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Project Cash Flow Forecasting

Wednesday, December 16th, 2009 by Machel

Bidding on large projects is bittersweet.  If you have an opportunity to bid on a project that could be either a blessing or a burden, it is important to manage the cash flow.  Because cash is King, it has the ability to put you in a castle or a shack.  What kind of living quarters you live in can be decided by cash flow.  A significant number of companies go out of business because of lack of cash, not a lack of great ideas.

When bidding on large projects there are a few questions that need to be addressed.  First, when are the costs of the project due?  Second, when will the majority of the labor be needed?  Third, what size of a down payment do I need?  When do I need progress payments?  Most companies think the down payment question should be answered first, but that is not always the case.  It is necessary to know when your costs are going out so you know what size your down payment needs to be and when your progress payments need to come in.

Let’s assume some facts for our example:

  1. Revenue on the project is $3,000,000
  2. Cost of Goods Sold (COGS) are $1,500,000
  3. Operating Expenses are $10,000 for the first 4 months, then gradually less as the project closes

Project Cash Flow at a 30% Down Payment

 

Jan-10

Feb-10

Mar-10

Apr-10

May-10

Jun-10

Jul-10

Income

 

 

 

 

 

 

 

Invoiced

900,000

 

 

1,500,000

 

600,000

 

$ Rcvd

 

900,000

-

-

1,500,000

-

600,000

COGS

 

 

 

 

 

 

 

Estimated COG

 

450,000

450,000

450,000

150,000

 

 

Total COGS

-

450,000

450,000

450,000

150,000

-

-

Est OE

 

10,000

10,000

10,000

10,000

5,000

3,000

Total Cost

-

460,000

460,000

460,000

160,000

5,000

3,000

Net Effect

-

440,000

(460,000)

(460,000)

1,340,000

(5,000)

597,000

Cum Effect

-

440,000

(20,000)

(480,000)

860,000

855,000

1,452,000

Project Cash Flow at a 50% Down Payment

 

40,179

40,210

40,238

40,269

40,299

40,330

40,360

Income

 

 

 

 

 

 

 

Invoiced

1,500,000

 

 

900,000

 

600,000

 

$ Rcvd

 

1,500,000

-

-

900,000

-

600,000

COGS

 

 

 

 

 

 

 

Estimated COG

 

450,000

450,000

450,000

150,000

 

 

Total COGS

-

450,000

450,000

450,000

150,000

-

-

Est OE

 

10,000

10,000

10,000

10,000

5,000

3,000

Total Cost

-

460,000

460,000

460,000

160,000

5,000

3,000

Net Effect

-

1,040,000

(460,000)

(460,000)

740,000

(5,000)

597,000

Cum Effect

-

1,040,000

580,000

120,000

860,000

855,000

1,452,000

Following the tables listed above, if you change the down payment from a 30% down payment to a 50% down payment, you go from needing $480,000 to not needing any additional cash at all during the entire project.  This is assuming a progress payment is scheduled four months into the project.

A spreadsheet like this does not take very much time to set up.  By putting in that extra time your company can go from living high on the hog to searching the couch cushions for change.

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Posted in Finances, Project Management | No Comments »

Why cash and profit are different

Thursday, September 24th, 2009 by JoeK

As managers and business leaders we tend to focus our efforts on the income statement.  After all isn’t business all about being profitable?  The income statement measures profit so that should be our focus as we look at the success of our business.  If the bottom line of the income statement is positive then life is good.  If it is negative, then it’s time to find some outside investors.

Well what many managers and owners don’t understand is that the real key to being successful in business is having cash flow.  Cash is king.  A business fails when the cash runs out not when the company had losses on the income statement.  Cash flow is becoming a key measure on Wall Street right now.  Why?  Because investors and analysts know that in a liquidity crunch if a company can generate its own cash it will survive.  A second reason is that cash flow is not subject to as many estimates and assumptions as profit from the income statement.

So now the question how can cash and profit be that much different?  There are really three reasons why cash flow and profit do not match up well.

First, we book or record sales not when we collect on them but when the product or service is delivered.  This can lead to sales on the income statement that will not be collected for a great deal of time.  In most cases it can take 30-90 days to collect on those sales recorded this month on the income statement.  In the case of long-term contracts the recognition of the sale and the collection of the cash can be more than a year a part.

Second, we record expenses on the income statement when those expenses are incurred not paid in cash.  This is part of the accrual process.  The income statement is about matching expenses with sales.  So if I make payroll on September 1st, I do not charge that expense to September.  Rather, I charge it to August since the September 1st payroll is to cover work that was performed in August.  So we show an expense in August even though the cash did not go out until September.

Third, when I spend my cash to buy capital equipment for a business, things like computers, building, and vehicles, I depreciate them on the income statement as expenses over several years.  When I spend my cash on capital it’s gone.  On the other hand, the expense associated with this capital takes years to impact the income statement.

When one takes these three issues into account, it’s easy to see why cash and profit are two different things.  The message here for the financially intelligent business manger is to watch both cash and profit because understanding them is critical.  Why do most businesses fail?  Because they run out of cash.

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Posted in Finances | No Comments »

Deciding on the Direction for your Company

Thursday, August 6th, 2009 by Brad

Companies that remain static and don’t evolve will eventually lose their profit margins and sink into oblivion. At Setpoint, as we try and adapt to the changing landscape I have noticed several things in dealing with deciding our company’s direction.

First, change is hard. It is much easier to continue doing what has been done in the past, even if it is not getting the results it used to, and rarely have I seen an idea that just works right out of the gate.

You can’t do everything, and if you try to, it will result in spreading your resources (money, time, people) so thin that you cannot be successful at anything. One of the hardest things is, deciding what not to do. It is difficult because you tend think that you are potentially leaving money on the table, and you may be – but you are doing it to pursue a better idea with more potential.

We have found that some feel more passionately about an idea than others, so we have developed a rule that is simply “whoever has passion about an idea gets less than 50% of the vote”. This helps us make more objective decisions. Key message is, don’t be so in love with a strategy or idea that you can’t dispose of it when all the facts point that way.

You never have perfect information before a decision needs to be made. As a result, assumptions are made in order to make progress. The problem is, unless those assumptions are tracked and noted they tend to become facts over time, and often those assumptions are wrong. You have to revisit assumptions to validate, modify, or eliminate them to reflect new information you now have. Not doing so can lead to less than desirable outcomes.

At Setpoint we try and follow the philosophy of “fail faster”. In other words, if something is not going to work the sooner you identify it the cheaper it is for the company in terms of money, time, and people. Most ideas can be validated or eliminated without much cost or time if the key issues have been correctly identified. The few key remaining ideas can then claim your valuable resources.

The shorter iteration cycles the better; the clearer the objectives, the easier it will be to identify the key issues that need to be proved out in order to validate the direction.

These are some of the techniques we are using at Setpoint to decide our companies direction.

This process is an ongoing part of a healthy company’s life. So get on with it.

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Posted in Creative Thinking, Process Improvement | No Comments »

Cash Flow Traps

Thursday, July 2nd, 2009 by Machel

Sweet!! Your company just received a 50% down payment on a project, let’s take everyone to dinner and buy that equipment we’ve been looking at.  Whoa there big fella, let’s think about this first.  Yes, you have cash, but the million dollar question is: Can you spend it?  Just like a lawyer the accountants answer is “not yet”, let’s look toward the future.  Just because you have a positive balance in your checking account, does not mean you have money to spend.  As opposed to the Government, they don’t think about this at all.

 The next question is: How long will this project last and what costs do I have before the next payment is received from your customer? Assume the project lasts 4 months, the down payment you received up front needs to be used to pay the salaries of the people working on that project, as well as any and all expenses associated with that project. Your company can get upside down in cash before you know it.  If you don’t receive any more money until the end of the project, you will have to borrow money from the bank or find some other financing just to finish the project. 

 Let’s assume some facts: 1st the total revenue on the project is $150,000 and you receive a 50% down upon receipt of order and the final payment is due when the project is delivered.  2nd costs for parts is 60% of the total project and you pay your vendors 30 days after receipt of PO from customer, and 3rd your operating expenses are $10,000 per month. 

 

Month 1

Month 2

Month 3

Month 4

Beginning Cash

0

$65,000

($35,000)

($45,000)

Received Cash

$75,000

0

0

$75,000

Cash Spent on Parts

0

$90,000

0

0

Operating Expenses

$10,000

$10,000

$10,000

$10,000

Ending Cash

$65,000

($35,000)

($45,000)

$20,000

 

As you can see, just because you have cash up front does not mean you have cash to use.  As a responsible company you want to make sure you have money in the bank to pay the salaries of your employees and pay your vendors.  You don’t want to be like California and issue IOU’s.  I’m not sure, but I don’t think that would go over well with your employees or your vendors.  If your employees don’t mind, please let me know they would be a great cash flow asset here at Setpoint.

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Posted in Finances, open book finances, open book management | 1 Comment »

Open Book Finance - Setpoint’s Projects Board

Monday, May 4th, 2009 by ksmith

Joe Knight, the CFO here at Setpoint, talks about open book finances and how we track our projects. In our latest YouTube video Joe walks through our project board that let’s us know how we are doing on each project. He walks through how GP is determined as well as how much we have earned.

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Posted in Finances, open book finances, open book management | 1 Comment »

Open Book Finance - The Board

Thursday, March 5th, 2009 by ksmith

What do your numbers mean?  Here at Setpoint we practice Open Book Finances.  Every week we look at the numbers that show us how far along we are on our projects.  In our newest YouTube video Joe Knight, our CFO, talks about how we know if we are making money.  He shows some key ratios that can be used in any industry to measure this.

 

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Posted in Finances, Humor, open book finances, open book management | 1 Comment »

Financial Bailout

Monday, October 13th, 2008 by JoeK

The following YouTube is my quick take on the financial crisis.  I think that a lot of the problems in our financial system come from a lack of understanding of the numbers.  I find this problem throughout the country when I am training.  We do not train our managers in business how to read financials.  The media makes it worse by feeding the fear with dire predictions and misinformation.

I am trying to explain how this financial crisis happened and why the solution will probably work.  On the other hand if the wide spread panic continues, we may be in for a rough ride.  We need to calm down and let the system correct…it will.

Also, if you get a chance read my book Financial Intelligence, it will give you a nice background on how to read the statements and what to look for in a company’s financials.  For you entrepreneurs, we just introduced Financial Intelligence for Entrepreneurs.

It was too long for one video so be sure to catch both part 1 & part 2.

Part 2:

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Posted in Finances, open book management | No Comments »

Open Book Management at Setpoint

Monday, September 22nd, 2008 by JoeK

Setpoint Systems, Inc. is an open book company, which means we open our books to our employees.  Every Monday at 1:00 pm we gather together to see how the prior week went financially.  It’s been that way at Setpoint pretty much from the beginnings of the company in 1992.

After arguing with their CPA and trying to understand QuickBooks, the founding Joe’s became confused and were looking for help.  I was working as a financial consultant after starting my career at Ford.  Joe Cornwell called me and asked if I could help him with his challenges in finance.  I remember Joe bringing me into Setpoint Systems which at the time had 5 employees, the two Joe’s and three others.  It was in the evening and it was just me and him.  He said “why do you finance guys have to make this so hard?”  He then went to the white board and said this is all that matters.  Then he wrote the following on the white board:

           Sales
- Stuff to Buy
——————————-
Aggregate Remainder

I told Joe C. that in finance we called aggregate remainder gross profit.  Joe told me that it is so great you finance guys have a name for that number because that is an important number in business.  So instantly I became the gross profit expert for Setpoint.  Later I would become a co-owner and CFO for the business.

Over the years we have developed our own system for tracking financial success in our business.  We have used Joe C.’s philosophy to keep it simple.  I told Joe that we did not need to follow GAAP (the Generally Accepted Accounting Principles) which is what his CPA was requiring.  Since we were a private company, we could present the numbers in a way that makes sense to our employees and managers.  I could take our home cooked numbers and present them to our banks and the IRS for taxes in the right format after the fact.

We developed three training courses on the income statement, balance sheet and cash flow.  We started a bonus plan based on our financial performance.  Along the way we realized that we had developed a unique open book approach to manufacturing automation equipment.  We now realize that the weekly board and our tracking system that is behind us is our single best asset in the business.

Over the years we have seen competitors come and go.  We have seen our employees work through problems on our books.  Recently one of our project engineers was under on the accrued profit on a very profitable job.  When it was presented on our board several of our shop employees challenged the numbers.  They knew that the conservative reporting understated the profits of the business for the month which would affect their bonuses for the month.  So our project engineer was forced to update the profit on the project more accurately.

I could tell several stories like this one.  Over the years our system has kept us honest.  When the board looks bad we have all worked together to solve the problems and when the board looks good we share in the success through bonuses.  If you are interested in learning more about Setpoint Systems open finance approach you are welcome to visit us on a Monday at 1:00 pm in Ogden, Utah.  Our system was featured in an article in Inc. Magazine, September, 2001 issue.

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Posted in Creative Thinking, open book management | 1 Comment »