Finding a client who hires you to complete a big project is exciting. A big project allows you to use your expertise and increase your company profits. However, many businesses run into trouble when they don’t plan correctly for the project’s expenses and required cash flow.
Use these tips to use progress billing to successfully complete a large project.
A big project may require your business to spend a large amount of money upfront to pay for labor costs, materials, and other expenses. The problem is that you must pay for the project costs before you receive money from the client. The upfront costs may impact your firm’s cash flow, and you may have to turn down other work, or borrow funds to operate.
A Solution: Progress Invoicing
One solution to this problem is to use progress invoicing to receive client payments while the work is in progress. You invoice the client based on completion milestones, such as a percentage of total completion or the completion of a specific project component.
The client benefits, because the customer does not have to pay for the entire cost of the work in advance. Your business can pay for costs incurred as your staff works on the project, and you earn a portion of your profit before the work is completed.
Progress billing also creates a more transparent process for your client, because the customer knows how much has been paid, how much is owed, and the amount of project work that is completed.
If you hire independent contractors, freelancers, or other firms to work on the project, you can make their payments contingent on reaching the same milestones.
This type of agreement motivates each outside party to complete their portion of the project on time.
How to Use Progress Billing
Assume, for example, that Sunshine Landscaping is hired to install $300,000 in landscaping for the Premium Office Park. Barb, the owner of Sunshine, creates a contract that requires Premium to pay a $60,000 (20%) deposit on May 1st, which she uses to pay for materials, labor, and for subcontractors. Barb’s profit margin (net income / sales) on the office park work is 10%.
When Premium pays the deposit on May 1st, Barb sends Premium an invoice with the following information:
|Project total cost||$300,000|
|Payments to date||$60,000|
To reach the 20% completion milestone, the contract requires Sunshine to build a set of stone retaining walls, and Barb hires Reliable Construction to perform the work.
Sunshine’s $40,000 contract with Reliable states that the construction firm will be paid after Premium inspects that retaining walls and pays for the 20% completion milestone, which is another $60,000.
On May 20th, Premium approves the work performed by Reliable and pays the next $60,000. Sunshine pays Reliable $40,000 of the total, and retains the $20,000 balance. On May 20th, Sunshine sends this invoice information to Premium:
|Project total cost||$300,000|
|Payments to date||$120,000|
Note that 40% ($120,000) of the total contract price has been paid at this point, but $60,000 of that total represents the deposit amount.
Why Change Orders Are Important
A change order is a change made to the written contract, and the change may involve the contract’s total price, specific requirements, or completion time. Change orders are common, and business owners can address these issues using a progress billing system.
For example, assume that, on June 1st, Premium decides to add a group of trees that will provide shade for the main parking lot. Sunshine quotes a $500 price to purchase and install each tree, and Premium signs a change order for 25 trees at a total additional cost of $12,500. The new total cost of the project is $312,500, and the new price is included in each future invoice.
Billing For Project Completion
Sunshine has two other milestones that are met to complete the project. On June 10th, the company finishes the trees, shrubs, and flower beds, which is considered to be 70% total completion. To reach 100% completion, Sunshine must plant flowers by June 15th. Sunshine is paid $100,000 on June 10th, and the final $92,500 on June 15th. Note that the payments received total $312,500.
Correctly Recognizing Profit
Of course, Barb operates her business to make a profit, so you need to understand the accounting principles related to progress invoicing. As you’ve seen above, the cash inflows from a project may not correlate to the percentage of completion. For example, Sunshine received a $60,000 deposit before any work was completed. This disconnect creates an issue when a business recognizes profits.
Nearly all companies use the accrual basis method of accounting, and this principle requires a business to recognize revenue when it is earned, and expenses when they are incurred. The idea here is to match the expenses incurred with revenue, and to post both revenue and expenses in the same time period (month or year).
With progress invoicing, a firm should recognize a portion of the profit when each percentage of completion milestone is reached.
Here’s an example, using the 10% profit margin for Sunshine:
|Payment Date||% completed||Portion of total contract price||10% profit in contract||Contract price|
Note the following:
- Sunshine recognizes profits based on the percentage of completion, not when cash is received.
- The June 1st change order increases the total contract price to $312,500, and the total profit to $31,250.
- On June 10th, Sunshine increases profit by ($21,875 – $6,000), or $15,875. On June 15th, the company increases profit by ($31,250 – $21,875), or $9,375.
- By the time the landscaping project is completed, Sunshine has generated $312,500 in revenue and posted $31,250 in total profit.
Take On Big Projects
Taking on a big project can feel overwhelming, but you can succeed with proper planning. Invest the time to plan for the project’s expenses, including material, labor, and the cost to hire outside firms.
Negotiate a progress invoicing schedule with your client, so that you can generate sufficient cash to complete the project. Once you’ve agreed on a schedule, try the progress invoicing feature in QuickBooks Online. It’s a tool that can automate the invoicing process, keep you on track, and give you some peace of mind.