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Cash Management Login |
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CASH FLOW MANAGEMENT FOR GOVERNMENT CONTRACTORS
by: Cameron S. McRae
reprinted with permission from Contract Management magazine (May 1997)
Government contracting is a cash flow business. Cash flow management is the aggregate of company actions taken to ensure adequate and timely availability of cash to support company operations. In short, it is a process; not solely a function limited to the finance and accounting department. The first requirement of successful cash flow management is total commitment and full support of top management, which must implement its cash flow management policies and procedures to fulfill the complete process. Without such commitment and support, the prospects for effective cash flow management are significantly diminished. The process includes all of the functions in the operations of the company:
Gaining access to all available intelligence is important in deciding whether or not to pursue prospective business opportunities. That information should include the source from which the company learned of the opportunity; the prospective client; the company's past and present relationship, if any, with the client; the company's contacts within the client; the time allowed and available to respond to the procurement notice; the evaluation criteria the client will use in awarding the contract; who the competition is, their strengths and weaknesses; the statement of work (SOW) and schedule requirements; the resources available to the company to meet those requirements; and the relative attractiveness of other opportunities. Thorough and objective analysis of all available intelligence will enable assessment of the chances of winning and performing the work. This analysis is an integral part of the bid/no-bid decision evaluation. The analysis should include a review of the company's history in performing similar work; the capability to develop a winning proposal (would the time, effort, and money be better invested on other opportunities?); the type of contract designated and its appropriateness to the SOW; the cash flow required to perform the contract and the available sources; the terms and conditions of the contract; and all appropriate costing and pricing considerations. The costs and cash required to support contract performance are critical elements of the evaluation, making attention to cash flow a vital factor in the bid/no bid decision. Chances of Winning Generally, a bidder's chances of winning the business are diminished if (1) the opportunity arose from the Commerce Business Daily (CBD) (now Fed Biz Ops, or other public notice source); (2) the time allowed for proposal submission is too short for an effective response; (3) the company has no past or present relationship with the client or strong contact at an influential level within the client; or (4) the competition has more capability, resources, and reputation, or is either a firmly entrenched incumbent or an outsider with better access to the client. This is where good sources of intelligence can be an invaluable advantage. If the analysis reveals less than a 50 percent chance of winning the award, a no-bid decision is probably indicated. An obvious exception to this general conclusion is the decision to make a marketing investment for the sake of future opportunities with the client. The opportunity and the bid/no-bid evaluation should be conducted by a team that represents all of the relevant company activities; executive, marketing, technical, contract administration, and finance and accounting. Systems and formats for conducting the opportunity and bid/no-bid evaluation are available, as well as assistance in using them. If the opportunity is for a subcontract or commercial work, information on the client's management, performance record, financial strength (if possible), and credit rating should be obtained and evaluated. The company should consider itself not only a vendor of goods or services but a lender of the value of the resources it applies to the job. The subcontractor should remember that its payment may depend on the above factors and the performance of the prime contractor. Not winning a contract is better than performing one on which the company cannot collect payment from its client. Failure to win the award involves only the loss of the bid and proposal (B & P) costs; winning and not being able to get paid carries a four-fold loss: B&P costs, performance costs, value-of-money costs, and lost-opportunity costs. Once a company decides to bid, proposal development activity should be started immediately. PROPOSAL DEVELOPMENT There are numerous essential skills in writing effective proposals, a crucial element of winning new business, but this discussion is limited to the cash flow considerations. Contract administration and finance and accounting personnel should be members of the proposal development team. Contract administration should ensure that the proposal is drafted in compliance with the terms of the procurement document and the applicable acquisition regulations, and that it provides the company with every contractual and regulatory advantage available. The finance and accounting representative should ensure that the costing and pricing is accurate and complete, and that cash flow opportunities are maximized. Interest expense is not an allowable cost under government contracts and therefore may be overlooked as a business expense when proposals are being costed. Maximizing cash flow from a contract can reduce borrowing requirements, thereby minimizing interest expense incurred for loans to finance contract performance and increasing profitability. Analyzing the benefit that can be realized from optimal cash flow and the resultant interest saving - and bidding accordingly - may be the competitive advantage that is the difference between winning and losing the contract. Sometimes, even the smallest edge is the winning margin. CONTRACT NEGOTIATION Only infrequently will the contractor be able to influence the type of contract awarded. Still, knowing the impact on cash flow of various contract types and payment terms enables the winner to negotiate for the most favorable type, terms, and payment schedule. Cost reimbursable, time and material, and fixed price labor hour contracts usually provide the best cash flow; firm fixed price and fixed price with progress payments the worst. For example, the cash flow from a fixed price contract with progress payments may be many times the cash flow from the same contract on a firm fixed price basis; but the cash flow from a CPFF contract with billing every two weeks can be approximately 25 percent better than the same contract on a fixed-price-with-progress-payments basis. Generally, the more often invoices can be submitted, the better; and partial delivery and milestone payments should be sought whenever appropriate. Small-business government contractors should be aware that under (some) circumstances their large-business primes are required by regulation to pay their costs prior to submitting their invoices to the federal government client. Consequently, the subcontractor may not have to accept terms that provide for payment after the prime receives payment from its client. Small-business primes are not required to pay costs before invoicing the client, and industry practice is generally that the subcontractor be paid after the small-business prime has collected from the government. Nevertheless, subcontractors should be aware that if the prime borrows against its accounts receivable and uses the proceeds to fund its operations; when the government pays the invoices, those funds belong to the lender and are not available to pay the subcontractor. The only way for the prime to pay the subcontractor is from subsequent invoices. In times of declining revenues, the prime may have difficulty paying its subcontractor because it has already borrowed and spent the money. With the end of the cold war and declining funding for many government agencies, some subcontractors became painfully aware of this lesson. Recent supplements to the Federal Acquisitions Regulations (FAR) offer subcontractors new, but limited, information and assistance. The Federal Assignment of Claims Act enables a bank or financial institution to serve as "Trustee" to collect payments for the benefit of two or more financial institutions. This is accomplished in the real world by a financial institution serving under an Escrow Agreement with entities having a claim on the payments made under a prime contract. Technically, the parties to the Agreement must all be financial institutions, but as a practical matter, the technique has worked well to protect the interests of many subcontractors. The escrow agency can serve the same purpose in a strictly commercial environment. In either case, any company considering participation in such an arrangement should first consult experts in the field. PERFORMANCE REVIEW AND COST CONTROL Technical and financial performance reviews at regular intervals throughout the life of the contract are advisable. If deficiencies occur, prompt remedial actions should be taken. Good communication between contracts administration and the finance and accounting is necessary to ensure full recovery of costs resulting from change orders and modifications. Both departments must be attentive to any alterations to the contracts. RISK MANAGEMENT - RETENTIONS, WITHHOLDS, AND UNBILLABLES Finance and accounting should utilize a tracking system to monitor the status of all retentions, taking timely action to require contracts administration to qualify the retention for billing, and submitting the invoice promptly. Periodic contract performance reviews should alert the company if indirect costs are at variance with provisional billing rates on cost reimbursable contracts or with indirect costs bid on other types of contracts, and cost controls should be promptly applied wherever possible. If such controls are not feasible, the necessary financial data should be submitted to the contracting officer (CO), along with a request for an adjustment to the company's provisional billing rates. When the contract has been completed and the government is withholding a portion of the company's profit, the company should have its accounting records in such condition to permit it to submit a close-out invoice at the earliest possible date. (Recent amendments to FAR 42.705 and FAR Clause 52.216-7 provide that the contractor normally has 120 days after settlement of the final indirect cost rates in which to submit its close-out invoice, or the CO may unilaterally modify the contract to specify the amount the CO determines to be due under the contract1). The invoice for final performance costs, however, should not include the close-out withholding invoice because combining the two invoices could, and probably would, delay payment of the entire amount, thereby depriving the company of access to the cash reimbursement of its final performance costs. INVOICING Contractors work hard to collect receivables as rapidly as possible. Equal or more attention and effort should be applied to the invoicing function and schedule. Successful contract negotiations enable invoice submission as frequently as reasonableness and company resources permit. Invoices to upper-tier contractors and commercial clients should be scheduled to coincide with their invoicing or payment schedules, respectively, even if internal schedule adjustments are required. Thorough and objective review of cost-marshaling and invoicing procedures may be prudent. Policy should ensure that all applicable cost data be submitted to the billing department in adherence to the billing schedule for each contract. Incentives may be used to achieve the desired results. The approval function in the invoicing process should be a linear one, not involving repetitious reviews. Finally, invoices should be reviewed before submission, by an employee familiar with the requirements of all contracts to ensure that each invoice is complete, accurate, correct, and in compliance with contract requirements. Rejected invoices are cash flow killers. Efficient invoicing and effective collection practices frequently require the training of appropriate individuals, both within the company and within the client. If the desired performance is to be achieved, people have to be trained to perform in the desired manner; such training must be a part of any cash flow management effort. 1National Contract Management Association, Contract Management magazine, April 2002, page 54, "Final Edition," contributed by Functional Director for Legislation & Regulations, C. Stanley Dees, with assistance from Associates at McKenna & Cuneo, L.L.P. FOLLOW-UP AND COLLECTIONThe old saying that "timing is everything" is truly applicable to invoice follow-up and collection. The first step is to verify invoice delivery to the designated recipient. In the absence of other payment agreements and/or the use of some automated invoice tracking system, contractors should begin to pursue payment about 30 days after invoice submission. If a projected remittance date is provided, the next follow-up effort should be two days after that date. Remembering that perseverance succeeds where all else fails, collection efforts should be unrelenting until payment is received, but discretion is appropriate. The company should gauge its collection effort to the value of the invoice and must be careful not to antagonize the client in the process. In some cases, the company may solicit assistance from the CO (procuring or administrative) or may seek the assistance of its banker, if the banker is experienced and circumspect in such matters. Whenever possible, the company should attempt to establish a face-to-face relationship with the payment office personnel handling the company's invoices. Knowing people is power! The trend in Department of Defense (DOD) to consolidate vendor payment functions, currently in Columbus, Ohio (and in other regional operating locations), makes meeting and maintaining personal contact with the right payment personnel impractical for many contractors - and in some cases, impossible for all. Another good DOD contact is Bill Blumberg, with Defense Finance and Accounting Service Headquarters. Contractors with DOD payment problems may contact him at (703) 607-0810 or by e-mail at wblumberg@dfas.mil. In addition, DOD offers electronic systems the contractor may use to track the progress of its invoices through the payment process or to check the status of a given invoice. Awareness of such systems, whether in DOD or in civilian agencies and the Treasury Department is prudent business practice and smart cash flow management. Reaching a preliminary mutually acceptable payment schedule agreement and committing the understanding to writing seems prudent for commercial or subcontract work. Including in the agreement the number of unpaid days or the amount of unpaid billings beyond which the company is unwilling to work and that workers will be removed from the job when that limit is reached is also advisable. The company caps its risk of loss, and the client knows what it must do and the consequences of not doing it. Continuing to work and incur costs while not being paid for extended periods has led to serious financial damage to some companies. Prudent companies will act promptly to cut their losses when such action is indicated, but the risk of having to do so is reduced if the client knows in advance what to expect if it does not meet the agreed payment schedule. Banks can play a vital role in the contractor's effective management of its cash flow. Three basics should be applied in the selection of a bank: analyze the financial condition of every bank under consideration and their capacity to serve the company's needs for three years; investigate the bank's experience in dealing with government contractors and its knowledge of the industry by asking exploratory questions, listening for the level of expertise in the answers, and validating the resulting impression by talking with some of its government contractor customers; and learn the bank's loan approval process, and become acquainted with the decision-makers on the loan committees. Banks should be able to provide credit facilities tailored to the industry and structured to fit the needs of the company. After selecting a short list of banks, learn the costs at each bank of the services the company will use and how those services are rendered. Banks must accept electronic payments from the government and provide the company with adequate supplemental data from which to post its accounting records. Finally, and perhaps most important, seek a bank that can serve as a value-added resource to the company, in ways other than simply lending more money. That capability can be an invaluable asset to the company. Questions and requests for additional information can be directed to McRae at (703) 506-8116 or by e-mail at cmcrae@afsb.com. Italicized information in parentheses represents edits made by the author. |
