Change Orders: How to Bill Them Before They Cost You Margin

The Hidden Margin Killer on Every Job

Change orders are a normal part of construction. Clients change their minds. Site conditions change. Subcontractors discover things that weren't in the original plans. But unbilled change orders are one of the fastest ways to erode your margin — and one of the most common causes of Profit Fade.

A change order that's executed but not billed is essentially free work. The contractor incurs the cost, but the revenue never shows up. Month after month, unbilled change orders accumulate, and by the time the project closes, the margin that existed on paper has evaporated.

A Numerical Example: The Cost of Delayed Billing

Suppose a $1,000,000 contract with an estimated margin of 15% ($150,000). In month 3, the client requests a change that adds $50,000 in cost and $60,000 in contract value — a $10,000 positive margin on the change order.

But the Project Manager delays billing the change order. The work gets done, the costs are incurred, and the WIP Schedule now shows higher costs without the corresponding revenue. The job's margin drops from 15% to 12% — and stays there for two months while the change order sits in the approval queue.

By the time the change order is finally billed, the damage is done: the company's cash flow was strained for two months, the WIP Schedule looked worse than it should have, and the owner's confidence in the job's profitability was shaken — all because of a delayed piece of paperwork.

The Step-by-Step Process to Bill Change Orders Correctly

Billing a change order correctly isn't complicated — it just requires discipline. Here's the process:

• Step 1 — Document the request: Get the client's request in writing, including a clear description of the scope change.
• Step 2 — Estimate the cost and margin: Calculate the additional labor, materials, and overhead, and apply your target margin.
• Step 3 — Get client approval: Before executing any work, get the change order signed by the client.
• Step 4 — Execute the work: Track costs against the change order separately from the base contract.
• Step 5 — Include it in your next billing cycle: Add the change order to your monthly progress billing as soon as the work is complete.
• Step 6 — Update your WIP Schedule: Include the change order in both total contract value and earned revenue.

How Change Orders Affect Your WIP Schedule

Your WIP Schedule is only as accurate as the contract value and estimated costs you plug into it. If change orders aren't included in both the contract value and the estimated total cost, your percent complete and earned revenue will be wrong.

Here's the rule: When a change order is approved, update both the contract value and the estimated total cost. If you only update one, your margin calculation is distorted — and your over/under-billing position won't reflect reality.

The 3 Most Common Change Order Mistakes

• Mistake #1 — Executing work before the change order is signed: This is the most expensive mistake. Once you do the work, you lose leverage. The client has less incentive to approve the change order, and you end up eating the cost.
• Mistake #2 — Not including overhead and margin in the change order: Change orders aren't just material and labor — they should include your overhead allocation and target margin, just like the base contract.
• Mistake #3 — Forgetting to update the WIP Schedule: Even if the change order is approved and billed, if it's not reflected in your WIP Schedule, your job profitability numbers are wrong.

The Tax Implications of Unbilled Change Orders

Under the percentage-of-completion method, taxable income is based on costs incurred and revenue earned. If a change order has been executed but not billed, the costs are included in the WIP Schedule — but the revenue is not. That means your taxable income is lower than it should be, which sounds good until you realize that next year, when the change order is finally billed, you'll pay tax on two years' worth of revenue at once.

This is why it's critical to bill change orders promptly — not just for cash flow, but for tax planning.

Frequently Asked Questions

What if the client refuses to sign the change order?

Stop work until it's signed. No signature, no work. It's the only way to protect your margin.

Should I include change orders in my bonding capacity calculations?

Yes. Approved change orders increase your contract backlog, which can increase your bonding capacity. But only if they're properly documented and included in your financial statements.

How do I track change orders in my accounting system?

Separate change order costs from base contract costs. Most construction accounting software allows you to track change orders as separate cost codes or sub-jobs.

Can a change order be billed before the work is complete?

It depends on the contract terms. Some contracts allow progress billing on change orders; others require completion before billing. Always check the contract.