Signing a multimillion-dollar project is a boost for any company and is usually not possible without partners such as suppliers and subcontractors. During the contracting process, project managers and buyers focus on defining technical parameters, quality standards, and timelines in addition to negotiating the best possible price and delivery date. But how cash-flow friendly is the contract?

Cash flow aspects of the project are often seen as the responsibility of “somebody else.” And yet invoicing frequency, payment terms, or dispute resolution, if unmanaged, can drive even a profitable project and company into liquidity difficulties.

Uncovering Payment Terms Issues

A recent client case showed the level of potential hidden in payment terms. The client typically applied payment terms of net 30, net 45, and net 60 days. Over a six-month period for one project, it negotiated payment terms of end-of-month + 45 days (EOM45) and 60 days + end-of-month + 2 days (60EOM02) with suppliers. Average payment terms improved by up to 20 days and the overall cash-flow benefit of the project amounted to more than $80 million.

Discount payment terms. Discount terms should be a reflection of the trade-off between cash and cost. However, it’s common for discount terms to be either what was offered by the supplier or the best term that procurement was able to achieve. Company policy should set discount terms that are acceptable and establish a sign-off procedure for pre-approval of non-standard payment terms before they are agreed upon in a supplier contract.

Net payment terms. A company cannot pay suppliers on time unless it runs daily payments, which is inefficient and leads to less control of outbound cash flows. Contracts should include language such as:“Payments shall be made on the next available payment run after payments are due. Payments shall be made four times a month. Should payment fall due on a Saturday, Sunday, or public holiday, payment shall be made on the following business day.” This makes it clear to suppliers how payments are made and eliminates the need to pull forward payment runs.

Delivery terms. These can impact the timing of when an invoice is due for payment. For example, EXW (Ex Works), FCA (Free Carrier), CPT (Carriage Paid To), or CIP (Carriage and Insurance Paid To) mean that goods are delivered once they leave the premises of the supplier. The delivery note and invoice are issued before the goods are physically delivered, and the payment period is running while the goods are waiting for clearance for export or are on their way to the company.

To avoid this, the contract with the supplier should specify the baseline date for calculating the payment due date, using language such as “the baseline date being the later of (a) the supplier invoice date, (b) the date a valid and correct invoice is received by the purchaser, or (c) goods/services receipt date.”

Figure-1-Cash-flow-impact-of-payment-aspects (1)

Invoicing Questions

Invoice project milestones. The larger the project, the more financially complex it becomes. Often much of the work is done before any physical delivery of end product, such as prototype development and project planning. Each stage reflects real costs incurred to the project: invoicing at each of these stages offers the company higher flexibility compared with fixed installments.

Specify down payment terms. In project-based contracts, suppliers often ask for down payments to establish the necessary project infrastructure. The company should never blindly accept such terms; the contract must specify (a) when down payments are allowed and (b) how large a down payment can be made.

Create separate terms for special situations. Pricing, delivery, or payment terms over and above what has been agreed to, should be minimized wherever possible and drawn up separately to avoid less favorable terms being applied to the main contract.

Figure-2-Cash-flow-impact-of-invoicing-contractual-work

Establish Clear Work Change Terms

To avoid project delays and consequent invoicing delays, the contract must detail the terms and procedures for approving and paying for additional work, partial cancellations, and postponements.

Figure-3-Cash-flow-impact-of-project-change-orders

Clear rules for approval procedures. Automatic invoicing without any approval procedures should always be avoided. The company can establish a contract provision that allows it to withhold a portion of the contract amount until it’s been determined that the project meets its deliverables.

Actively manage credit limits and guarantees. If credit limits are being reached before payments are due, the first step is to discuss with the supplier if limits can be increased. Next the company can review what options are available for underwriting credit options at the corporate level rather than the local level.

Guarantees represent further protection, ensuring that the liabilities of a debtor (company) against the supplier will be met.

Address external factors impacting cash flow. Local legislation, professional associations, banks, or insurance companies might limit individual cash flow elements. For example, with the implementation of the EU Late Payment Directive, all 28 European Union member states have legislative limits on how payment terms can be set.

Cash-Flow Awareness

Large, complex projects bring many challenges, including a high risk in terms of overall cash flow. The most glaring example is the construction industry in the United Kingdom: cash-flow factors are largely responsible for the level of insolvency in this sector. Project managers need to be aware of cash-flow elements and have contracts in place with suppliers that optimize the cash flow to ensure a positive project outcome.

Tomas Szabo is a manager with REL, a division of The Hackett Group. He has more than 12 years of experience in corporate finance and logistics in an international B2B environment, and has acted as a key link between finance, sales, logistics, and operations in terms of working capital optimization. His specialty is defining processes to achieve improvement in account payables and receivables management, procurement, and logistics.

, , , , ,

2 responses to “How Cash-flow Friendly Is Your Contract?”

  1. We were a $5 million software company in a very specific industry niche – asset finance & leasing. We grew into software + implementation contracts of $500,000+ over a 12 to 18 month timeframe. 90 day payable were a non-sequitur for us.

    Our customers were automotive finance companies who certainly had the cash resources. If we agreed to terms as shown in the article, we would’ve been out of cash and out of business. We explained that problem to our customer and crafted a special supplier-customer relationship that allowed us to maintain adequate cash flow and to satisfy the executive management of our customers ( not the accounts payable department ).

    Beyond the shown contract terms there is a significant list of sensible business issues for the project contract from a legal
    standpoint. I hope you will write another article regarding key clauses in the project contract.

    Ike

    P.S. we learned the hard way that we needed to hold our customers ‘feet to the fire’ when they had to make a key delivery of information to us; previously we were naïve and allowed customer delays to affect our schedule, and it made us look like the ones who were late on delivery.

    Sent from my iPad

Leave a Reply

Your email address will not be published. Required fields are marked *