Project Cash Flow
In this article, we would like to discuss about the project cash flow. Why is it important to manage the project cash flow, when it should start to be worked on and how to make it as simple as possible.
Using the same terminology is important for common understanding of the different definitions. First of all we need to have a common understanding of what cash flow is. Cash flow accounts for all the revenue and expenses of a project. In other terms, all payments received from the client and all the payments to suppliers (internal and external) that will be executed during the life of the project.
A good project, under the financial optics, should have positive cash flow all the times, which means that there is enough revenue to cover all project expenses during the life of the project. There are cases where the client is not willing to maintain a positive cash flow, in these cases the contractors should seek financing to cover the gap. Financing could be internal financing with own capital or external via banks. In any option there will be capital cost that must be transferred to the client.
In the cash flow calculation, there are two important factors: The first is the timeframe when money will be spent or received. The second factor is particular to the supplier payments. Typically the project purchase orders have a payment schedule and payment terms, that will be released according to the progress of the work. A common payment schedule for suppliers is:
20% down payment
30% upon transfer of ownership of the supplier's raw materials
20% at factory acceptance test
25% at delivery
5% final documentation
Of course, the payment schedule depends on the complexity of the package, company preferences and project requirements.
The payment terms are normally net 30, which means that the project has 30 calendar days to pay the invoice. There are some companies that require different payment terms. And this should be accounted in the cash flow calculation.
Having the receivables schedule and payment schedule, one can prepare the project cashflow and follow up during the execution.
Question: But what does the supplier payment schedule affect the project cash flow?
Answer: Each purchase order issued by the project, will have a payment schedule and payment terms and these should be taken in consideration for the cash-out calculation.