Some contractors send clients lump-sum bills, while others charge on a time-and-materials basis. These billing methods have their merits, but progress billing, or billing periodically throughout the project, is the most common choice for large-scale projects.
This billing method comes with a learning curve, but it can help mitigate financial risks, increase transparency, and ultimately strengthen your relationships with your clients. Let’s take a closer look at how progress billing works and how to determine whether it’s right for you.
Progress Billing in a Nutshell
When a contractor uses progress billing, they periodically bill clients based on the percentage of the project that’s been completed.
Some contractors will send a new invoice every month. Others will consult with the client to identify project milestones that will trigger new invoices. For instance, a client might receive the first invoice when the project design has been approved and the next when the foundation has been completed.
Because the client pays gradually over the course of the project, this approach can help improve cash flow. It also serves to reduce both parties’ risk of major financial losses.
Additionally, progress billing gives all those involved a chance to pause and check in. Contractors and clients can review the invoice and ask themselves the following:
- What was accomplished during this billing cycle?
- Was the work done correctly?
- Was it done on time?
- What was the total cost?
- Is the project on track to be completed on time?
- Is the projected budget still accurate?
This built-in checkpoint makes it easier to identify potential issues and address them before they cause serious hang-ups.
Key Elements of Progress Billing
Construction projects are rarely simple. To adequately reflect the percentage of work that’s been completed, therefore, invoices must be fairly complex. Here’s a look at the main elements of a progress-billing invoice.
Schedule of Values (SoV)
The schedule of values is arguably one of the most important elements in a progress-billing invoice. It breaks the project down into specific work tasks and assigns a dollar value to each.
Percentage of Work Completed
At each billing cycle, the contractor can examine the SoV and assess what percentage of each task has been completed. Doing so allows them to determine the dollar amount the client owes for each task.
Current and Previous Billing Amounts
Each invoice will include the total project budget, the amount the client has paid to date, and the amount that’s due for the current billing cycle.
Any Approved Change Orders
A change order is an amendment to the original contract that the client and the contractor both agree to. Once a change order has been finalized, it should be added to the SoV to ensure that future billing is accurate.
Retainage Percentage
In most cases, a client will withhold a small portion of each payment made to a contractor until the end of the project. The withheld amount is known as “retainage.” It acts as a kind of insurance policy in case there are defects in the work or amendments must be made.
Typically, retainage is roughly 5%–10%. Some state laws limit the amount of retainage permitted in a contract. As long as they remain in compliance with state laws, contractors and clients can negotiate a retainage they think is fair.
How Often Should You Send Out Invoices?
There are three primary payment schedules used in progress billing: time-based, milestone-based, and percentage-based.
Time-Based
Invoices are sent out at regular intervals, usually monthly or biweekly.
Milestone-Based
Invoices are sent each time the contractor reaches a major project milestone. Typically, the contractor and the client will work together to decide which milestones will trigger invoices.
Percentage-Based
With this method, invoices are sent out at regular intervals based on the percentage of completion. For example, you might bill the client each time your team completes another 10% of the project.
What Happens After the Client Receives the Invoice?
Sending a progress-billing invoice isn’t like sending a bill. The client isn’t expected to pay right away; rather, they review the contractor’s work to verify that it lines up with the invoice. That usually involves visiting the construction site and performing a detailed inspection.
If there are discrepancies, the client will discuss them with the contractor. If the invoice is accurate, they’ll make a payment in accordance with the terms of the contract.
How Contractors Keep Track of Progress Billing
Progress billing has advantages for both contractors and project owners. However, billing clients periodically is much more complex than sending an invoice upon project completion.
Fortunately, the American Institute of Architects (AIA) creates standardized contracts for architects, contractors, and others in the construction industry. The AIA library includes more than 200 types of documents, but the following two are the most commonly used for progress billing:
- Document G702–1992 (Application and Certificate for Payment)
- Document G703–1992 (Continuation Sheet)
Document G702 outlines the work that’s been done, retainage, and any relevant change orders. It’s a one-page document that works like a billing summary.
Document G703 is a longer document that breaks the information on Document G702 down into more detail. It divides the project cost into a schedule of values (SoV).
Advantages of Progress Billing
Progress billing may not be the right choice for every construction project. However, when you’re working on a big or complex project, incrementally billing clients comes with several advantages.
It Supports a Healthy Cash Flow
For most contractors, major projects can cause cash-flow issues. Those issues can be exacerbated if a client doesn’t receive an invoice until the very end of the project. With progress billing, you’ll receive consistent income.
It Decreases Financial Risk for Everyone
If you wait to bill a client until the work is finished, there’s always a risk that payment will be delayed, or that the client will refuse to pay at all. However, when a client makes regular, smaller payments, you’ll be less likely to be stuck financing a project out of pocket.
Progress billing reduces the financial risk for clients, too. With each invoice, they’ll have a chance to inspect the work and address any concerns.
It Makes Adjustments Easier
Construction projects don’t always go exactly as planned. Because it’s easy to amend your schedule of values with one or more change orders, project billing establishes a clear procedure for adjusting the scope or timeline of the project.
It Supports Stronger Client Relationships
Progress billing creates transparency and holds all parties accountable. Because the contractor and the client each have a chance to review progress at each billing cycle, this billing method can create and enhance collaborative relationships.
Potential Challenges of Progress Billing
Progress billing is a smart choice for many in the construction industry. However, no billing method is without disadvantages. Here are a few of the prospective challenges of progress billing.
Potential Progress Disputes
There’s always a chance that your client might not agree with the percentage of work you’ve completed. At best, this can lead to reduced or delayed payments. At worst, it can lead to costly legal disputes.
Administrative Work
Creating an initial schedule of values and frequent, detailed invoices takes a significant amount of time. For many contractors, it’s difficult to dedicate the necessary time to preparing key documents.
This is where outsourcing can help. When you work with an outside partner to create invoices, handle billing, and manage payroll, you’ll be able to turn your full attention to your projects.
Potential for Calculation Errors
Most projects have long, detailed schedules of values, and with each invoice, every item on the SoV is assigned a percentage. That leaves plenty of room for error. If an invoice has one or more errors, it could lead to payment delays or other problems.
Steady Cash Flow Isn’t Guaranteed
Progress billing can help you avoid the cash-flow issues that come with lump-sum billing. However, that doesn’t mean there’s no possibility of running into a bottleneck. If your client disputes an invoice or sends one back because of an error, you might end up waiting longer for payment than you’d anticipated.
There’s a Potential for Underbilling or Overbilling
Determining what percentage of each item has been completed can be a challenge. Some contractors end up mistakenly billing clients less than they should, which can lead to cash flow shortages.
Other contractors run into the opposite problem. They may end up billing for more than what they’ve completed in a given period. Overbilling, whether intentional or accidental, can lead to payment disputes and an erosion of trust with the client.
Specialized Accounting Services for Your Construction Business
Whether you’re a contractor who uses progress billing or you prefer to rely on another method, careful accounting is vital for any construction project. When you have a reliable bookkeeping and accounting partner, you can focus your energy on delivering the best work you can.
Devine Consulting LLC can do more than handle your company’s finances. We’ll work closely with your business to develop tailored solutions aligned with your goals. Contact us today to schedule a consultation.