Understanding and Analyzing Contractor Financial Statements: Part I of II
Q: Why would a contractor bill in advance of incurring expenses or not bill for costs actually incurred?
A: The quick answer is that a contractor will bill in advance of contract costs being incurred or fail to bill for costs already incurred based on what the contract calls for or what the contract allows.
A contractor may reach certain completion milestones ahead of either time or cost expectations. For example, if a contract specified that no more than 30% of the project total could be billed on March 31 but the contractor had completed 40% of the project at that point, its cost and profits would exceed its billings. By the same token, if it had completed only 20% of the project total, its billings would exceed cost and profits on the billing date.
Further, a contract may call for the contracting party to provide advance payment for specialized materials, which would lead to billings in excess of cost and profits. Along the same lines, the contract may require the contracting party to make deposits in advance of work performed, another example of billings exceeding cost and profits.
The billing provisions in a contract point to the importance of effective contract negotiations on the part of the contractor. The contractor has very good operating cash flow reasons to bill in advance of cost incurred and profits earned, since payment of such invoices by the client provide the contractor with cash for project expenses that would otherwise come from his own resources. By the same token, a contractor has very good operating cash flow reasons to avoid billings that fall short of cost and profits since, in such circumstances, the contractor bears more of the cash cost of the project as it unfolds.