Progress, Advanced, Arrears: Different Methods of Billing Construction Clients

Cash flow is king in construction. Without proper control over the money that comes in and out of your construction business, your company can easily succumb to major financial bottlenecks.

Part of maintaining a healthy cash flow is having a robust billing process. If you have a streamlined procedure for billing your construction clients, you are able not only to track your cash flow accordingly but also to be proactive in preventing major financial mishaps from happening.

Billing in construction

One unfortunate reality that every construction business must face and prepare for is late payments. The construction sector is simply notorious for delayed payments, which renders even more importance to having an organized billing process.

A messy and disorganized billing process will most likely sink your business to bankruptcy. For instance, while you are sorting your invoices for a finished project, you may not have the cash to fund another project and to cover your fixed operational costs. Tough circumstances like this can snowball into bigger issues, and before you know it, you are buried in debt.

As such, you need to sort your billing process and find the best type of billing method that best fits your company.

Different types of billing methods in construction

There are three major billing methods in construction: progress billing, advanced billing, and arrears billing.

1. Progress Billing

   Progress billing¹is when you bill and get paid in increments based on how much work you have completed for a project.

   Say, for example, you are working on a long-term project that is expected to take 12 months to complete. Over the course of 12 months, you can use progress billing to bill your clients whenever certain milestones of the project have been completed.

   Progress billing is ideal for projects that have a long duration. This ensures that you receive payments throughout the course of a project. This way, you are able to earn money to pay for supplies and labor as you complete your remaining project deliverables.

2. Advanced Billing

   Advanced billing is when you bill and get paid in full before you even begin working on a project.

   For example, you are working on a simple residential project that will take two months to complete. You can bill in advance by asking the client for a lump sum that will cover the cost of the entire project before the project begins.

   Billing in advance is ideal for short-term projects, and it also has its pros and cons. It can be beneficial for you since you will receive the payment upfront to shoulder the necessary costs. However, it can also be disadvantageous if you go over budget and the client has already given you your full payment.

3. Arrears Billing

   Arrears billing² is the opposite of advanced billing. Instead of billing and getting paid before you work on a project, arrears billing means that you get paid after you have completed your work and everyone has signed on off the project’s completion.

   For instance, you can sell and deliver supplies to a construction client and not ask for payment until after the project is complete. Contractors can also bill in arrears by finishing all project deliverables before asking for a lump sum payment.

   Like advanced billing, arrears billing is also ideal for projects with a short duration. Billing in arrears is usually more favorable for your clients, but it requires you to have a strong and healthy cash flow as you will need to shoulder the costs required to complete your project deliverables.

Pros and cons of progress billing in construction

Advantages of construction progress billing

• Continuous payments throughout the course of a project
  Barring any major payment dispute or project closures, you can expect to receive regular payments throughout the course of a project if you use the progress billing method. Note the progress billing does not work as lump-sum payments. As you complete certain milestones for a project, you will receive your hard-earned payments accordingly.Progress billing, therefore, allows you to have a consistent source of cash throughout the project. You can use the progress payment not only to fund the next steps of the project but also to shoulder your regular operational costs.
• More leverage in cases of payment disputes
  When you use progress billing, you are highly encouraged to include a clause in a contract that will give you an out in case your client goes delinquent. For instance, in the event that a client does not fulfill their payment obligations after you have finished a project milestone, you should be able to quit working on the project completely and file a mechanics lien.Progress billing, therefore, gives you stronger leverage if you ever need to recover your payment. If a client turns out to be delinquent, you do not necessarily have to be obligated to complete the project using the money out of your own pocket.

Disadvantages of construction progress billing

• Time-consuming
  Because progress billing is not based on the full scope of the project, it requires more time to prepare and process. To illustrate, it is much simpler to prepare a single invoice to charge a client than to prepare multiple invoices throughout the course of a project.Progress billing, however, is not necessarily complex in all cases. Some projects can be easier to bill, especially if the scopes and contract terms are clear and simple. Still, billing in increments is relatively more involved compared to arrears or advanced billing.
• Prone to payment disputes
  Progress billing can be more prone to payment disputes compared to other billing methods in construction. For example, a client may contest your claim that a project milestone is already complete. Consequently, they can refuse to pay the invoice.In circumstances like this, you can always file a mechanics lien to assert your case and recover your payment. Note, however, that you need to have served a preliminary notice to be able to file a mechanics lien in most states. Also, note that a client can request that you enforce a mechanics lien, which requires a full lawsuit to be filed against them.

Pros and cons of advanced billing in construction

Advantages of construction advanced billing

• Available funding upfront
  Advanced billing allows you to have the money upfront, even before the project begins. This is a big advantage because you are given the money from the get-go, which means that you can use that money to buy the materials you need and hire the right laborers to complete your work.As noted earlier, advanced billing is also simpler compared to progress billing. You bill for the full scope of the project, and you receive a lump sum as payment.
• Lower risk for late payments
  Because you receive the payment in advance, there is a low risk for late payments when you use the advanced billing method. This is an important advantage, especially if you consider how common late payments are in the construction industry.

Disadvantages of construction advanced billing

• Unfavorable to clients
  Understandably, not all clients will be down to pay in advance without any assurance that the job will be completed properly. If you only bill in advance, it may be difficult for you to gain new clients and prove to them the quality of your work.Advanced billing is, therefore, ideal for billing clients who have already worked with you. If you and the client have already established a good business relationship, they will be more willing to trust you and release a lump sum payment, even before you begin working on a project.
• High probability of going over the budget
  One major disadvantage of using the advanced billing method has to do with improper budgeting. If you ever go over the budget, you will need to shoulder the extra expenses using your own money as you already received the full payment before the project began.This is why advanced billing is better suited for short-term projects. As with all other projects, regardless of billing method, you need to be mindful of how you spend and allocate your cash to ensure that you do not dig yourself into a big financial hole.

Pros and cons of arrears billing in construction

Advantages of construction arrears billing

• Favorable for clients
  Construction clients generally prefer arrears billing over advanced billing. In arrears billing, clients need to sign off on the project and verify that the work is of good quality prior to releasing the payment.When you bill in arrears, you are therefore more likely to find new clients who are willing to work with you for the first time. Invoices and payments are also more likely to be correct and accurate with the arrears billing method. Since the project has been completed and the stakeholders have signed off on it, disputes are less likely to happen.
• Fewer refunds
  Processing payment refunds can be quite complicated for progress and advanced billing. In arrears billing, refunds are not as necessary and are relatively simple. Because clients are less likely to contest an invoice, they do not need to ask for a refund. If ever a refund is required, it can be easily traced in the books and issued as a lump sum.

Disadvantages of construction arrears billing

• Costly out-of-pocket expenses
  If the payment arrives only after a construction project has been completed, you need to have enough cash to pay for the materials and manpower needed to complete the project, to begin with. This implies that you need to have a strong cash flow if you bill in arrears.Bear in mind that you cannot bill in arrears without proper budget planning. You need to know where you are going to source the funding that would allow you to complete a project. You also need to understand the impact this project has on your other expenses, such as payroll, utilities, etc. While billing in arrears can help attract new clients, you must still be mindful of your cash flow’s health.
• Risky when it comes to late payments
  Billing in arrears means that you trust your client to honor their payment obligations after you have completed your work. However, the construction industry has always been notorious for late payments. You must therefore prepare for the possibility of a client not paying your invoices.If ever a client goes delinquent, you can file a mechanics lien to recover your payment. Note that you must have served a preliminary notice, among other applicable requirements, prior to filing a mechanics lien successfully.

How to choose the right billing method for your construction projects

In construction, you do not necessarily need a single billing method and apply it to all your projects. There is room for flexibility depending on your company’s policies, and also depending on the following factors:

1. Project duration

   When determining the best construction billing method to use, one of the most important aspects to consider is project length. How long will it take you to finish the project? Is it a long-term project or a short-term project?

   Progress billing is ideal for long-term projects, while advanced or arrears billing are better suited for short-term construction projects.

2. Manpower and resources

   Another factor to consider is the manpower and resources that your company has. Who prepares and sends the invoices? How are the invoices sent?

   Progress billing for multiple projects can be complicated, so you may need to hire more people or use sophisticated software to manage your invoices. Arrears and advanced billing can be relatively simpler; however, they can also be complex if payment disputes come up or late payments occur.

3. Cash flow

   The most important factor will always be your cash flow. More specifically, you need to understand your fixed and variable operating costs and how you plan to pay for them based on your expected revenue. Without a proper understanding of your cash flow, you could fall into a financial trap if you choose the wrong billing method.

   For instance, you do not want to bill in arrears if you know that you do not have the cash to shoulder the project’s expenses. Remember that when you bill in arrears in construction, you will not receive your payment until all the stakeholders sign off on the project.

Common payment terms for contractors

When trying to understand your cash flow and deciding on the best billing method to use, you also need to consider the payment terms that you set or will set for your clients. Payment terms are the rules or conditions that govern your relationship with your clients when it comes to payment, including down payments and payment deadlines.

According to law firm King & Spalding LLP ³, the standard payment term in construction is 30 days. The terms can be longer or shorter, and they can extend up to 90 days, depending on the company.

The payment terms may also include early payment incentives to encourage clients to pay before the deadlines. Additionally, you can also impose late payment penalties to discourage payment delinquencies.

Construction billing best practices

1. Establish a robust billing process

   Part of establishing a robust billing process is having a fixed schedule every month for when to prepare the bills and process the invoices. This needs to be standardized; otherwise, your billing department might lose track of which clients to bill and how much to charge them.

   Another important aspect of good billing practices in construction is automation. You can take advantage of available technologies and software to help you with billing and bookkeeping. Manual processing has its advantages too, but it is also more prone to human error, which can lead to payment disputes and other complications.

2. Send out invoices on time

   It is extremely imperative that you send your invoices on time. Without sending the invoices on time, your clients will not know how much they need to pay, so you will not receive your payment right away. This applies no matter which construction billing you choose. Your business needs to have good invoice management practices to solidify your billing policies.

   Just as important is making sure that the invoices your send are correct and accurate. Invoices that are riddled with errors and mistakes may lead to further delays, and it can trigger payment disputes that would have otherwise been avoided if invoices were prepared with keen attention to detail and correctness.

3. Send out preliminary notices to protect your lien rights

   Protecting your lien rights should be a non-negotiable practice within your company. In most states, your lien rights will only be preserved if you serve a preliminary notice within the imposed deadlines. Without serving a preliminary notice, you may jeopardize your chances of ever recovering your payment should the need arise.

   No matter how loyal your clients are or how high their business credit score is, always err on the side of caution. Keep in mind that filing a mechanics lien is your best weapon against non-payment. Be sure that your lien rights are protected by abiding by all the applicable lien rules in your state.

Further reading

• How to Build an Effective Accounts Receivable Team in Construction
• Are Late Payment Penalties a Good Idea in Construction?
• Early Warning Signs of Delinquent Construction Clients

1. NetSuite, Progress Billing Defined: Advantages & How to Implement
2. Intuit, Arrears billing and payments: What does it mean to be “paid in arrears”?
3. Lexology, King & Spalding LLP, Construction project financing and payment in the USA