Contending with cash flow can be one of the more frustrating aspects of managing your firm’s finances. But before we look at some solutions, you should first consider if what you think is a cash flow problem might actually be a profitability problem. After reassuring yourself that the ups and downs of receivables and expenses really is a matter of timing, not of lack, there are some helpful techniques that can help.
One of the main causes of genuine cash flow problems is poorly structured billing terms. Often projects are billed half up front, half on completion, or a third up front, a second third at some defined project benchmark, and the remainder on completion. There are some real problems with these two common approaches.
Problematic Billing Practices
The half and half billing is the most problematic. Firms often do this because they want to capture as much of the new project revenue as soon as possible—usually because they need the money to cover current expenses. That of course represents a profitability problem–and the prospect of a significant cash infusion from a new project is a tempting solution. But this practice only kicks the can further down the road. And if the new project goes over budget as well, you’ll find yourself looking for yet another new infusion of cash from a new job–to subsidize the old. Not a healthy cycle.
Billing in thirds is slightly better than halves but it has a significant liability–it introduces a big invoice right at the tipping point of the “trust-exchange.”
Understanding the Trust Exchange
At the outset of any new project (especially with a new client), as soon as the client pays that first invoice they extending a lot of trust. From day one the firm is “in debt” in this trust exchange. And it’s up to them to validate the client’s trust by being diligent to meet schedules, deliver good work, and be responsive in communications. There will be an unspoken anxiety on the client side for the first few weeks or months until they begin to see that their trust was not misplaced. But by the end of the project, the trust exchange shifts from the client to the firm. When all the work is done and all the firm’s time has been spent the firm has to trust that the client will pay their final invoice. Now the anxiety is on the other side
Whenever money changes hands from one party to the other, the balance in the trust-exchange changes. And whichever party has possession of the majority of money involved in a project has the greatest power in the exchange. At the start the firm is in debt in the trust-exchange. At the end the client is in debt and the firm has to trust them. Somewhere in the middle of a project the trust exchange makes this shift. There’s quite a bit of unspoken, non-project related stress happening as this shift begins to take place–and it’s right about this time that the pesky middle invoice gets submitted.
If that middle invoice comes too early, if the client hasn’t come to fully trust the firm, or if their sense of progress is less than they expected, their tension will be high. If the invoice is sent too late, the firm can be at serious risk if the client fails to pay–thus the higher stress for the firm.
If we mix in problems experienced in the project itself–a missed email, a misunderstanding, a dropped deadline, a design that was not loved–the stress is further heightened. The tipping point in the trust-exchange is a loaded moment in any project.
Sending a significant invoice, one which will move the majority of the project revenue to the firm, at this angst-filled moment could be the spark that ignites the fuming tensions lurking under the surface of a project.
You may have noticed how projects that have gone very smoothly right up to the point of the second invoice suddenly get bogged down at this point. Clients that have been cooperative suddenly get reserved. Approvals that came quickly are now withheld.
The middle progress invoice almost always comes at the height of all these tensions. If for no other reason than avoiding sending an invoice at the tipping point of the trust-exchange, changing your billing practices would be worth it.
Fix Your Billing Terms to Ease Cash Flow Stress
The solution to these problems is to divide your project payments into smaller payments and send them on an agreed upon schedule rather than on project benchmarks. Breaking payments down into fifths, sixths, sevenths or more will resolve many of these problems. This simple solution allows financial transactions to flow more evenly with the dynamics of the trust exchange. And since the amounts of each invoice will be lower and since they will be received on a predictable schedule the client can process them without having to consider the balance of trust and power so severely.
But there are other benefits to breaking invoices out into several smaller, scheduled payments. It keeps your firm from receiving disproportionate infusions of cash compared to the work required to actually earn the money—or at the other end of a project—from essentially becoming a bank for the client by extending significant labor credit to them before getting paid. With monthly scheduled payments the revenue you receive will come more closely to the time you’ve actually earned it. This will make it harder for you to practice the unhelpful patterns of looking for new project payments or final payments to solve cash flow problems that are not really cash flow problems. Getting paid closer to the time work is actually done will force you to see profitability problems for what they really are–and address them in a more timely manner. (Of course you should also be diligently recording and analyzing your time records to reveal profitability issues in a timely manner!) Connecting your cash flow to your actual work flow prevents will help you from looking to new business wins as a solution to the underlying real problem of a lack of profitability.
Applying this to Smaller Projects
If you have a project that won’t take more than three months to complete you might consider a bi-monthly payment schedule in order to smooth out the tensions of cash flow. Or if you do continue to bill in thirds you should exercise as much patience and delay your second invoice until you’re confident that you have fully earned the client’s trust–as well as delivered on the project’s benchmark. as long as possible. Of course you’ll need to already be operating profitably, from a position of financial strength, in order to extend generous terms and billing practices–but when you can do that it will only reinforce your competence and professionalism with your clients.
Lastly, make sure you keep an accurate running spreadsheet of all projects and invoices broken out by month and tie them to your running monthly expenses. This cash flow document can help you forecast any real cash flow problems, or serve to indicate how profitable you are operating (by showing how many months of positive cash flow you can expect–or how few). If you’d like to see a sample cash flow Google spreadsheet to get started just email me and I’d be happy to send you a template.