In our previous posts, we covered profit fade and underbillings, so with tis post we will attempt to answer, what are overbillings? Overbillings are an item that may come up in a meeting with a surety bond underwriter as part of the pre-qualification process of establishing a surety bond program. The first assumption is that the contractor is recognizing their revenue on a percentage of completion basis. If you are a contractor that is contemplating pursuing a bond line for performance and payment bonds, percentage of completion accounting method is the industry standard. Simply put, this method of financial reporting requires a contractor to report the profit on a project throughout the project’s life time. For instance, if a project has an estimated profit of $100,000 at completion and the project is 75% complete at the date of the financial statement reporting, the contractor would recognize $75,000 of profit on that project. If the project were 35% complete, the contractor would recognize $35k in profit
Overbillings are billings in excess of costs and estimated earnings. For example, a contractor has:
Suppose the billing to date on that project was $550 k. That would mean the project is overbilled by $50 k, the difference between the costs and estimated profits earned to date on the project and the actual amount billed.
Obviously as a contractor, if you have the ability to overbill, using the owners money to finance the construction in progress, this is a good thing. When overbillings can become a concern is if there does not seem to be any cash and the account is overbilled. At some point in time that project is going to have to be completed. If the contractor has overbilled, yet lacks liquidity, the underwriting will wonder where the money is going to come from to complete the project? Pure job borrow, is when the project is overbilled in excess of the profit to be earned on the project at completion. Again, if there is not offsetting liquidity, this could be a sign of future cashflow issues for the contractor.
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