By Mike Sanders, AFSB Senior Vice President of Underwriting, Old Republic Surety Company
Large overbillings or under-billings can be an indication of problems that could jeopardize the stability of a contractor’s bond program. Generally Accepted Accounting Principles (GAAP) state that to be accurate, the best way for a contractor to report earnings is most often on the Percentage of Completion (POC) method of accounting. This method ties together what the contractor actually earned, with what they actually billed, showing differences as either assets or liabilities on the balance sheet.
For example, if a contractor is 50% complete with the costs on a contract, then they should only have billed 50% of the total contract price on the job.
Billing concerns in the eyes of an underwriter:
Large under-billings. This may be a sign of slow billing practices, and/or of unapproved change orders being included in the contract price.
Large overbillings. An underwriter will look to see that any large overbilling amounts are offset on the other side of the balance sheet by a like, or greater amount of cash and receivables. A strong positive working capital position (Current Assets minus Current Liabilities) is important as well.
Most contractors try to overbill at least a little when possible. Overbilling a job to the extent that the estimated costs to complete the job exceed the remaining unpaid contract balances can be a concern to a bond underwriter. This excess amount is known as “job borrow”. It is important for the contractor to realize that the cash flow for the remainder of the job will be negative, by the amount of the job borrow, and he/she must plan accordingly so that funds are available to cover remaining job expenses. At Old Republic Surety Company, we can coach contractors and their trusted CPA adviser to understand what ramifications their billing practices could have on their financial statements. We also consult on ways a contractor can improve their balance sheet which will enable them to be more competitive and grow their business. Contact your independent insurance agent for more information about bond programs with Old Republic Surety Company. For more great content by Old Republic Surety, refer to their blog.