scratches the surface. The underlying reasons offer the true measure of a project’s well-being.

Structure of Schedule of Values

The subtle intricacies of a project’s schedule of values can significantly sway over/underbillings. A well-tailored and favorable schedule of values can naturally lead to an overbilling early in a project when project cash flow is often challenging to manage. This phenomenon is mostly when contractors strategically front-load their schedule of values, earmarking a more substantial portion of profit and overhead for activities slated earlier in the project timeline.

The first metric I look at when analyzing the WIP is over and underbillings. It tells me a pretty good story. Being overbilled is great, being underbilled isn’t.

Wick Zimmerman
CEO at OTL, Inc.

Cost Savings or Bust

Overbillings can sometimes be harbingers of cost savings, whereas pronounced underbillings may set off alarms for potential cost overruns. Consider a scenario where a project has a budget of $1 million and a contract value of $1.2 million. If half the work is complete and leads to a bill of $600,000, but the costs overshoot to $600,000 instead of an anticipated $500,000, without the requisite adjustments, the revenue recognized would be overstated, creating an underbilling. In such cases, updating projected final costs is imperative to ensure revenue is recognized at the correct margin. Often, a large underbilling can be the earliest warning sign that a project might experience profit fade.

Expert tip: A large underbilling can be a warning signal for profit fade. Proactively billing early on will prevent this from occurring.

Project Progress

The rhythm of a project’s progression versus its billing cycle often plays a pivotal role in over/underbilling. Given the norm of monthly billings in construction, often centered around the 15th or 20th of the month, contractors often need to project what costs they will incur for the rest of the month. A slight lag, like being 45% complete instead of the projected 50% by month-end, will create an overbilling. It’s noteworthy that this particular overbilling scenario is the only cause of overbilling that could be an early warning sign for a project.

Unrealized Costs

A temporary inflation in overbilling might be due to the gap between receiving materials or services and the associated invoices’ arrival. Imagine procuring materials worth $100,000 on a given day, say June 19th. While this gets factored into the June 20th billing, the actual invoice for the materials doesn’t grace your desk until June 26th. This interim period witnesses a temporary surge in overbilling, bridged only upon the invoice’s receipt.

Wrapping Up: Genuine Overbilling or Underbilling

The billing status sometimes mirrors the stark reality. For example, if a project’s 30% completion corresponds with a 40% bill, it stands genuinely overbilled.

To wrap up, while the metrics of over/underbilling offer a bird’s eye view of a project’s health, delving into the nuances behind these numbers allows for a deeper understanding of a project’s health and potential risks.