In the business of construction, it’s all about money. Not just profit and bonus checks, either. I’m talking about cash flow (via Accounting Tools). If a building or infrastructure project is going to be built, someone is paying for it, and someone else is being paid for it. This is how a construction project gets built on the most basic, fundamental level. As you can imagine, there’s a lot more to it than that. For the vast majority of projects out there, projects are paid for as they go. This is done through a process call progress billing. How does progress billing work in construction? In this article, we’re breaking it down into each fundamental step.
This Progress Billing Example Is Based On This Type Of Project…
We’ll base this construction billing process on the following information:
- 10-Story Apartment Building Paid For By A Development Company
- A General Contractor Has Been Hired To Build It
- The General Contractor Hires Many Different Subcontractors To Build Various Parts Of The Building
- The Subcontractors Must Hire Workers To Build The Building, Plus Purchase Materials, Equipment, Etc.
- The Project Will Take Several Months To Complete.
- The Developer Will Pay The General Contractor On A Monthly Basis
The Lifecycle Of Progress Billing In Construction
Progress billing in construction involves several key steps. Typically, the project’s owner or developer will be invoiced by their contractor(s) on a monthly basis. In this article, we’ll focus on eight most important steps of progress billing in construction and what you need to know about each step. Check out our written list or our construction billing infographic below and click to jump to a specific section!
- Subcontractors Perform Their Scope Of Work, Paying For Labor, Equipment, Material & Any Other Costs In The Process
- Once Per Month – Typically Mid-Month – Subcontractors Will Bill The General Contractor For The Total Cost Of Doing Their Work, Including Work They Haven’t Done Yet But Are Forecasting To Complete By The End Of The Month. Subcontractor Bills Will Include Any Supporting Documentation.
- The General Contractor Will Review These Invoices From The Subcontractors. If Changes Are Needed, The General Contractor Makes Notes & Requests A Revised Bill From The Subcontractor.
- Once All Subcontractor Invoices Are Finalized, The General Contractor Will Submit A Bill To The Owner/Client. This Bill Will Include The General Contractor’s Own Profit, Overhead & Management Costs, Etc.
- The General Contractor & Owner/Developer Will Then Review The General Contractor’s Invoice, Which Will Include All Subcontractor Invoices. They Review The Actual Project Progress In Comparison To The Amount Being Billed.
- Once The Month’s Final Invoice Is Approved By The Owner, They Release Payment To The General Contractor.
- The General Contractor Then Releases Payments To Their Subcontractors Based On What The Owner Approved & Paid.
- Subcontractors Account For Their Payment (Revenue) & Costs Of Construction (Expenses). This Is Particularly Important For The Subcontractor As The Subcontractor May Not Be Paid For 100% Of Their Monthly Invoice, Should The Owner Dispute The Work And/Or Amounts That Were Billed. Under Normal Conditions, Work Will Continue And The Process Repeats Next Month.
Progress Billing In Construction: An Infographic
If you’d like a visual depiction of how progress billing in construction works, feel free to download and share the infographic below.
Progress Billing In Construction: The Reality…
Before we get into the details of each step above, there are a few big-picture things to keep in mind:
- Most often, contractors do the work and THEN get paid. Contractors must have enough money on hand to pay many of their costs up front. As the number of projects a contractor is working on increases, so will the amount of money they need to have set aside. If not…
- Construction projects can run into cash flow issues. This not only applies to contractors not having enough money on hand to cover their costs, but also to Owners or General Contractors that either don’t have the money to pay, don’t pay in a timely manner, or even go bankrupt. With this in mind, it’s easy to see that…
- Owners hold nearly all of the cards. Since contractors must pay their own costs before getting paid, the Owner has a lot of leverage. This can include paying contractors less than they’ve billed, requiring repairs/remedial work before payment is released and disputing Change Orders or claims. “That’s not fair!”, they say. In reality, the Owner gets to do this because…
- Adherence to the Contract ultimately dictates payments. Typical construction contracts afford both parties some leverage. Owners, however, can demand that certain criteria be met before they release payment, cancel contracts for many reasons and require that subcontractors continue working during disputes.
These are just a few reasons why billing and cashflow are the lifeblood of a construction project. Let’s get into the details of each step within the progress billing cycle!
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1. Subcontractors Perform A Portion Of Their Work
As said earlier, contractors perform the work and THEN get paid in the majority of cases. This is why many contractors bill for a deposit or mobilization fee up front, so they have some money to fund the upcoming months of work.
Deposits and mobilization fees are billed to make purchases, too. Construction companies of all kinds need to buy materials up front before work can begin. This ranges from small items like electrical wiring or decorative items all the way up to huge purchases like structural steel, glass curtainwall, concrete, etc. Expensive material items often require a deposit themselves.
Other up front costs can include establishing a field office, renting expensive equipment, paying for management/staff, etc.
As the work gets underway, labor crews must be paid each week to perform work. If the contractor does not have payments in hand or is experiencing cost overruns, they must be able to pay for payroll out of pocket, or take out a loan to do so (an emergency option).
Contractors will continue to spend money on overhead expenses, supplies, tools, materials and other miscellaneous costs to get the project going.
2. Subcontractors Submit A Progress Invoice To The General Contractor
Once work is underway, the subcontractor will submit a bill for their first month of work onsite. This is otherwise known as an invoice or requisition. Subcontractors usually submit these requisitions during the middle of the month, forecasting the value of how much work they’ll complete by month’s end.
The General Contractor will first double check subcontractor invoices before submitting them to the Owner for review. Since these subcontractor invoices are basically draft versions, they’re known as “pencil requisitions“.
Subcontractors and General Contractors submit requisitions based on a Schedule Of Values (SOV). This SOV breaks down the contractor’s scope of work into line items, and the dollar value associated with each from the contract. Below is a sample monthly requisition for a hypothetical subcontractor.
A few columns worth noting are:
- Column A – Total Value Of Each Line Item, Based On Scope Of Work
- Column C – What’s Being Billed This Month (‘Period’)
- Column D – Materials That Have Been Billed For, Purchased & Are Stored Offsite For Future Installation
- Column F – Percent Each Line Item Is Complete. Owners Often Review Requisitions Based On This ‘Percent Complete’ Compared To Onsite Progress
- Column H – This Retention Is A Portion Of Payments That The Owner Holds Back (‘Retains’) From The Amount The Contractor Has Billed For/Completed. They Do This For Future Leverage In The Event A Contractor Defaults, Goes Bankrupt, Etc. Contractors Only Receive Retention Once They’re Done.
In addition to the requisition, subcontractors submit several supporting documents as well. Here are some typical examples of backup documents required in the progress billing process:
- Certified Payroll For All Wages & Benefits Paid To Workers
- Summary Of Stored Materials & Their Dollar Values
- Certificate Of Insurance Covering Value Of Materials Stored
- Bill Of Sale – A Document ‘Selling’ The Stored Material To The Owner, Who In Turn Has Official Legal Ownership Of It In The Event Of Future Disputes, Defaults, Etc.
- Signed Lien Waivers Which Waive A Contractor’s Right To File A Lien On The Property (via Investopedia) Due To Non-Payment
- Copies Of Material, Equipment Or Other Invoices If Part Of A Change Order Or Additional Work
Contractor’s monthly requisitions are the most vital part of a construction project. Without them, contractors wouldn’t get paid and Owners wouldn’t know what they’re paying for, or how far along the project actually is.
3. General Contractors Review The Subcontractors’ Invoices
General contractors then review the subcontractor’s pencil requisitions. Oftentimes, they require that subcontractors make changes to these requisitions and resubmit them.
Here are a few common reasons subcontractor invoices get rejected or require a revision:
- Subcontractors Are Billing Too Much On A Particular Item
- Documentation Or Approvals Are Required Before Work Being Billed For Can Proceed
- Supporting Documents Aren’t In Hand
- Stored Material Amounts Are Not Correct, Delayed, Etc.
It’s worth noting that final bills are due by a certain date each month. If a final bill and all of its’ supporting documentation isn’t complete by a certain date, that contractor won’t be able to bill ANYTHING for that month, meaning they collect no money! In this way, timely billing is critical to maintaining cashflow on a construction project.
4. General Contractor Submits Their Progress Invoice To The Owner For Review
At this stage, the General Contractor has all final subcontractor invoices in hand. Now it’s time to submit them to the Owner or Developer for review.
In addition to the bills from the subcontractors, the G.C. will add on a few items of their own:
- Overhead Expenses Like Management Staff, Office, Supplies, Etc.
- Any Supporting Documents Required Like Insurance Certificates, Permits, Legal Forms, Progress Charts, Status Reports, Etc.
- Profit
The big moment happens in the next step: how much the Owner or Developer will agree to pay that month!
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5. The Owner & General Contractor Review The Progress Invoice Based On Actual Performance Of Work
The requisition review between Ownership and the General Contractor is not unlike the G.C.’s review of the subcontractor’s invoices.
Typically, the Owner has also hired a third-party firm to oversee and monitor the project on their behalf. While sometimes the Owner has its’ own representation, they often hire an Owner’s Representative like a Construction Manager or an Architecture/Engineering firm.
These third party firms will often determine how much money can be paid, based on how much work is actually complete. Here are a few things the Owner considers when deciding whether to approve or reject a contractor’s invoice:
- Field Inspections Take Place To Double-Check Percentage Of Work Completed Or If Any Deficiencies Need To Be Repaired.
- Whether Or Not The Owner Had Overpaid On Any Items In Previous Months, Considering The Percentage Presently Complete.
- Third Party Inspectors May Test Finished Products Like Waterproofing, Windows And Many Others To Make Sure Quality Is Being Met.
- Inspections Like Those Above Also Apply To Materials Being Fabricated Or Are Stored – They’re Checked For Deficiencies, Quantity & Quality.
- How Many Days Were Lost Due To Weather Or Delays In The Period Between The Bill Getting Submitted & The End Of The Month.
After the month invoice is reviewed, the job site is inspected and paperwork is collected, the Owner or Owner’s Rep. will officially respond to the submitted invoice along with any reductions and comments.
6. Once The Invoice Is Approved, The Owner Releases Payment
This step comes down to the Owner’s financial situation.
Some Owners have cash on hand to finance the project themselves. In this case, they’re writing checks to pay contractors out of pocket.
Other times, the Developer/Owner has secured a construction loan to finance the project. In this instance, the Owner submits the requisition and all supporting documentation to the lender – usually a bank – who then releases the funds.
In some instances, a portion of a project can be funded via a grant from the city, state or federal government. The process of releasing these funds for payments is similar to lenders and banks – a final paperwork package containing the requisition and all backup is submitted for review. Upon approval, the funds are released.
One example of this is after natural disaster, the U.S. government provides disaster relief funding, which is a form of grant.
Though it sounds straightforward, the construction payment process can get messy.
- If costs and scope exceed the Owner’s estimated budget, they might not have the money on hand to pay for overruns.
- Banks begin charging interest on construction loans after a certain window. If the project is funded through a loan and delays and scope changes extend the project, money from the loan might not be as readily available, or available at all.
- Grants don’t always release money right away. They often require specific criteria or milestone be met before funds are available. This goes back to point #1 above – contractors needing to have cash on hand.
Good or bad, it’s good to know where the money is actually flowing from to fund a construction project.
7. The General Contractor Releases Payments To Subcontractors
General Contractors collect the money from the Owner, and once the check clears, begin to write checks for subcontractors.
As stated earlier, the release of subcontractor payments is predicated around having documentation on hand. Before subcontractors see any checks, they’ll need to have proper insurance documents, waivers, legal forms and other types of backup information turned in.
It’s worth pointing out that a subcontractor might not get the payment they were hoping for. If the Owner reduces the General Contractor’s invoice, certain subcontractors will be paid less accordingly.
8. Subcontractors Receive Payments & Account For The Month’s Income & Expenses
At this stage, subcontractors are getting paid. For most subcontractors, that check isn’t going to just sit in the bank. It’s going to get released in the form of payroll, material costs, rentals, overhead expenses and more.
For a subcontractor, the accounting month’s end is a make-or-break moment.
If a contractor is performing well, their costs will be a fair amount less than the amount that comes in via payments. Rather than count all of this surplus cash as profit right away, contractors often accrue placeholder costs against the revenue brought in. This way, contractors’ accounting records can show a more consistent profit margin each month. Less money is accounted for as profit right away – only at the end of the year above a certain margin.
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What if a contractor is paid less than they expect?
In this instance, contractors might need to pay costs out of their own pockets until the payments come in. In dire circumstances, contractors need to take out loans to pay their costs until they’ve been paid.
Other times, contractors can’t pay their costs, have no money coming in and need to close their doors – either until money comes in, or permanently. Neither is a good position to be in. As a reminder, most contractors are getting paid even less than what they’ve billed, since retention is held by the Owner until the project is finished.
Given that it can be a few months between when a contractor submits an invoice and when they actually get paid, profitability and cash flow are king.
Progress Billing In Construction: A Summary
We’ve written this article to address this popular question: “How Does progress Billing Work In Construction?“. You now have an understand of how money flows on a construction project, how bills get submitted, what’s required to release payment and what construction companies need to do to cover costs, perform working collect proper, timely payments. We’ve also discuss the many hazards that contractors must look out for when working for an Owner, Developer or General Contractor. One last thing to remember: in construction and contracting, cash is king!
