Contracts
This is part two of our four-part series around project bookkeeping and accounting. Today I want to talk about contracts and more importantly, how they can be helpful to the accounting process.
PODCAST TRANSCRIPTION
Darell Brown:
Welcome to the ProProject podcast with ProProject Bookkeeping. This is your host Darell Brown bringing you bookkeeping tips and tricks to make your project finances run a little smoother.
This is part two of our four-part series around project bookkeeping and accounting. Today I want to talk about contracts and more importantly, how they can be helpful to the accounting process. Contracts don't necessarily fall into the realm of accounting, but the language in them can help with cash flow forecasting, tracking budgets, and just putting a workflow in place so the accounting of a project flows smoothly. So contracts, in general, should really contain the framework for the project. It should outline the project's goals, services to be performed, the project's timeline and the final deliverables. In a project, there are contracts with the client and depending on your company, also contracts for subcontractors providing services on the project.
So when a company I'm working with receives a signed contract and sends it to me, I review the contract for the project fee, invoicing schedule, and payment terms. For example, the project fee is $600,000. It is split into six payments due by the 10th of each month, with the first payment due upon receipt of invoice. So I immediately create the first invoice and send it to the client reminding them of the due upon receipt payment terms of the signed contract. I then schedule the next five invoices to send to the client on the first of each month so we can receive payment by the 10th. So the contract having this information allows me to map out invoices in the accounting system. Being able to do this also allows me to have cash flow expectations for the next six months. So for the next six months, I know to expect $100,000 coming through by the 10th of each month. And then I can use that information to make decisions on paying bills related to this project or related to the company in general.
So speaking of bills for this project, the next contracts to review would be the contracts for the subcontractors providing services on the project. So I need to review their contracts to determine a payout schedule for their services on the project. If payment from the client is expected by the 10th, it's ideal to have a contract that has payment terms for the subcontractor due on the 30th. It gives a small window to follow up with the client if they're slightly late on payment.
So we now have payments of $25,000 due to various subcontractors on the 30th of each month for the next six months according to the subcontractor contracts. Again, we can use this for the purposes of forecasting our cash flow. We already know based on the client contract and scheduled invoices, we can expect $100,000 of cash to come in by the 10th of each month and bills for subcontractors of $25,000 to be paid by the 30th. So based on the various contracts, we know the remaining cash flow forecast is $75,000 for remaining company expenses. And the numbers I'm using here are just based on one project, but of course, ideally, a company would have multiple projects that would be a part of their cash flow forecast. So jumping back to client contracts, the next area of a client contract that's important is reimbursable expenses. It's important to have some language in the contract around reimbursable expenses.
This may include travel for your consultants or project supplies. If you send a client a bill for reimbursable expenses without mentioning this possibility in the contract, they may refuse to pay for them, or they may have limits in place for food, airfare, and hotels, which will result in a reduced payment on your reimbursable expenses. And this can result in these expenses actually eating at your cash flow as well as your project's net income. Budgeting and keeping track of budgets in real-time is another area where contracts can be helpful. We know that based on the client and subcontractor contracts, the net revenue expectation for the project is $75,000 per month for six months for a total of $450,000 in net revenue. With that expectation in mind, we can review the budget against actual numbers in regular intervals to see if there are any expense anomalies. The reimbursable expenses might cause anomalies.
They are usually higher at the start of the project and then taper off. We have to make sure we account for them being reimbursed by the client when reviewing the actual numbers versus the budget. So in the process of tracking the actual numbers versus the budget, we see that towards the end of the second month, the net revenue for the month is likely to be $65,000 instead of $75,000. Upon researching further, we see that two subcontractors charged an additional $5,000 on their invoices in the second month. We send this information to the project manager and she informs us to contractors have done additional work this month, but they will taper off on the project later on. So their overall contract amount will still be the same.
So this means we're still on pace for $450,000 in net revenue. Of course, it doesn't always work out this way. And if there are cost overruns, we can use the actual numbers versus the time left on the project to figure out potential effects on the overall net revenue. If we catch the cost overruns early enough in the project's timeline, actions can be taken to get the numbers and revenue estimates back on track. To summarize contracts and why they are helpful, if they are awarded correctly, they lay out the framework for the accounting processes. I can schedule all client invoices and the accounting system based on the contract. And it also gives me an expectation on when payment will arrive. I will also know amounts to be paid for subcontractors and win based on their contracts.
And having this information can be useful for cashflow forecasting, as well as tracking actual numbers versus the budget. And from a personal standpoint, it has always been easier for me to collect payment on behalf of my clients when their contracts are laid out and terms are clearly stated. So that's my two cents on contracts and why they are helpful to the accounting process.
If you found this information helpful, or just want more information on how contracts can ease your accounting process, feel free to get in touch with us at info@proprojectbooks.com. Once again, that's info@proprojectbooks.com. This is Darell Brown with the ProProject podcast signing off. Thank you for listening and happy tax season.