Column: Cash flows --the lifeblood of your business
by Michael Smigocki, CPA, CVA
Senior managing director, Federal Strategies Group LLC
So what is the primary reason for business failures in the government contracting industry? If you guessed unprofitable contracts, you would be wrong.
The primary reason is inadequate cash flows. This issue is accentuated for a growing contractor as it takes additional cash to fund the growth of the company. This article will discuss specific strategies that a contractor can implement in order to improve its cash flows.
The cash cycle
Before we get into the specific strategies, a basic understanding of the cash cycle is necessary. When you begin performance under a new contract, you incur direct employee costs, direct vendor costs and indirect expenses needed to operate the business. Employee costs are paid according to your payroll cycle (weekly, bi-weekly, bi-monthly, etc.) while vendor costs are paid according to negotiated terms.
After performing under the contract for the month, the contractor is typically allowed to invoice the government and await payment, which generally ranges from 30 to 60 days.
Thus, you will need either the internal cash or access to outside funding (from a factor or bank line of credit), to fund the company’s operations for a 60-to-90-day period. The time period between when you pay for your expenses and when you ultimately collect your receivable is what is known as the cash cycle. Anything a contractor can do to shorten its cash cycle will improve cash flows.
Cash flow planning
Cash flowing planning and improvements can occur at all stages of the contract life-cycle including:
- Upon receipt of the RFP;
- During contract negotiation;
- During contract performance;
- At close-out.
Successful contractors are proactive in developing and implementing strategies to improve their cash flows at each of these stages.
Receipt of the RFP
The most important stage for cash flow planning is upon receipt of the RFP. It is at this time that possible cash flow issues during contract performance can be identified and strategies developed to negotiate during contract award. In conjunction with the preparation of the cost proposal, a monthly cash flow projection model should be developed identifying periods of reduced or negative cash flows. The goal at this stage is to reduce the dependence on either internal or external funds to the lowest possible level. Utilization of upfront billings for large direct expenditures and utilizing pay-when-paid terms for subcontractors are two common strategies. If inadequate internal or external funding is unavailable, and the company is unable to negotiate better payment terms with the government, a no-go decision should be made on this procurement.
Negotiating the contract
When negotiating the contract, there are various strategies a contractor can discuss with the contracting officer to improve the cash flows during contract performance. These include:
- Ensuring the contract is specific and clear as to payment terms;
- Negotiating more frequent milestones billings for fixed price contracts;
- Negotiating more frequent progress payments (i.e. bi-monthly);
- Offering prompt payment discounts;
- Negotiating provisional billing of award fees;
- Reducing contract retention amounts;
- Limiting or even deleting various levels of invoice approval;
- Negotiating for reduction in the necessary backup documentation for invoices.
Remember, if you do not ask for these items, the Government is not going to offer it up for you.
During contract performance
During contract performance, the objective is to reduce the time period from the incurrence of an expense to the ultimate collection of the receivable (the cash cycle). Strategies that can have a positive impact include:
- Utilizing a dummy invoice prior to sending the first real one under the contract to determine if all necessary requirements are met;
- Implement procedures to reduce the number of days to invoice after month-end such as; electronic timesheets, automated billing within the accounting system, and utilizing subcontractor accruals (instead of waiting for the actual invoice).
- Sending copies of contracts and/or modifications to the payment office along with the invoice;
- Negotiating higher provisional billing rates if they are not in line with actual rates;
- Negotiating “pay-when-paid” terms for your subcontractors;
- Ensuring that the Government adheres to the provisions of the Prompt Payment Act (Agencies are required to pay interest if they do not pay within 30 days after receipt of a proper invoice);
- Having an approved accounting system.
Follow-up and perseverance are the two best qualities a company can have.
Close-out stage
Finally, at the close-out stage, the goal should be to close-out the contract as quickly as possible in order to free up any retention or final billings that need to occur. One such strategy to accomplish this is utilizing the quick close-out procedures under FAR 42.708.
Improving your company’s cash flow should be a continuous goal for any company. Understanding the government’s process can be an important step in this equation.
Michael Smigocki, CPA, CVA is the senior managing director of Federal Strategies Group LLC. He provides government contract and management consulting, M&A advisory, litigation support and expert testimony to the government contracting industry. He can be reached via email at MikeS@FedStrat.com .
