Have you decided which billing method to use for your construction company? The truth is that the construction industry is in a tough spot when it comes to collecting payments. Because of the project-based, decentralized nature of construction work, contractors need to use various billing methods to ensure they’re compensated for their work, and that they’re able to pay for labor and supplies prior to a project beginning.
The Five Most Common Construction Company Billing Options
In general, we see five construction company billing options used by contractors to support their business operations and prioritize positive cash flow. Let’s review the five most common construction company billing methods – and how you can determine which is right for your business.
1. Lump sum billing.
Sometimes known as fixed price, lump sum billing sets a single cost for an entire project based on a detailed estimate. This method works well for jobs with clearly defined scopes when there are no anticipated fluctuations in labor or materials costs. Finishing early or underbudget can heighten profit margin, but you also run the risk of paying out of pocket for cost overruns.
If you typically use lump sum billing, read through each contract carefully to determine whether it allows for contingencies because of unforeseen events. Also, you can ask for payment in advance, on project completion, or through scheduled installments. Typical installment approaches include:
Advanced billing. This gives you access to the funds needed to buy materials, pay subcontractors and vendors, and mobilize on the job site before construction starts. It’s recommended that, even if you don’t bill for the entire project in advance, some portion of the project funds are collected in advance to avoid negative cash flow in your construction business.
Arrears billing. This approach involves sending an invoice after work is complete. Doing so means you must pay out of pocket to mobilize and complete construction — all the while trusting that the project owner won’t reject your work or delay/deny payment after completion. As you’re likely aware, arrears billing works best for smaller, short-term jobs for trusted customers. However, should something go awry, it can cause problems for your business finances and put a strain on client relationships.
Progress billing. This can happen on a percentage-of-completion basis with retainage withheld. You follow a payment schedule, billing the owner when designated project milestones are met. It’s typically used for long-term projects with larger budgets. When using progress billing, ensure the payment schedule is clearly spelled out in the contract.
2. Cost plus billing.
Cost plus billing includes the total project cost plus a fee for profit. The project cost includes direct costs (such as labor, materials, and equipment) as well as indirect/overhead costs such as travel mileage, insurance, and administrative expenses.
On top of that, contractors generally apply a flat fee or charge a percentage of overall costs incurred, allowing for the fee to escalate when job costs rise.
A good approach for projects with largely undefined scopes, this billing method allows for change orders and rising materials prices without cutting into profit margins. Some owners might place a cap on total project costs in the contract – or limit the scope of work to ensure the project timeline and associated costs don’t get out of hand.
3. Time and materials billing.
Time and materials billing bases the contract price on an hourly or daily labor rate plus the cost of materials used. Under this method, you’ll generally need to apply a standard markup for both the labor and materials/equipment components to account for overhead costs and build in a profit percentage.
Time and materials billing is a sound method for projects with undefined scopes or deadlines. The contract should allow for change orders and, ideally, offer a bonus for early completion to keep crews working efficiently.
4. Unit price billing.
Under a unit-price contract, you bill a customer at a fixed price per “unit.” The project is divided into blocks or segments (units), with the number of blocks undefined at the beginning of the job.
This is an especially common billing method among heavy-highway and utility construction companies taking on projects with repetitive work that can easily be priced out as units. It’s a good approach when you can’t estimate with certainty the project’s schedule or scope.
The unit price method also provides leeway for tacking on additional work and materials, which can result in production quantities higher than estimated. To avoid losing money, it’s critical to estimate the unit pricing correctly. Units will be priced out based on the cost of materials, labor, and any other additional costs you and your team could incur over the course of the project.
5. AIA progress billing.
This common construction billing method uses American Institute of Architects (AIA) standardized forms for progress billing. The contractor invoices the customer based on the percentage of work completed for that billing period.
You can use costs, units, or labor hours to calculate the percentage of the project that’s complete. Although widely used for long-term projects, AIA forms can be costly to use and customize. You must also ensure any changes made won’t lead to legal compliance issues. AIA billing is traditionally used for fixed-price work.
A Common Thread
Running through all five construction company billing options described above is a common thread: The need for accurate, detailed estimates, and good project record keeping.
With these in place, you can provide the documentation needed to increase the likelihood that you’ll get paid on time and with minimal conflicts. Unfortunately for many construction businesses, the time and energy it takes to put these items in place are enough of a roadblock that the task falls to the back burner.
At Mashburn CPA, we can assess your billing methods and help you better organize your financial information for results that move the financial needle in your business. Our team serves as a fractional CFO for our clients – offering assistance with tax and financial services, as well as guidance about industry best practices (including which billing type is right for your business!).
Ready to learn more? Contact us today by clicking here. We’d love to learn more about your construction business, and what unique financial needs we can help you fill.
