Beyond the Basics: Overbilling and Underbilling as Strategic Signals
If you have read anything about construction accounting, you know the definitions. Overbilling occurs when you have billed the owner more than you have earned based on your percentage of completion. Underbilling occurs when you have earned more than you have billed. Overbilling shows up as a current liability on your balance sheet; underbilling shows up as a current asset.
What most articles stop there. What they do not explain is why your net over/under position across all active jobs is one of the most revealing numbers in construction finance, and how deliberately managing that position can give you a meaningful competitive advantage.
Think of it this way. If you are overbilled on a job, you are holding the owner's cash. You have been paid for work you have not yet performed, which means you have use of that money until you perform the work. That is effectively an interest-free loan from the owner. If you are underbilled, the reverse is true: you have performed work and spent your own cash to do it, but you have not been reimbursed. You are making an interest-free loan to the owner.
The question is not whether overbilling is good and underbilling is bad. The question is whether your billing position across your portfolio is deliberate and sustainable, or accidental and fragile.
What Does a Healthy Over/Under Position Look Like?
The 2% to 5% Net Overbilled Benchmark
A well-managed contractor should typically carry a net overbilled position of 2% to 5% of total active contract value. If you have $8 million in active contracts, your net overbilling should be somewhere between $160,000 and $400,000. This indicates that you are billing slightly ahead of your costs across the portfolio, maintaining positive cash flow without being excessively aggressive.
A net overbilling position above 8% to 10% of active contract value starts raising questions. Either you are front-loading billings aggressively and will face a cash crunch as projects wind down, or you are billing for work that has not actually been performed, which creates real financial and legal risk.
A net underbilled position, meaning you are underbilled in aggregate across all projects, is a warning sign. It means your company as a whole is funding the owners' projects. Unless you have enormous working capital reserves, a net underbilled position will eventually create cash flow problems.
The Job-Level View
Aggregate numbers tell one story, but the job-level detail tells a richer one. A healthy portfolio typically has most jobs slightly overbilled (by 2% to 8% of individual contract value), a few jobs near neutral, and one or two jobs slightly underbilled due to billing timing or change order resolution delays.
What you do not want to see is a pattern where a few jobs are massively overbilled while others are deeply underbilled, and the net position happens to look fine. That pattern often means you are front-loading billings on some jobs to generate cash that covers underbilling on others. It works until a front-loaded job ends and the cross-subsidization collapses.
Why Chronic Underbilling Is More Dangerous Than You Think
Contractors tend to focus on overbilling because it feels like a cash management win. But chronic underbilling, especially on specific jobs, is the more dangerous condition.
The Hidden Financing Cost
If you are underbilled by $150,000 on a project, you have effectively loaned the owner $150,000 at zero interest. If your cost of capital is 8% (a reasonable estimate for a mid-size contractor using a line of credit), that underbilling costs you $12,000 per year in financing expense. Across multiple underbilled projects, this hidden cost can total $30,000 to $50,000 annually for a $5 million contractor, money that comes directly out of your bottom line but never shows up as a line item on your income statement.
What Causes Chronic Underbilling?
The most common cause is poor billing discipline. The work is being performed, but the pay applications are not being submitted on time, or they are not reflecting the full value of work completed. Project managers who focus on building and neglect paperwork create underbilling without realizing it.
The second most common cause is unpriced change orders. You have performed extra work, incurred the costs, but have not yet submitted a change order or received approval to bill for it. Your costs are ahead of your billings, and the gap grows wider every month the change order remains unresolved.
The third cause is genuinely difficult billing environments. Some owners and their construction managers aggressively challenge pay applications, cutting line items they claim are not complete to their satisfaction. When 10% to 15% of every billing gets cut, you fall behind in billings relative to costs incurred.
How Sureties Read Underbilling
Sureties interpret persistent underbilling as a weakness. It suggests either poor billing practices (a project management concern) or unresolved commercial issues with the owner (a financial risk). A project that is 70% complete by cost but only 55% billed is a project where the contractor is exposed. If the owner terminated the contract tomorrow, the contractor would have a significant unbilled claim to negotiate, with no guarantee of full recovery.
Schedule-of-Values Front-Loading: The Art and the Science
The schedule of values (SOV) is the billing tool that determines your overbilling or underbilling position. It breaks the contract into line items with assigned values, and each month you bill a percentage of completion for each line item. The SOV is typically submitted for owner approval before the first billing and becomes the framework for all subsequent pay applications.
What Is Front-Loading?
Front-loading means assigning higher values to line items that are completed early in the project and lower values to items completed later. For example, if mobilization and site preparation actually cost you $80,000 but you assign a value of $140,000 in the SOV, you will bill $140,000 when that work is complete, creating an overbilled position of $60,000 from the very first pay application.
Front-loading is standard practice in construction and is not inherently improper. The contractor has legitimate early-project costs (mobilization, bonding, insurance, equipment transport, temporary facilities) that are real expenses but do not produce permanent work. Assigning appropriate value to these early items in the SOV ensures that the contractor's cash flow keeps pace with their expenditures.
Where Front-Loading Becomes Problematic
There is a line between reasonable front-loading and aggressive manipulation, and sophisticated owners know where that line is. If your SOV assigns $300,000 to mobilization and site prep on a $2 million job when the actual cost of those items is $100,000, the owner's construction manager will likely reject the SOV or require adjustments.
More importantly, front-loading creates a cash flow timing pattern that works against you at the end of the project. If you bill 40% of the contract value when you are only 25% complete by cost, your late-project billings will be compressed. You will perform 30% of the remaining work but only have 15% of the contract value left to bill. The overbilling reverses, cash flow slows, and you may find yourself underbilled on the backend of the job.
The Strategic Approach
The best practice is moderate, defensible front-loading. Assign realistic but slightly favorable values to early-project line items. Ensure that your SOV values can be justified if challenged. Target an overbilled position of 5% to 10% of contract value during the first half of the project, knowing it will naturally decline toward neutral as the project progresses.
Also consider the composition of your line items. Combining material procurement and installation into a single line item allows you to bill for stored materials before they are installed, which is a legitimate form of front-loading that creates early overbilling without distorting the SOV structure.
ASC 606 Reclassification: What Changed and Why It Matters
Under the older accounting guidance, overbilling and underbilling were presented on the balance sheet as "billings in excess of costs and estimated earnings" and "costs and estimated earnings in excess of billings." Under ASC 606, these have been reclassified as contract liabilities and contract assets, respectively.
Why the New Labels Matter
The reclassification is not merely cosmetic. Under ASC 606, a contract asset represents a right to consideration that is conditional on something other than the passage of time. That condition is typically the completion of additional work or the achievement of a milestone. A contract liability represents an obligation to transfer goods or services to the customer for which payment has already been received.
This framing has implications for disclosure requirements. ASC 606 requires more detailed disclosures about contract balances, including the opening and closing balances of contract assets and contract liabilities, revenue recognized from amounts in the contract liability balance at the beginning of the period, and significant changes in contract asset and liability balances.
For contractors, this means your notes to the financial statements need to explain your over/under billing positions in more detail than before. Sureties and lenders who review your financials will see these disclosures and use them to assess your billing practices and financial discipline.
Net Presentation Versus Gross
Under ASC 606, you present the contract asset or contract liability for each contract on a net basis. If a single project has $50,000 of overbilling and $20,000 of underbilling on different performance obligations, you present the net $30,000 of overbilling as a contract liability for that project. You then aggregate all contract assets and all contract liabilities across projects for balance sheet presentation.
This means your balance sheet will typically show two separate line items: total contract assets (net underbilled jobs) and total contract liabilities (net overbilled jobs). The difference between these two numbers is your net portfolio position.
Reading the Balance Sheet: What Each Pattern Tells You
Large Contract Liabilities, Small Contract Assets
This pattern means most of your jobs are overbilled and few are underbilled. If the amounts are moderate (net overbilling of 2% to 5% of active contract value), this is the ideal position. It indicates strong billing discipline and positive cash flow from operations.
If the contract liability balance is very large relative to your portfolio, dig deeper. Are you front-loading aggressively? Are there jobs where billings are significantly ahead of actual progress? The risk is that these inflated billings will reverse as projects wind down, creating a cash crunch.
Large Contract Assets, Small Contract Liabilities
This pattern signals trouble. Most of your jobs are underbilled, meaning you are financing the owners' projects. Investigate the causes immediately. Are change orders pending? Are pay applications being submitted late? Are owner representatives cutting billing amounts? Each cause has a different remedy, and the longer you wait, the deeper the hole gets.
Both Large, Roughly Offsetting
This is the most deceptive pattern. Your net position might look acceptable, but you have large overbilling on some jobs masking large underbilling on others. This cross-subsidization creates fragility. If an overbilled job completes and the cash inflow stops, the underbilled jobs are exposed.
Sureties are particularly attentive to this pattern. They will look at job-level detail, not just the net number, and they will ask questions about the outliers on both ends.
The Monthly Billing Position Review
Your overbilling and underbilling position should be reviewed monthly as part of your WIP process, but it deserves specific attention beyond the standard WIP walkthrough.
Questions to Ask Every Month
For each overbilled job, ask whether the overbilling is sustainable. Will it hold as the project progresses, or will it reverse? Is the overbilling the result of legitimate front-loading, or have you billed for work not yet performed?
For each underbilled job, ask why. Is it a billing timing issue that will self-correct next month? Is it a pending change order that needs to be resolved? Is it an owner who is aggressively cutting pay applications? What specific action will move the billing position closer to neutral?
For the portfolio as a whole, ask whether the net position is within the target range. If it is trending unfavorably (overbilling shrinking or underbilling growing), what is driving the trend and what can you do about it?
Connecting Billing Position to Cash Flow
Your net over/under position directly affects your operating cash flow. An increase in net overbilling from one month to the next means you collected more cash than you earned, which is positive for cash flow. A decrease in net overbilling (or an increase in net underbilling) means you earned more than you collected, which drains cash.
By monitoring the month-over-month change in your net billing position, you gain an early warning system for cash flow problems. If net overbilling has declined for three consecutive months, your cash flow is deteriorating even if your income statement shows healthy revenue and margins. This is the kind of insight that prevents the unpleasant surprise of running out of cash while your jobs are supposedly profitable.
The contractors who master their billing position treat it as a deliberate financial strategy, not an accounting afterthought. They build their schedules of values intentionally, manage their billing processes with discipline, and review their over/under positions monthly with the same rigor they apply to their job cost reports. That discipline translates directly into stronger cash flow, higher bonding capacity, and a balance sheet that tells a story of competence.