Given all the possible ways to bill clients, the construction billing process certainly can be confusing. Here we’ll explain the different types of construction billing methods and how to tell which one is right for you. We’ll also share how to make billing tasks easier overall, with tips on invoicing, incentivizing quick payments and more.
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What is billing in construction?
On the most basic level, billing in any business involves requesting payment for goods or services rendered, as well as tracking and following up on those requests and processing payments. However, unlike fixed-cost consumer goods (a pair of sneakers, say) or single services (such as a haircut), construction projects tend to include many layers of costs — labor, materials, products, overhead, change order fees and so on. And the projects tend to be completed over a lengthier period than a one-off consumer transaction. Put those two factors together and it’s easy to see how the construction billing process can get quite complex.
5 types of construction billing methods
Here we explain the five most popular types and share some pros and cons of each.
1. Fixed Price/Lump Sum
At first glance this is the simplest construction billing method of all, as it involves charging a single price (lump sum) that covers every part of the project. For instance, the client wants a new deck, and you charge $10,000. As for when to bill, you have two choices:
- Advance billing — meaning the client pays the whole sum up front. This does require a good deal of trust on the part of the client, and some clients might balk at this option if they don’t know you and your work standards.
- Arrears billing — meaning the client pays when the work is completed. This requires trust on your part. (Note that while in other circumstances, “arrears” implies late or should have been paid sooner, here it just means after project completion.) Because you’ll have to accurately pre-determine every cost associated with the project, the fixed-price billing method often works best for small, easily defined projects not subject to scope creep. Also, be aware that you can include stipulations in the contract — for instance, a bonus for finishing work ahead of schedule, or extra payment required if change orders exceed a certain number.
Pros: Makes bidding simpler. Easy to bill and track, for the client to pay, and for you to account for on tax statements. Incentivizes completing the project under budget, which would increase your profit margin.
Cons: Riskier for you, because it requires accounting for every single possible variable ahead of time. You’ll still have to do detailed takeoffs and estimates, to avoid underestimating and paying out of pocket. Any unexpected occurrences (weather delays, products going out of stock) also can cut into profits.
2. Cost-Plus
With this construction billing process option, the client pays all of the project costs plus an extra fee so you make a profit. The fee can be a lump sum or a percentage of the project costs. Note that sometimes a price cap is included in the contract.
Pros: Ensures you’ll make a profit. Unforeseen circumstances such as price hikes in materials would be less worrisome. The client has more freedom to request design changes, so there’s more flexibility.
Cons: Clients might not feel comfortable with not knowing costs ahead of time. You’ll have to provide a highly detailed accounting of costs, and clients might resist paying a percentage of your overhead or other indirect costs, such as mileage.
3. Time and Materials (T&M)
This construction billing method is similar to cost-plus, except the “plus” part is an agreed-upon pay rate — that is, an hourly or daily wage. “Materials” refers to the costs of materials. Note that as with cost-plus, sometimes a cap on costs is included in the contract.
Pros: Provides budget flexibility, which is especially helpful when the scope of work isn’t pre-defined. Also allows for design flexibility.
Cons: As with cost-plus, you’ll have to account for all the costs and hours you bill to the client. Because of the hourly or daily wages, there’s no incentive to finish the project early unless a bonus for this is included in the contract.
4. Unit Price
With this construction billing method, you bill separately for specific parts (units) of the project. You can use it for the project as a whole or just for specific parts, such as pouring a concrete foundation.
Pros: You’ll get paid incrementally throughout the project (versus getting a lump sum at the end with arrears billing in the fixed-price method). Allows for some budget and design flexibility. Can be simpler to invoice for than using a wage-based system.
Cons: Clear blocks, with all the requisite documentation, must be defined. If the blocks are undefined or documentation is lacking, the client can dispute costs. It can be difficult to define blocks if the project scope itself isn’t clearly defined.
5. AIA Progress Billing
This last answer to the question “What is billing in construction?” derives its name from the American Institute of Architects (AIA). Traditionally it has been a form of progress billing using AIA forms, although now it also can refer to progress billing using other means. With this option, clients are billed for completed portions of the project. It’s typically used for projects that will be completed over a longer period of time, and the invoices are based on the percentage of work completed.
Pros: Brings in funds while the project is ongoing. The AIA forms can be used for a variety of project types. Can help with IRS income reporting requirements.
Cons: The AIA forms are considered somewhat complicated and expensive to use, and modifications can add further expense and lead to compliance errors. Calculating the percentage of work completed at various stages can be complicated.
What is the best construction billing method?
Now that you’ve learned about the five options for the construction billing process, you’re probably wondering which is the right one for your business. The answer is, it depends on the type, scope and time length of your projects.
For instance, if you’re constructing a small home addition with two subcontractors and you’re pretty sure it will take about three months, and you don’t have capital reserves to purchase materials, a lump sum in advance might be the best option to choose. If you’re undertaking a lengthy whole-house remodel in your immediate area and the clients might add to the project as it goes, you might choose the cost-plus option.
So you’ll want to carefully analyze each project to see which type of billing method works best. You don’t need to choose just one and stick with it for everything!
8 Tips for a smoother construction billing process
No matter which method you choose, following certain best practices can make things easier on yourself (or your accountant) and minimize errors.
1. Compare projected costs against actual costs. Analyzing completed projects will help you prepare better and forecast costs more accurately for future projects. It can also help if you need to declare losses on your taxes. So you’ll want to do this with each project. Need help understanding How to Manage a Construction Budget? Our comprehensive guide has you covered.
2. Provide detailed invoices. This is necessary no matter which construction billing method you’re using. Clients, especially in the age of internet research, want to know where all their money is going. Keep learning and explore our guide on How to Make a Construction Invoice or How to Do a Construction Change Order to ensure you get compensated for every expense.
3. Send invoices quickly. Getting those invoices out quickly helps ensure that you’ll get paid faster. And aside from the fact that the IRS might require you to pay estimated taxes quarterly or otherwise, having funds is essential to keeping any business’ doors open. Plus, paying any subcontractors and vendors promptly helps cement trust.
4. Clearly define payment terms in the contract. Specify any project blocks or other payment milestones, how many days the client has before payment is due, any penalties and bonuses, what forms of payment are acceptable, and anything else relevant to do with your getting paid. Any unclear terms or wiggle room can cause problems down the road. Learn more about How to Write a Construction Contract.
5. Incentivize quick payments. Again, money in your pocket is always better than money owed. Consider offering discounts for payment within a short time frame or even instantly online. You also might consider offering an incentive for paying cash, which means you won’t have to pay fees to any payment processors, such as a credit card company. Keep reading to learn How to Build a Construction Payment Schedule to protect your cash flow.
6. Establish an invoicing follow-up process. An unpaid and forgotten invoice is as good as one never sent; tracking and following up on billings regularly and in a timely manner will ensure that nothing falls through the cracks. Consider setting up a certain time every month or even bimonthly to follow up.
7. Include back charges in the contract. Back charges protect both you and the client in case of unforeseen circumstances, allowing for recovery of costs. You might have to pay extra for site safety because of a condition the client forgot to mention, for example, or materials might be defective and you need to pay to replace them.
8. Use construction billing software. As you’ve learned from reading about the different construction billing methods, invoicing and getting paid can be complex, especially as you take on more projects. You have to come up with a process not just for billing but for tracking and getting paid. Software is invaluable in helping with this. Houzz Pro, for example, has features to streamline all of those facets but also to help you create accurate takeoffs and estimates (and more quickly too!), track time and expenses, handle change orders and much more.
Conclusion
Using everything you now know about the construction billing process, and understanding just how important software is in helping you handle it with greater ease and accuracy, you’re set to take on projects of varying types with confidence that you’ll get paid for the hard work you put into them. Remember also to be patient with yourself! And if you’d rather not handle billings at all, hiring an accountant either part-time or on staff can be a worthwhile expense.
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