Yes, overbillings reduce revenue. Yes, overbillings are a liability. BUT, they're not bad once you understand them more.
Brief overview of overbillings
Overbillings occur when you're recognizing too much gross profit based on your billings and costs in comparison to your estimates. To reduce your gross profit to match your estimates, a liability is created (overbilling), which reduces revenue.
Imagine you start a project and have little to no costs yet but you bill the project owner $100,000 (kind of like mobilization). You're ahead at this point meaning you've positioned yourself to have more cash coming in than going out. The $100,000 is in receivables and will soon be collected and shown as cash.
What you should be focusing on instead
As we all know, the cash we collect on a project in progress is meant to fund the completion of the project. Until we're done, punch and list and all, we owe the project owner/general contractor a building, a road, a bridge, utility work, HVAC system, electrical work, etc. etc. etc. Once the project is complete and you've paid overhead, you can do whatever you want with that money. Until then, the money better stay in the company.
In the following example we have five projects in progress with a total net overbilling of $(138,000). For a lot of small to midsize contractors, that's a significant adjustment to income. That's bad right? Not necessarily. There's something more important to look at when evaluating overbillings.
The more important matter is what your balance sheet looks like, and by that I mean what is your cash and contracts receivable balance for the same reporting period. Are those amounts, individually or collectively greater than your overbillings? Great! That means you're keeping the money in the company and are set to pay off the liabilities to complete the project. Are cash and contracts receivable less than your overbillings? Not good! Where'd the money go? How are you going to finance your short term obligations? Do you need to draw on your line of credit or take on additional debt to complete the project? Did you take out a large distribution to buy assets for personal use? The money went some where other than the project(s).
Illustration:
What you want to see:
You want your cash and/or receivables to be greater than your overbillings or at least enough to cover your overbillings. That means we can trace those overbillings by project to current assets. There's more confidence in your ability to complete the project(s) when this is the case.
What you don't want to see:
You don't want your cash and/or receivables to be less than your overbillings because it likely means you don't and are likely won't have current assets to satisfy upcoming obligations. You are likely going to need to take on debt to meet those obligations which means that you'll add another liability to your books.
So before you get concerned about the reduction in revenues with overbillings, focus on your cash and receivable balances.
Thank you!
Ara