Measure and improve under-billing | EC&M

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Many of us live and believe in the motto, “cash is king”, which means that an overall positive cash flow will ensure the health and success of your business. Without positive cash flow, banks and other financial institutions may not allow you to continue operating.

Cash flow is often measured through a cash conversion cycle. A long cash-to-cash cycle (CCC) means you’re funding jobs and even payroll out of pocket. A shorter cash conversion cycle reduces this problem and leaves cash available in the business for use as needed, including demonstrating business profits. Recognizing and improving underbilling is key to improving your business cash flow. The best way to do this isn’t through the accounting, which often looks back, it’s on the ground – assessing where you are today and looking forward to what’s left.

What is your CCC?

A graph of the CCC is shown in Fig. 1. To explain the movement in the graph, follow the numbers circled:

  1. You receive the material you ordered (this can be on site or in your warehouse or prefabrication workshop).
  2. You pay for the material.
  3. You install or use the hardware
  4. You charge for the material
  5. You get paid for the hardware installed

The time between when you pay for the materials and when you are paid for the installation of those materials is defined as the CCC. The longer this cycle, the longer you and your company pay for this work. The knobs you can turn to reduce CCC are your sub-bills and your accounts receivable.

How do you charge and what impact does this have on under-billing?

Before we talk about how to improve underbilling, it’s probably best to think about how billing is done and how you choose what to charge. Do you use the cost to cost method or the observed percentage complete method? It is important as a project manager/invoicing person that you invoice according to whichever is higher. This will keep your cash flow higher. If you use the cost accounting method when the observed percent complete is greater than the costs, Figure 2 demonstrates that you may be leaving money on the table

without recognizing it. An example is a $1 million contract. The most obvious/known under-billing would be the difference between the $500,000 you billed and the $620,000 you spent. This is the traditional accounting under-invoicing. This tracks costs spent in billed dollars. This is available by looking back in your accounting system. What you may be missing is: How complete is the job? Remember that with the Observed Percent Complete method via ASTM E2691, you can get paid for pre-work and non-installation activities if you can track them and show how they contribute to performance achievement.

ASTM E2691 is the construction productivity standard that uses Job Productivity Management (JPM). It starts at the task planning stage of the project and uses a work breakdown structure (WBS). By tracking this WBS using the job complete independent variable, the electrician can report the observed percent complete for each task and retrieve revenue (including profit) for the actual percent complete on the job. The amount of true underbilling, according to Figure 2 on page 13, would be $250,000 instead of $120,000. It’s critical to note that while the accounting underbill would show zero if you billed $620,000, you’re actually $130,000 underbilled if you used the full method observed. Billing for this work is critical to the success of your business.

Link underbilling costs and accounts receivable (A/R)

Using an example of dollars involved in CCC, let’s see what the true cost of money is to your business. The Table we explain the work a company has to do to cover under-invoicing and aging customer accounts.

  1. Amount tied up in accounts receivable older than 60 days plus company underbills – you can change this to your value.
  2. Opportunity cost: When the money is not received, not only do you not have the real money, but you also have no use for it. The typical 30-year average stock market return is 12% per year, so every month you don’t have those funds, you lose market gains (or pay interest on lines of credit).
  3. Revenue Required: Insert your gross profit number here. You need to earn extra money to pay for the money that is tied up in your CCC.
  4. It is likely that your estimated success rate is not 100%. The industry average is 10%. So you have to bid 10 times the job to get a job that will earn you the income to cover your CCC money.

What is the lesson here? It’s essential that you reduce underbilling and cash in your customer account so that you don’t have to tie up estimators and profits to cover this.

Develop a plan to maximize your profits by measuring and improving your underbillings

The key to this equation is shown in Figure 3. You need to minimize or eliminate under-billing. Your accounting team should track company profits based on FASB ASC606 for revenue recognition. If you charge neither cost to cost nor observed percentage of completion on the job, your business will show a loss. You really need to know your observed percentage of completion using the ASTM E2691 standard for labor productivity management on your jobs. You do this by browsing the job and comparing the work breakdown structure that defined the job. Follow that up with a work productivity management tool. Charge based on that percent complete, then make sure you collect that money.

Jennifer Daneshgari is Vice President of Financial Services at MCA, Inc., Grand Blanc, Michigan. She can be contacted at [email protected]. Dr. Perry Daneshgari is President and Chief Executive Officer of MCA, Inc., Grand Blanc, Michigan. He can be contacted at [email protected].

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