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Managing a contractor's billings.

MANAGING A CONTRACTOR'S BILLINGS

Construction contractors generally have small administrative staffs and weak controls. Billing practices are not a priority. However, enhancement of these practices is important to survival in a competitive environment.

PROGRESS BILLINGS

Progress billings to customers are a contractor's prime source of cash flow. The schedule for submitting billings varies with the terms of construction contracts. Usually, progress milestones (such as the completion of excavation) are set out in the billing schedule to the contract. Sometimes units of work (such as cubic yards excavated) are used as the basis for the billing. Other stipulations might include the right to bill on delivery or installation of material or following an architect's estimates of percentage of completion. In cost-plus contracts, qualified costs frequently constitute the basis for billing.

BEFORE THE CONTRACT

The contractor should be concerned with maximizing cash flow at the time a job is negotiated or a bid is being prepared. Often cash flow considerations are neglected in the haste to obtain a contract. However, once a contract is signed, the contractor loses the power to negotiate terms that will maximize cash flow.

The creditworthiness of the customer (often referred to as the owner) is one important factor. The owner has title to the property where the construction will take place. Before submitting a bid, the contractor should assess the owner's financial strength. For example, the owner's construction loan commitment should be reasonable in relation to the expected full contract price. This type of assessment is not done frequently enough.

Once the contractor is satisfied with the owner's creditworthiness, his or her attention should turn to the billing schedule. A favorable contract billing schedule should anticipate the progression of costs incurred as work is performed. Front-end loading should be used, consistent with the contract's restraints. Otherwise, negative cash flow may result.

An example of front-end loading for the first five months of a contract is presented in the exhibit Front-end loading. In that example, receipts from the owner exceed the contractor's expenditures on the contract for the first three months, resulting in a favorable cash flow. In subsequent months, expenditures by the contractor exceed receipts from the owner.

Thus, front-end loading of contract billing will result in a surplus of funds during the earlier stages of construction. It is important this surplus be safeguarded and used to complete construction during the later stages, when billings will be less than costs.

During contract negotiations, working capital advances should be provided for on-construction projects requiring significant mobilization and other start-up costs. Moreover, contract terms should permit billing for materials delivered and uninstalled at the job site, if heavy cash outlays are required.

Owners generally retain, or withhold, 10% of the amount billed by the contractor to ensure satisfactory performance. To minimize the adverse cash impact of these retentions, contractors must negotiate similar retention terms on subcontractors' billings.

AFTER THE CONTRACT

The following billing practices can be used to accelerate project cash flow if they are permitted by the contract terms.

If billings are based on completion milestones (such as excavation), their completion should be communicated and billed as soon as possible. If billings are a function of costs incurred (such as in a cost-plus contract or a contract using costs incurred to measure the percentage of completion), the feasibility of using an early accounting cutoff should be considered. For example, the contractor should not wait until all costs have been recorded before billing the owner. Instead the contractor should prepare bills when substantially all costs have been recorded and estimate those not recorded. In the succeeding month, the estimate can be adjusted to actual.

If progress billings are based on an architect's estimates of percentage of completion, these should be made early enough to permit the owner's accounts payable section to process the related billing promptly. Coordination with the owner's architect may be required.

"Punch-list" items--those items deemed by the owner to be completed unsatisfactorily--should be attended to as rapidly as possible so that the amounts retained can be released promptly. Similarly, disputes about any items, such as a disagreement about contract specifications not being met, should be resolved quickly. If the nature of the dispute prevents prompt resolution, the contractor should seek at least partial payment, pending resolution.

The timing of billings should be adjusted to conform to the owner's accounts payable cycle, if it can be learned. If, for example, it is the owner's practice to pay vendors on the tenth of each month, the contractor's billing should be rendered sufficiently in advance of that date for it to be included in the owner's processing of payables.

If permitted, the words "due upon receipt" should appear on the bill. In addition, accounts receivable agings should be prepared at least monthly and collection of past due accounts pursued.

CONTRACT ADJUSTMENTS

Contract adjustments are the most neglected area of a contractor's cash flow management. To maximize construction revenues and cash flow, it is essential that progress billings take into account contract adjustments such as

* Back charges. Billings for work performed or costs incurred by one party (for example, the contractor) that, according to the contract, should have been performed or incurred by another party (for example, a subcontractor). The party that incurred costs that should have been incurred by another would bill them back to the other party.

Back charges are too frequently accounted for on a cash basis. Unbilled back charges can become uncollectible over time. Back charges should be documented, approved and billed on a current basis. They should be checked against contract provisions to justify the charge. The lack of control over unbilled back charges can result in significant revenue loss.

* Change orders. Modifications to an original contract that change its provisions without adding new provisions. They might include changes in specifications or designs, as well as the method or manner of performance.

Pricing of change orders should be in accordance with the parties' understanding and pursuant to applicable contract terms. A properly documented and priced contract change is ordinarily necessary for owner approval. To minimize disputes, it is important to get owner approval promptly. Once a contract change has been documented, priced and approved, billing should be notified so that the change can be billed promptly and subjected to normal collection practices.

* Escalations. Contract provisions for price adjustments of specific items as conditions change.

* Incentives. Contract provisions that add or reduce the basic contract price as a reward for exceeding, or a penalty for not meeting, contract targets, schedules or specifications.

Contract escalations and incentives are sometimes overlooked. Like back charges and change orders, these items should be substantiated in the contract and then included in progress billings promptly.

WORK SITE INVOLVEMENT

Too often, the billing part of the construction cycle is neglected and cash flow impaired. The contractor's ability to negotiate favorable contract terms and more efficient billing practices will contribute significantly to improvement in cash flow. Essential to strengthening the billing function are the receipt of accurate and timely information from the job site as well as better control of contract adjustments. Cash flow is the lifeblood of a contractor; therefore, it must not be neglected.

Front-end loading

January February March April May

General requirements:
 Cash receipts $ 10 $ 15 $ 15 $ 12 $ 12
 Cash disbursements 6 11 12 14 14
 Net 4 4 3 (2) (2)


Concrete work:
 Cash receipts 90 40
 Cash disbursements 70 50
 Net 20 (10)


Totals:
 Cash receipts 100 300 300 400 200
 Cash disbursements 70 280 280 410 220
 Net 30 20 20 (10) (20)
 Cumulative 30 50 70 60 40


Eugene S. Abernathy, CPA, a consultant to the firm of Mauldin & Jenkins, Atlanta, Georgia, discusses how a construction contractor can maximize cash flow by bargaining for favorable terms during negotiations as well as by improving the billing process.
COPYRIGHT 1990 American Institute of CPA's
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Copyright 1990, Gale Group. All rights reserved. Gale Group is a Thomson Corporation Company.

Article Details
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Author:Abernathy, Eugene S.
Publication:Journal of Accountancy
Date:Feb 1, 1990
Words:1300
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