Construction Progress Billing: Keeping the Cash Flowing

Rome wasn’t built in a day, and neither are skyscrapers and bridges. Construction projects take time, and because of that, they require significant upfront costs for labor, materials and equipment. Progress billing ensures that contractors have the necessary cash flow to cover these costs as the project progresses, rather than waiting for the full payment upon completion.

Progress billing in construction refers to the practice of invoicing a client incrementally over the course of a construction project, based on the amount of work completed or milestones achieved, rather than requiring a single lump-sum payment at the end of the project. This method aligns payments with the progress of the work, ensuring that cash flow is maintained for the contractor and reducing financial risk for both the contractor and the client.

Let's examine the scenarios to use progress billing on a project, benefits, challenges and best practices for progress billing in construction.

When is progress billing used?

There are different ways to bill for progress, depending on the type of contract used for the project. Lump sum, time and materials, unit price, a guaranteed maximum price, and cost plus are all likely to use progress billing. However, the type of contract does define how that progress billing would be performed. 

Whether a project uses progress billing or not may have to do with the project's overall cost or timeline. Companies often have internal guidelines as to what size of project may be worth progress billing. For instance, it might not be worth it to set up partial payments on an 8–12 week project, since the project may well be finished by the time the administration team sets up the billing in their budgeting and accounting software. On projects that short, the contractor may bill in a single amount instead.

Some smaller companies may use progress billing for shorter projects if they can't float the cash for the duration of the project. Even if it is a $30,000 project, a smaller firm may send a monthly invoice based on progress to ensure adequate cash flow and keep the project moving along.

The Difference Between Progress Billing and Milestone Billing

Progress billing and milestone billing both base invoicing on the amount of a project’s completion — the difference is in how that amount is calculated.

Milestones, while they may correlate with percent complete, are calculated based on a schedule rather than on the budget. A good example of a milestone on a house project might be when the structure is a boxed-in container — when the framing is done, the roof is on and the rough-ins are installed.

Contrast that to a progress complete configuration, in which an invoice might be sent when 100% of framing, 50% of plumbing and 100% percent of foundation are complete — which might equal 30% of total project progress.

Which billing method is used is often up to the project owner's discretion. Public projects are often very schedule-driven, so milestone billing may be the preferred method. On the other hand, lending institutions may prefer progress billing based on financial draws and the schedule of values.

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How does progress billing work?

On most projects, there will be a person or a team of people in charge of collecting all the information to complete a progress billing. For smaller companies, the project manager may have to collect all the required materials and distribute them to the administration team. A larger company might have a project coordinator or a project accountant that's in charge of gathering the data, who will work closely with the superintendent and project manager to verify the progress noted in the billing.

The person responsible for billing will have to ensure the company has systems in place to ensure all the relevant billing and backups are in place before a progress bill deadline. For instance, if an owner's billing is due the fifth of the following month, the contractor will have to receive sub-billings prior to that to allow for processing time before then.

How are progress billings calculated?

Before billing, the contractor should break the work into a schedule of values to identify what to bill against. Using the schedule of values — which is a breakdown structure of the work and its costs, contractors, and owners can both identify how much to pay for the amount of work completed. Often, there are multiple downstream schedules of values that roll up into the prime schedule of value for the owner.

The schedule of values can be segmented by phases or buildings with details of what each section of work entails. When the contractor produces a bill, it will make it easier to determine whether the billed work is, in fact, complete. Software can help break this down to verify completion. Software helps verify the sub has been on site and the work is complete as stated before the contractor approves the invoice for payment.

What Contractors Should Include in a Progress Billing

Industry standard dictates that contractors submit progress billings using AIA formatting. The pay application includes sections to sort out all the information the owner needs to make a payment.

• Committed cost
• Contracted cost
• Change orders
• Percentage complete billed against so far
• Retention/retainage
• Backup document requirements laid out in the construction contract, which could include lien waivers, certified payroll, photos, bills of materials and insurance documents for stored materials

What are the advantages of using progress billing?

Like many aspects of construction, the advantages and challenges of progress billing are dependent on the perspective of the owner or the contractor. For owners, the benefit of progress billing is that they don't have to front all the money for a project before the project even begins.

For contractors, progress billing makes cash flow management easier. They can bill as they spend on project costs rather than receiving all the costs at the beginning of the project and having to use them gradually over the course of the project.

Progress billing also makes it easier to account for any unforeseen changes that happen during the project build, as the change order can be billed along with the other costs incurred during a phase of work.

Finally, it's easier to keep contractors and subcontractors accountable with progress billing — a contractor who's getting paid along the way has more incentive to complete the project efficiently. The owner has a chance to keep tabs on project progress based on how much of the total project costs were already paid out.

Challenges for Contractors When Using Progress Billing

Each and every bill that a contractor issues involves a lot of paperwork. Each step helps owners and GCs verify they're paying the correct amount, but it involves a lot of communication that goes back and forth to make sure that billings are accurate and all the paperwork is compliant.

Many of the challenges with progress billing are related to the paperwork and communication required for accurate payments.

Disputes about how much can be invoiced

Change orders

Change orders are a common part of the construction process, but they can create a lot of chaos if they're not handled carefully. Often the dispute comes when a sub bills a GC or a GC bills an owner for a change order that the owner never formally approved. When the bill comes, the owner refuses to pay, and then there's a dispute about who will cover the costs associated with it.

Retainage

Many owners — especially for residential projects — don't fully understand how retainage is handled when it comes to billing. A contractor can bill a commercial land owner for 100% completion and still have retention held. Retention allows the owner to hold on to 10% of the project cost while verifying that all punch list items are done and through the closeout process. That's the owner's safety net of making sure that the project is completely done and ready to go for their use.

5 Best Practices for Progress Billing

1. Track and reconcile expenses regularly

Contractors want to avoid being in a position of paying subs for work that isn't completed or for change orders that weren't approved. If the subcontractor has any issue and can't complete the job, or if the owner denies the change order, the contractor can wind up paying for the work out of pocket.

Contractors should be timely on gathering all sub billings so that they can bill the owner accurately. Otherwise, they run the risk of either overbilling for a project, which could eat into future cash flow, or underbilling and having trouble covering project costs when those invoices come in.

2. Use the checks and balances

On the AIA G702 form, there's an area for the architect to sign to verify that the progress that's being billed is correct. Often, there are even more signatures required before a billing is approved. For example, the contract may require that the owner's rep come view the project before the billing ever gets to the owner.

Having these checks and balances in place prevents the owner from paying for work that's not completed, and it protects the GC from the impacts of overbilling.

3. Follow change order protocols

Contractors can avoid many of the challenges associated with billing disputes by ensuring they have iron-clad change order processes. The process should include ample written communication about change orders that will provide documentation that each has been approved. Standard operating procedures should ensure that no changes fall through the cracks.

Construction software can provide the structure for change events within a tool that allows the contractor to gather everything into one spot to review drawings and specs to ensure that proposed change orders actually represent changes to the contract before they are sent to the owner.

4. Communicate

Construction involves many different stakeholders, all with their own concerns. The key to helping everybody get what they want is open and consistent communication.

Owners know what they expect to pay at each billing date, but change orders may represent an increased cost for them. The contractor can help by informing the owner in advance that a change is coming and inviting any clarifying questions about it. Pencil drafts are a good way to open that conversation. Contractors who fail to communicate clearly from the beginning will be a lot more likely to have discrepancies or disconnections when it comes to project billings.

5. Avoid changes whenever possible

Finally, though change orders are very difficult to avoid, a good way to make sure change orders don't create waves during the billing process: avoiding changes altogether.

The contractor is not in control of the initial design, of course — it's up to the owner and the architect to get the design as close as possible to the finished project by considering all angles of the build. Contractors can do their part to avoid changes through the estimation process. By doing enough homework on the project, the contractor can ensure the scope of work is accurate and inclusive, thereby avoiding many changes during construction.

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