How do you handle cash management for long-term contracts with multiple performance obligations?

1 Know your contract terms

The first step is to understand the terms and conditions of your contract, and how they affect your cash flow and revenue recognition. For example, do you have fixed or variable prices, upfront or milestone payments, penalties or incentives, warranties or guarantees, or any other clauses that could impact your cash flow or revenue? You should also know how to measure and allocate the transaction price to each performance obligation, and when to recognize revenue for each one. This will help you plan your cash inflows and outflows, and comply with the accounting standards.

2 Forecast your cash flow

The next step is to forecast your cash flow for the duration of the contract, and update it regularly based on the actual performance and changes in the contract. You should consider the timing and amount of your cash receipts and payments, as well as the impact of any external factors, such as exchange rates, inflation, interest rates, or market conditions. You should also account for any uncertainties or contingencies, such as delays, disputes, or revisions in the contract. A cash flow forecast will help you identify any potential gaps or surpluses in your cash flow, and take appropriate actions to manage them.

3 Optimize your working capital

The third step is to optimize your working capital, which is the difference between your current assets and current liabilities. Working capital is essential for your day-to-day operations and liquidity. To optimize your working capital, you should aim to reduce your inventory and receivables, and increase your payables and deferred revenue. For example, you could negotiate better payment terms with your customers and suppliers, offer discounts or incentives for early payments, invoice promptly and accurately, collect debts efficiently, and defer revenue until you meet the performance obligations.

4 Manage your risks

The fourth step in managing your risks is to identify the factors that could affect your cash flow or revenue recognition negatively. Common risks for long-term contracts with multiple performance obligations include scope creep, which occurs when the customer requests more work or changes than agreed in the contract without adjusting the price or timeline. This could lead to increased costs, delays, or disputes and impact cash flow and revenue recognition. Revenue reversal is another risk, where you have to adjust revenue already recognized due to changes in the contract, customer dissatisfaction, or non-compliance with accounting standards. This could result in lower profits, tax liabilities, or audit issues and affect cash flow and reputation. Lastly, a cash flow mismatch is when inflows and outflows do not match in terms of timing or amount due to variations in the contract, customer behavior, or market conditions. This could lead to cash shortages or excesses and affect liquidity and solvency. To mitigate these risks, it is important to define and document the scope of the contract clearly, follow accounting standards and principles, forecast cash flow accurately, optimize working capital, and use appropriate financing or investing strategies.

5 Monitor and report your performance

The fifth step is to monitor and report your performance, which is the process of measuring and communicating your progress and results for each performance obligation and the contract as a whole. This will help you track your cash flow and revenue recognition, and identify and address any issues or opportunities. You should use relevant and reliable indicators and metrics, such as percentage of completion, earned value, customer satisfaction, or profitability. You should also report your performance to your stakeholders, such as customers, managers, investors, or auditors, in a timely and transparent manner.

6 Review and improve your processes

The final step is to review and improve your processes, which is the process of evaluating and enhancing your cash management and revenue recognition practices for long-term contracts with multiple performance obligations. This will help you learn from your experience, and improve your efficiency and effectiveness. You should review your processes periodically, and compare your actual performance with your planned or expected performance. You should also solicit feedback from your stakeholders, and identify and implement any improvements or changes in your processes.

7 Here’s what else to consider

This is a space to share examples, stories, or insights that don’t fit into any of the previous sections. What else would you like to add?