In this lesson we'll cover the second common scenario with underbillings, the "nothing to see here folks" scenario (2). Let's get to it!
I call it the "nothing to see here folks" scenario because the underbilled amount appears reasonable in light of other factors. According to scenario (2), we are $32,404 underbilled, which relatively low to begin with, regardless of the other factors. One of the first numbers I look at when we have underbillings is percent complete. 33.7% complete tells me that we're passed the overbilling stage, typical at the start of projects. We've started construction and can expect to be underbilled. The next number I look at is the contract amount, in our example, $750,000. Underbillings relative to total contract amount is fairly low, something we hope for. Based on billings and costs, we're recognizing profit at a rate of 20% ((220,000-175,000)/220,000), which is 11% shy of our expected profit of 31%. Even with this difference, we're only $32,404 underbilled, which is nothing to lose sleep over. Generally, this scenario doesn't raise any red flags, which is why I call it the "nothing to see here folks" scenario.
BUT WAIT!
Just because it doesn't raise any red flags, doesn't mean you're free and clear. This scenario assumes your inputs are accurate meaning all your costs incurred are included in the cost to date amount. However, suppose there was an invoice for $75,000 that was being held by the project manager for costs incurred during the period (not included in cost to date). This invoice was for work completed through the report date and the billed to date amount reflects said work. Now we're in a different place. If you run the numbers to include the $75,000 invoice (see below), we're underbilled by $140,577, which is significantly higher than our original amount. Now we're closer to 50% complete with the same contract amount, which means it's time to question the estimate. Upon further investigation, it turns out that the job isn't going to perform as anticipated and we need to add an additional $160,000 in estimated costs, bringing our total estimated cost to $680,000. I've seen this scenario pan out multiple times so beware! Just because the amounts appear reasonable doesn't make them correct!
Note: This is a standard scenario(s) I come across. Your scenario may be different. I advise you to consult with your CPA or accounting professional for further guidance.
Thanks!
Ara
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