In yesterday’s part 1 blog (click here for post), we introduced percentage of completion and how to calculate. For this blog we’ll breakdown how to calculate over and under billings from the WIP, which is then entered as a current asset or current liability which in turn, affects bonding capacity. Let’s start with an example of what a simple work-in-progress (WIP) schedule looks like:
As we learned in Part 1, revenue earned is calculated by taking costs to date divided by total estimated costs, and multiplying the percentage by contract price. To calculate if the contractor is over and under billed simply subtract earned revenue to date from billings to date.
Let’s calculate job #1. Revenue earned is ($200,000/$400,000) x $500,000 = $250,000. Since job #1 has billed $220,000, the job is ‘underbilled’ by $30,000. Since the work is already done and the contractor just needs to bill, the $30,000 is transferred to the balance sheet as a current asset called an underbilling.
Let’s calculate job #2. Revenue earned is ($120,000/$160,000) x $200,000 = $150,000. Since job #1 has billed $200,000, the job is ‘overbilled’ by $50,000. Since the contractor must still perform that $50,000 worth of work, the $50,000 is transferred to the balance sheet as a current liability called an overbilling.
Over and under billings happen and it’s impossible to always be correctly billed. However, too much of either can raise red flags with the surety company. In general, projects that are continually underbilled is usually a sign of poor internal controls and cash flow management, or that there could be that costs are escalating on jobs. Surety companies would prefer more over billings as this is a sign a contractor is better utilizing its cash. However large of over billings means the contractor has a lot of obligation left to perform.
There is no rule of thumb on the percentage a contractor should be over or under billed. But by understanding how to calculate over and under billings and its effect on the contractors balance sheet will pay dividends. It will increase or decrease bond capacity, help the contractor manage jobs more effectively, and ultimately help the contractor grow and thrive.
Give us a call to learn more about POC accounting, and how it can lead to qualifying for larger performance and payment bonds. 877-737-5723