Understanding Commitments, Expenditures & Payments
Before we discuss commitments, expenditures and payments, the concept of cash flow must be addressed. Commitments, expenditure and payment plans and curves are often mistakenly confused with cash flow. A typical cash flow is comprised of:
“Cash Out,” which includes bid costs, engineering & design costs, material purchase orders, labor, overhead, and subcontracts.
“Cash In,” which includes billings, retentions, claims and change orders.
Many factors influence the cash flow including project duration, contractual retention clauses, payment schedules, contract types (milestone, progress etc.), credit arrangements and equipment rentals. A commitment, expenditure and payment curve is not a cash flow, because it does not include the cash-in portion.
Let’s first review the definition of what constitutes a commitment, expenditure and payment.
Commitment: A legal undertaking to commit capital at a future date. When a commitment is made it is considered a liability. The best examples include the award of a contract or placement of a purchase order.
Cost incurred for services or goods rendered stemming from a commitment. This includes a known cost that has not yet been invoiced (accruals).
This is cash out. These are the actual payments of your expenditures. If an invoice is held up for a period of time, it remains an expenditure until actually paid.
Generating the Plan
Each and every project uses various cost control mechanisms to keep a project on budget, identify potential cost impacts and define the financial position of the project. One such mechanism is a commitment, expenditure and payment plan vs. actual curve. To support your cash flow and make available the required funds for payments, it is essential that you have a well-defined financial work flow plan.
It all starts with the commitment. Establishing an accurate commitment plan is important as it will ultimately drive your expenditure and payment plans. The best method to do so is by using all your team resources such as procurement, contracts and planning & scheduling.
Expenditures follow your commitments. After you have committed to paying for a good or service, the good or service is then provided/performed and actual booked cost is then incurred. You should note that retention and advances are NOT included in expenditures, because this is not a cost associated with actual work performed. You will typically find that with contracts, your first expenditure is associated with mobilization or first engineering. Purchase orders will vary, but you will often see a payment upon commencement of fabrication or first shipment/delivery.
Many people try to use a standard process to spread expenditures and calculate accruals for contracts and PO’s, but each one has its own terms and payment setup. Some are milestone based, others are direct progress, and some are even standard monthly payments. To develop an accurate expenditure plan you must evaluate the terms of each and every contract/PO upon award. Prior to award, it is common to use your progress plan to spread your expenditures over time.
The key to a good payment plan, which contributes directly to producing a good cash flow, is a well-defined expenditure plan. Much like expenditures, payment plans are dictated by each contract/PO. You must review each to determine the payment terms and payment cycle. You will find that many require payment 30 days after receipt of invoice, but others are 60 or even 90 days. This is important, because your payment plan will lag your expenditure plan in accordance with the time defined by the payment cycle.
At the end of the task, you should have a curve (typically) where your payments trail your expenditures, and your expenditures trail your commitments. Your curves should line up with your schedule and progress plans. You should not have expenditure values in your plan extending past your scheduled completion date.
For more information, contact one of our team members at 972.905.9045.