Why a big contract can become a financial problem
Winning a large contract is an important milestone for any growing business.
However, a large order can require the business to spend substantial amounts of money before receiving its first payment.
This is particularly risky for SMEs that do not have large cash reserves.
Imagine a small construction company wins a R1 million contract.
The business needs to purchase materials, hire additional workers, arrange transport and pay suppliers before completing the work.
If the customer only pays after delivery and approval, the business could be financing the entire project for several months.
The contract may look profitable on paper, but the business may not have enough cash to execute it.
Five cash-flow traps to check before signing
1. Payment milestones
Find out exactly when payments will be made.
Does the customer pay a deposit? Are payments linked to completed stages? Is the final payment made only after inspection and approval?
A contract with milestone payments may be easier to finance than one that pays everything at the end.
2. Retention payments
Some contracts withhold a percentage of the contract value until certain conditions are met.
For example, a customer may retain 10% of the payment until the end of a defects-liability period.
That retained money should not be included in your immediate cash-flow calculations.
3. Penalty clauses
Check whether the agreement includes penalties for:
- Late delivery.
- Failure to meet specifications.
- Incomplete work.
- Failure to meet service levels.
- Other contractual breaches.
A penalty can reduce the profit you expected to earn from the project.
4. Scope changes
A customer may request additional work after the contract has been signed.
If the business agrees to extra work without documenting the change, it may incur additional costs without receiving additional payment.
Use a written variation process that confirms the additional work, cost and payment terms before proceeding.
5. Customer concentration
If one customer accounts for a very large portion of your revenue, losing that customer or experiencing a payment delay can seriously affect the business.
A large contract may increase revenue while also increasing dependency on one buyer.
Example: The cash-flow requirements of a large contract
A business wins a R500,000 contract.
Its estimated delivery costs are R350,000.
| Project expense | Amount |
|---|---|
| Materials | R180,000 |
| Labour | R100,000 |
| Transport | R30,000 |
| Equipment and other costs | R40,000 |
| Total estimated costs | R350,000 |
Expected project surplus before other overheads, tax and financing costs:
R500,000 − R350,000 = R150,000.
However, the business must still finance the R350,000 delivery cost at the appropriate times.
A profitable contract can therefore create a serious cash shortage if payment only arrives after completion.
How to protect your business before accepting the contract
Negotiate a mobilisation payment
Request an initial payment to cover materials, mobilisation or other agreed upfront costs.
Introduce milestone billing
Divide the work into stages and invoice as each stage is completed and approved.
Agree on payment documentation
Confirm what documents the customer needs before releasing payment.
Calculate the cash requirement
Estimate the highest amount of cash your business will need before the first payment arrives.
Prepare a project-specific forecast
Do not rely only on the normal business cash-flow forecast. Build a separate forecast for the contract.
Arrange financing before work begins
If a funding facility is necessary, arrange it before committing to supplier orders and delivery deadlines.
Project cash-flow checklist
Before signing, answer these questions:
- What is the total contract value?
- What are the direct delivery costs?
- When must suppliers be paid?
- When must employees be paid?
- Is a deposit available?
- When will each milestone be invoiced?
- How long will the customer take to approve invoices?
- Is any amount retained?
- Are there late-delivery penalties?
- What happens if the customer changes the scope?
- Can the business deliver the contract without affecting existing customers?
- What is the maximum cash requirement before payment?
Frequently asked questions
No. Assess profitability, capacity, payment terms and cash requirements before accepting.
You can negotiate one, although some procurement contracts have fixed payment terms. Check the tender or contract conditions.
Assess the funding gap and whether you can finance it without placing the rest of your business at risk.
Potentially, once eligible invoices or receivables exist. It may not solve all upfront costs before work is invoiced.
Should I accept every large contract?
Can I request a deposit from a corporate customer?
What if the customer refuses to change its payment terms?
Can invoice financing help with a large contract?
Your next action
Before accepting your next large order, prepare a project cash-flow forecast showing every major expense and the date each customer payment is expected.