Use Your Contracts to Improve Financial Flexibilityby Michelle Bomberger | April 30, 2020
We all want to close deals quickly, without strife, and with financial flexibility. However, if professional relationships are just casual, you may lose that opportunity to improve cash flow and profitability. Don’t fear the best tool in your belt: Contracts. For businesses, formalized contracts are the most important tool to secure revenue and protect assets. How is this accomplished?
The contract represents the ground rules of the relationship and describes what each party is obligated to do and how the parties will interact with one another – in good times and bad. More importantly, many of your relationships are not stand-alone contracts –They fit together into your supply chain and create dependencies upon one another. By evaluating your supply chain, you can see where these dependencies exist and manage them as a group to minimize your risk. Here are a few areas to focus on:
Cash Flow Risk
The payment terms in the contract should reflect your company’s cash flow needs. Cash flow management is about the timing of cash. For example, if you have subcontractors you must pay, make sure payments required TO you come before payments required FROM you. To make this work, you need to negotiate the terms of both contracts – the one with your customer and the one with your subcontractor – for cash flow alignment. You need to evaluate the size and likelihood of the risk of non-payment by your customer and build in enough flexibility for your payments.
Similarly, you want to implement levers that encourage customers to pay on time or sooner. These levers include pre-payment discounts and penalties or interest on late payments. Looking at the end-to-end cash flow cycle will help you determine how much financial flexibility is needed, which you can then negotiate into your contracts.
Supply Chain Risk
When considering how this relationship fits into your business’ broader supply chain, you’ll see areas of risk and can create the right terms in the contract to lessen the risk. The needs of your business (or your vendor’s or customer’s business) may change during the relationship, and you can incorporate terms in the contract that allow you to make changes to specific terms when needed. For example, you may want to incorporate certain Service Level Requirements to maintain cost, volume, and quality controls. Contracts also describe the circumstances where you may terminate or amend the contract. You’ll want to understand how much risk you have in locking yourself to the contract compared with the flexibility of going elsewhere quickly. Each contract requires these terms to be spelled out and agreed upon.
Your contracts should include procedures to manage disputes. Clear dispute resolution procedures can help the parties limit the costs and uncertainty of what happens if the relationship goes sideways. You’ll want to understand your options – from litigation to arbitration to mediation or a mix of the three – and which makes the most sense for the relationship. When a dispute arises, you want to be able to move forward feeling confident that the costs are in line with the scope of the risk.
It’s easy to shake hands and get the relationship going – but a thoughtful assessment of how the relationship fits into the bigger picture of your company’s cash flow, supply chain, and dispute risk is key to financial flexibility. Taking a proactive approach will help you manage these risks and be ahead of the game when your situation changes – for good or for bad.
Learn more about Cash Management and Profitability
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You’re not alone – Speak with an attorney to review your current contracts, help to draft incoming contracts, and to make sure financial flexibility is maximized in your contracts. Contact us at 425-250-0205 or firstname.lastname@example.org.
Legal Disclaimer: This article contains general information and should not be viewed as legal advice. You should talk with counsel familiar with your unique business needs before taking or refraining from any action.