Overbilling & Underbilling Explained: A Contractor's Complete Guide

By Martin · 12 min read · Updated 2026-02-02

After two decades of reviewing contractor financials, I can tell you that billing position — the balance between what you've billed and what you've earned — is the most misunderstood and most consequential number in construction finance. It's not just an accounting detail. It's the heartbeat of your cash flow, the lens your surety uses to evaluate risk, and the first place I look when a contractor tells me they're profitable but struggling with cash.

This guide covers everything you need to know about overbilling and underbilling: what they are, how they work mechanically, how they affect your business, and how to manage them strategically.

The Fundamentals: What Overbilling and Underbilling Actually Mean

In percentage-of-completion accounting — the standard method for most contractors — revenue is recognized based on the work you've performed, not the cash you've collected. Your billing position compares how much you've invoiced to how much you've actually earned.

Overbilling (billings in excess of costs and estimated earnings) means you've billed your customer more than the revenue you've earned through work performed. It appears as a current liability on your balance sheet.

Underbilling (costs and estimated earnings in excess of billings) means you've performed more work than you've billed for. It appears as a current asset on your balance sheet.

Neither is inherently good or bad. Both become dangerous when they're unmanaged, chronic, or misunderstood.

The Mechanics: How Billing Position Is Calculated

Let's walk through a detailed example.

Project: Municipal Water Treatment Plant

At 40% completion:

Now the billing position depends on how much you've actually invoiced:

Scenario Billings to Date Billing Position Amount
Matched $2,000,000 Neutral $0
Overbilled $2,300,000 Overbilled $300,000
Underbilled $1,700,000 Underbilled $300,000

In the overbilled scenario, you've collected $300K more than you've earned. That cash is in your bank account, but it's not yours — it's a future obligation. You'll perform $300K of work over the coming months without corresponding billings.

In the underbilled scenario, you've done $300K more work than you've billed for. You're owed that money. Until you bill it and collect it, you've financed that work from your own pocket.

How Billing Position Flows Through Your Financial Statements

Understanding where overbilling and underbilling appear on your financial statements is critical for managing bank and surety relationships.

Balance Sheet

Overbilled positions create a liability: "Billings in excess of costs and estimated earnings on uncompleted contracts." This is a current liability, meaning it reduces your working capital and net worth as presented to your surety.

Underbilled positions create an asset: "Costs and estimated earnings in excess of billings on uncompleted contracts." This is a current asset, but sureties and banks often discount it because it's not as liquid as cash or traditional receivables.

Income Statement

Billing position doesn't directly affect your income statement under percentage-of-completion. Revenue is recognized based on percent complete, regardless of billing. But here's the catch: if your billing position is masking margin problems (more on this below), your income statement is misleading.

Cash Flow

This is where billing position has the most visceral impact. Overbilling improves cash flow today at the expense of tomorrow. Underbilling hurts cash flow today but represents future billing capacity.

Your cash flow statement won't isolate this effect, but your bank account will feel it acutely.

The Real Dangers of Chronic Overbilling

I need to be direct about this: chronic overbilling is the most common way I've seen profitable contractors get into serious financial trouble.

The Ponzi Dynamic

When you're overbilled across multiple projects, you're using cash from Project A to fund operations on Project B. As long as you keep winning new work and billing aggressively, the cycle continues. But it's unsustainable.

I worked with a $20M GC who had $1.8M in net overbilling across 10 projects. They felt flush with cash. Then three projects closed out in the same quarter. Suddenly they owed $600K worth of work with no corresponding billings. They couldn't fund it from operations because the cash had been spent. They maxed their line of credit and still came up short. A profitable company nearly went under because of billing position management.

The Cash Cliff

When an overbilled project reaches 70-80% completion, you hit the cash cliff. You've billed most of the contract value, but you still have significant work to complete. The last 20-30% of the project gets built with minimal new cash coming in.

If you're only overbilled on one project and the rest of your portfolio is healthy, you can manage this. If you're overbilled across multiple projects that are all reaching the 70-80% mark at the same time, you're headed for a crisis.

Masking Margin Problems

This is the insidious danger. When you're overbilled, your WIP report can show healthy cash flow and acceptable margins even when a job is actually losing money. The excess billings create a buffer that hides cost overruns until the project catches up.

By the time the overbilling runs out and the true margin becomes visible, you're 70% or more through the job. Your options for recovery are limited. The time to catch margin fade is at 30-40% completion, not 70%.

The Real Dangers of Chronic Underbilling

Underbilling gets less attention than overbilling, but it's equally damaging in different ways.

Working Capital Drain

Every dollar of underbilling is a dollar you've spent but haven't collected. You're financing your client's project with your working capital. At $500K underbilled, you effectively need $500K more in working capital to maintain the same level of operations.

This shows up as increased line of credit draws, tighter cash management, and less capacity to take on new work. You're paying interest on money your clients owe you.

Bonding Capacity Impact

Sureties view chronic underbilling as a warning sign. It suggests:

A surety reviewing your WIP might discount underbilled assets by 20-30%, which directly reduces the working capital they use to calculate your bonding capacity.

Tax Cash Flow Mismatch

Under percentage-of-completion, you pay taxes on earned revenue — not collected revenue. If you've earned $1M but only billed and collected $750K, you still owe taxes on the full $1M. That $250K in underbilling represents taxable income that hasn't turned into cash yet. For a contractor at a 25% effective tax rate, that's $62,500 in taxes on money you haven't collected.

Managing Your Billing Position Strategically

The goal isn't to be perfectly matched on every project. The goal is to manage your portfolio billing position deliberately, with awareness of the implications.

The Ideal Portfolio Position

For most contractors, the healthiest position is slightly overbilled at the portfolio level — 5-10% of total costs incurred. This provides a modest cash flow cushion without creating excessive liability or masking problems.

At the individual project level, some variation is normal:

Setting Billing Caps

I recommend setting a hard cap on overbilling per project: no more than 15% of costs incurred. When a project hits that cap, slow down billing and let the work catch up.

Similarly, set an alert threshold for underbilling: any project underbilled by more than 10% of costs incurred gets a billing review. Why are we behind? Is there a dispute? Is the PM not submitting pay apps on time?

Monthly Portfolio Review

Every month, as part of your WIP review, calculate:

  1. Net billing position: Sum of all overbilling minus sum of all underbilling. Track this month-over-month.
  2. Billing position by project: Identify which projects are driving the net position.
  3. Billing position trend: Is the net position improving or deteriorating? A deteriorating trend over 2-3 months requires immediate attention.
  4. Cash cliff exposure: Which overbilled projects are approaching 70%+ completion? What's the cash flow impact when they cross that threshold?

Billing Strategy by Phase

Project start (0-20%): Bill mobilization and early costs aggressively if the contract allows it. This front-loading is normal and creates healthy cash flow. Just don't spend the excess — you'll need it later.

Active construction (20-70%): Bill to match earned revenue as closely as possible. This is the phase where you have the most control over billing position. Don't let underbilling accumulate during this phase.

Late stage (70-95%): Watch for the cash cliff. If you're overbilled, start planning for months of work with reduced billing. If you're underbilled, push hard on final billings before the project closes out and leverage disappears.

Close-out (95-100%): Collect retainage. Resolve disputed billings. Close out change orders. Every week of delay in close-out is a week of cash locked up.

How Sureties Evaluate Your Billing Position

Understanding how sureties view your billing position helps you manage it more effectively.

What Sureties Look For

Net overbilling as a percentage of backlog. If your net overbilling exceeds 10-15% of remaining backlog, sureties get nervous. It means you've collected a significant portion of future cash and still owe the work.

Consistency. A consistent billing position quarter-over-quarter is better than wild swings. If you're overbilled by $200K one quarter and underbilled by $300K the next, sureties see unpredictable cash management.

Individual project outliers. Even if your net position looks fine, one project that's 30% overbilled will draw scrutiny. Sureties will want to understand why and whether you can fund the remaining work.

Trend direction. Growing overbilling is a red flag. It suggests you're increasingly dependent on front-loaded billing to fund operations. Sureties want to see stable or declining overbilling over time.

How to Present Billing Position to Your Surety

Be transparent. Don't try to hide overbilling or explain away underbilling. Instead:

The worst thing you can do is have your surety discover a concerning billing position without context. If they find it themselves, they assume the worst. If you present it proactively with explanation, they see competent management.

The Connection Between Billing Position and Cash Forecasting

Your billing position is the bridge between your WIP schedule and your cash forecast. Here's how to connect them:

  1. Start with your WIP schedule. For each project, note the current overbilled/underbilled position and the remaining contract value.

  2. Project future billing opportunities. Based on the contract terms and work schedule, when will you be able to submit billings? How much? Are there milestone billings coming up?

  3. Identify cash cliffs. Which overbilled projects will run out of billing capacity in the next 60-90 days? When will you need to fund work without corresponding billings?

  4. Model collection timing. Apply your actual collection history (not contractual terms) to forecast when billings will convert to cash.

  5. Overlay with costs. Map your projected costs by project against your projected collections. The gaps are your cash flow exposure.

This analysis takes 2-3 hours monthly and is the single most valuable exercise in construction financial management. It connects your project-level performance to company-level cash flow and gives you weeks of advance warning before problems become crises.

Common Mistakes

Treating overbilling as profit. It's not. It's a liability. Don't spend it on overhead, equipment, or distributions. It belongs to the project.

Ignoring underbilling because it's an asset. An asset you can't spend is useless. Underbilling only becomes cash when you bill it and collect it. Treat it with urgency.

Not tracking billing position by project. The net position can mask problems. You might be perfectly balanced overall, but one project is $400K overbilled (cash cliff coming) and another is $400K underbilled (collections problem). Net zero, but two serious issues.

Assuming front-loaded billing is "smart." It's smart if you plan for the cash cliff. It's dangerous if you spend the cash and assume it'll work out.

Not connecting billing position to cash forecasting. Your WIP tells you where you are. Your cash forecast tells you where you're going. Without connecting the two, you're flying blind.

The Bottom Line

Overbilling and underbilling are not accounting abstractions. They are the mechanics of construction cash flow. Every dollar of overbilling is tomorrow's work funded with today's cash. Every dollar of underbilling is today's work funded from your own pocket.

The contractors who manage this well — deliberately, strategically, with monthly visibility — maintain healthy cash flow, strong bonding capacity, and the ability to grow without cash crises. The contractors who don't end up scrambling, maxing out lines of credit, and wondering why they're profitable on paper but broke in practice.

Start tracking your billing position monthly. Set caps on overbilling. Set alerts on underbilling. Connect it to your cash forecast. And present it proactively to your surety.

It's not complicated. But it requires the discipline to look at the numbers every month and manage them before they manage you.