Financial statements are the backbone of any business’s financial reporting, but in the construction industry, they take on a unique form. Unlike standard GAAP-based statements for traditional businesses, construction financial statements must account for long-term contracts, progress billing, and specialized metrics like underbillings and overbillings. These differences are critical for accurate financial reporting, bonding capacity, and cash flow management.

In this post, we’ll explore how construction financial statements differ from standard statements, the key components you need to understand, and why underbillings and overbillings can significantly impact liquidity.

Why Construction Financial Statements Are Different

Most businesses recognize revenue when goods are delivered or services are rendered. Construction companies, however, work on projects that can span months or years, making traditional revenue recognition impractical. Instead, construction accounting relies on percentage-of-completion (POC) or, in some cases, completed-contract methods to match revenue and costs with project progress.

This creates unique reporting challenges:

• Revenue is tied to project progress, not just invoicing.
• Job schedules (Work-in-Progress reports) become essential for understanding profitability.
• Billing practices (progress billing, retainage) affect cash flow and balance sheet presentation.

Core Components of Construction Financial Statements

Construction financial statements typically include the same three primary reports as other businesses—Balance Sheet, Income Statement, and Cash Flow Statement—but with construction-specific nuances.

1. Balance Sheet

The balance sheet for a construction company includes standard assets, liabilities, and equity, but with additional accounts related to contract performance:

Costs and Estimated Earnings in Excess of Billings (Underbillings):Represents revenue earned but not yet billed to the customer. This is an asset because the contractor has performed work but hasn’t invoiced for it.

Billings in Excess of Costs and Estimated Earnings (Overbillings):Represents amounts billed to customers in excess of work performed. This is a liability because the contractor has collected cash for work not yet completed.

Retainage Receivable:Amounts withheld by the owner until project completion. Often classified as a separate line item under accounts receivable.

Retainage Payable:Amounts withheld from subcontractors, shown as a liability.

These accounts are unique to construction and provide insight into the company’s billing practices and cash position.

2. Income Statement (Profit and Loss)

The income statement for construction companies often uses job schedules to support revenue recognition. Key features include:

Revenue Recognized on Contracts: Based on percentage-of-completion, not just invoicing.

Job Costs: Direct costs (labor, materials, subcontractors) tied to specific projects.

Gross Profit by Job: Many contractors present job-level profitability to monitor performance.

Unlike traditional businesses, construction companies often include supplemental schedules showing contract revenue, costs, and estimated gross profit for each project.

3. Statement of Cash Flows

Cash flow in construction is heavily influenced by billing practices and retainage. Even profitable companies can experience cash shortages if:

• Retainage is significant and slow to release.
• Underbillings accumulate due to delayed invoicing.
• Overbillings create temporary cash surpluses that reverse later.

Understanding these dynamics is critical for liquidity planning.

The Role of the Work-in-Progress (WIP) Schedule

The WIP schedule is a cornerstone of construction financial reporting. It tracks:

• Contract Value
• Costs Incurred to Date
• Estimated Costs to Complete
• Revenue Recognized
• Billings to Date
• Over/Underbilling Position

This schedule supports revenue recognition and helps identify problem jobs early. It also feeds into the balance sheet accounts for underbillings and overbillings.

Underbillings and Overbillings Explained

Underbillings (Costs and Estimated Earnings in Excess of Billings)

• Occur when earned revenue exceeds the amount billed.
• Example: A contractor has completed 60% of a $1,000,000 project ($600,000 earned) but has only billed $500,000. The $100,000 difference is an underbilling.
• Impact: Indicates delayed billing or aggressive cost recognition. Can strain cash flow because work is performed without corresponding cash inflow.

Overbillings (Billings in Excess of Costs and Estimated Earnings)

• Occur when billings exceed earned revenue.
• Example: A contractor has billed $700,000 on the same project but has only earned $600,000. The $100,000 difference is an overbilling.
• Impact: Provides short-term cash benefit but creates a liability. If overbillings are excessive, it may signal future revenue shortfalls.

Why These Accounts Matter for Liquidity

Underbillings and overbillings directly affect cash flow:

• Underbillings tie up cash in work performed but not billed, reducing liquidity.
• Overbillings create temporary cash inflows but can lead to future periods with little or no billable work.

Bonding companies and lenders scrutinize these accounts because they reveal billing practices and potential financial stress. A pattern of large underbillings may indicate poor billing management, while excessive overbillings could suggest aggressive cash collection or project delays. And not every controller understands what they are looking at.

How Construction Financial Statements Differ from Standard GAAP

While construction companies still follow GAAP, they apply specialized guidance under ASC 606 (Revenue from Contracts with Customers) for long-term contracts. Key differences include:

• Revenue Recognition: Based on progress toward completion, not delivery of goods.
• Job-Level Reporting: Supplemental schedules like WIP are standard practice.
• Specialized Accounts: Underbillings, overbillings, and retainage are unique to construction.
• Disclosure Requirements: Contracts in progress, performance obligations, and estimates must be disclosed.

Best Practices for Managing Construction Financial Reporting

Maintain Accurate Job Costing: Job cost data drives revenue recognition and WIP reporting. Inaccurate costs lead to misstated financials. Accurate payroll allocation is foundational.

Update Estimates Regularly: Forecast costs to complete, including change orders, frequently to avoid surprises and ensure accurate percentage-of-completion calculations.

Monitor Billing Practices: Avoid excessive underbillings or overbillings by aligning billing schedules with project progress.

Use Construction-Specific Accounting Software: Systems like Sage 300 CRE, Viewpoint, or Foundation can automate WIP schedules and integrate with financial statements.

Communicate with Stakeholders: Share WIP reports and financial statements with project managers to keep operations aligned with financial goals. Strong financial leadership matters here.

Final Thoughts

Construction financial statements go beyond standard GAAP reporting to address the unique challenges of long-term projects, progress billing, and specialized accounts like underbillings and overbillings. Understanding these differences is essential for accurate financial reporting, maintaining liquidity, and building trust with lenders, bonding companies, and project owners. By leveraging best practices and robust systems, contractors can ensure their financial statements provide a clear and accurate picture of their business performance.

‍