TERMS OF PAYMENT


The financial structure of a typical consultancy practice is that although revenue is dependent on sales volume, costs are largely fixed. Costs arise mainly from employee costs and office overheads such as premises. Such a financial structure means that cash flow has to be rigorously controlled. Take, for example, John Smith's practice, where a consultant costs an average of £80,000 per annum with fully absorbed costs. Assume John Smith starts work on 1 May on a three-month assignment, which is completed satisfactorily on 31 July. If he has worked 62 days at £600 per day in this period, the fees will be £37,200, against costs of £20,000 (being the cost related to three months of his time). The profit of £17,200 is healthy. The cash flow may not be, though. Suppose the consultancy submits an invoice for the fees on 15 August. The client may have a system that pays the invoice at the end of the month following that of submission. This invoice will then be paid on 30 September, and the consultancy receives the amount a few days later. The consultancy has therefore had to bear the cost of an increasing amount of work in progress while the assignment was being carried out and the full cost of the assignment for two months while raising the invoice and waiting for it to be paid.

If this is replicated across the practice, there will need to be a large amount of working capital, which will add to the costs of the business. It is therefore important to keep work in progress and debtors low, and this starts with the terms of payment, included in the terms of business.

Because of the time lag in the example given above, consultancies like to have payment on account, or interim payments, for an assignment. These will be against the fees agreed, but the fact that they are made before the end of the assignment will help improve cash flow. The aim is to transfer 'work in progress' to 'debtors' quickly.

In an ideal world, a client would pay for an assignment on commissioning it. This would be marvellous for the consultancy's cash flow, but bad for the client's. Clients are (for the most part) also subject to the same cash flow considerations as the consultancy firm; from the client's point of view, their cash flow would be considerably enhanced by deferring payment until well after the completion of a consultancy project. There has to be a compromise. The client might make stage payments throughout an assignment, perhaps at significant milestones. For example, a recruitment consultant might be paid as follows:

  • one-third of the fee at the start of the assignment;

  • one-third on presentation of a shortlist of candidates;

  • one-third on the position being filled.

Whenever there are interim payments, consultants should try to ensure that invoices coincide with the client receiving some value, as in the above example, or on submission of a report, or the completion of a phase of a project. Fees might also be charged according to the time spent by consultants each month. In the example given above, the invoicing schedule might be as shown in Figure 7.1.

Month

Days on fees

Amount (£) invoiced

May

19

11,400

June

21

12,600

July

22

13,200

Total

62

37,200


Figure 7.1: Invoicing schedule

Some firms on major projects might invoice more frequently - perhaps on a weekly basis. Whatever the basis of invoicing, this should be agreed with the client and summarized in the terms of business.

Credit Terms

The other major factor affecting cash flow is the time lapse between the client receiving an invoice and paying it. Businesses often have payment systems that classify accounts payable into categories of payment at (say) 7 days, 30 days, 60 days, 90 days. Unless the consultancy insists otherwise, the client will put the account payable into the category that offers maximum credit, so the credit period should be agreed and specified in the terms of business.

Payment can be deferred if there is a query on an invoice. Businesses seeking to improve their cash flow may excuse nonpayment because 'we have a query on the invoice', whether or not there are grounds for query. Here the consultancy practice might agree with the client at the outset that queries must be raised within a given time after the invoice has been received, otherwise the invoice will be regarded as acceptable.

A consultancy's own procedures can also result in high levels of working capital being required. For example, in one practice, invoices for the month were raised by the sixteenth of the following month. These were then sent to consultants for onward transmission to their clients. Because of queries, consultants being out of the office, and this task being given a low priority compared with selling and operating, it often took as long as a further month before the invoices were sent out. This resulted in high levels of work in progress and debtors. The situation was resolved by the invoices being sent out without approval, direct from the accounts department to the client, but on an agreed basis for each assignment.

The final building block in keeping working capital requirements down is credit control. Consultancies should have a system for chasing up invoices due, but not yet paid.

Cancellation Charges

A consultancy can incur expense if a project is cancelled or postponed by a client, particularly at short notice. For example, if a consultancy has reserved two consultants to run a three-day interview programme next week, which the client then postpones, it is usually difficult to find fee earning work at such short notice to fill their time. Even if the consultancy work is carried out at a later date, the six consultant days next week will have been lost.

Under these circumstances, a consultancy practice may seek redress by having a cancellation clause in the contract. This is particularly appropriate when running short projects or training courses, which tend to be one-off events. Obviously, whether the cancellation charge is levied will be subject to wider considerations of the client relationship. Part of the value of a cancellation or postponement clause is, however, that it can restrain clients from changing a programme needlessly - it becomes more worthwhile for them to put themselves out to avoid the cancellation charge!




The Top Consultant. Developing Your Skills for Greater Effectiveness
The Top Consultant: Developing your Skills for Greater Effectiveness
ISBN: 0749442530
EAN: 2147483647
Year: 2003
Pages: 89

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