Cost reports and cash flow tell different stories: watching both on projects

The monthly project review goes well. The major jobs are on budget, earning roughly what they cost, and the one with a cost overrun has a credible recovery plan. Nobody is worried. A few days later, the business has to ask its bank to extend an overdraft, because the cash needed over the next two months no longer fits the limit. No document links the request to any of the projects. It is caused by all of them.

Both pictures are accurate. They are expressed in different units, produced by different people on different cycles, and nobody reconciles them. The project report measures cost recognised against work performed. The bank request measures money that has actually moved. Between them sits a gap through which profitable businesses can run out of cash while their project reports stay green.

This article explains why project cost reports and cash flow diverge, where the gap comes from, why it is widest when a business is growing, and a simple reconciliation that shows each project’s peak cash requirement and when it occurs. It is written for owners and managers of project-based businesses such as fabricators, builders, installers, engineering firms and service providers.

Two ledgers

Accrual accounting records revenue when it is earned and costs when they are incurred, regardless of when cash changes hands. Cash accounting records money when it is received or paid. Project control systems are almost always built on the accrual side. Budgets, cost-to-date, forecast cost at completion and variances all measure cost against work performed.

Project management teaching usually draws this distinction clearly. It explains that a time-phased budget records cost when work is committed and performed, while a cash flow records money when it moves, and it names the items in the gap: supplier terms, invoicing delays, retentions and the cost of carrying working capital. It warns that a project can be profitable on paper and still fail because the business cannot fund the difference. Then it builds every performance measure on the accrual side and leaves cash to someone else.

A related measure, earned value, compares the value of work completed with its budgeted cost and with actual cost incurred. It is a useful measure of efficiency, but it too is an accrual measure. Cost incurred is not cost paid. An approved but unpaid supplier invoice is fully present in cost-to-date and entirely absent from the bank balance.

Common misreadings

• The spending curve is the funding requirement. A chart of when costs will be recognised is often described as the project’s cash curve. It is not. On jobs with large purchases, the two can differ by months, in both directions.
• Under budget means cash is fine. Often the opposite. A project running ahead of schedule draws cash sooner than planned, while every efficiency measure improves.
• Shaping the budget to match payments solves it. Some practitioners distort the cost budget to reflect payment timing, such as putting a whole supplier deposit in the first month. That makes the budget a poor measure of work while still not producing a proper cash forecast.

Where the gap comes from

The difference between cost recognised and cash moved is made of identifiable items. On most projects, the main ones are:

• Deposits paid to suppliers before goods are received.
• Deposits received from customers before work is done.
• Work performed but not yet invoiced.
• Invoices issued but not yet paid by the customer.
• Retentions held back by the customer until after completion or a defects period.
• Materials bought ahead of use and held in stock.
• Tax and duty timing, such as GST, import duties and freight paid before costs are recognised.
• Supplier credit terms, which delay cash out relative to cost.

Each of these can be estimated and given an owner. Together they explain why the two pictures differ.

Why the gap is widest when you are growing

Growth consumes cash. A business winning more work, starting more jobs and buying more materials is spending ahead of receipts by its nature. Its project reports look strongest, with more jobs in progress and good margins, at exactly the point its cash position deteriorates fastest. Owners can experience this as a disagreement between an optimistic operations team and a pessimistic accountant, when in fact both are reading their own data correctly.

The gap also grows as you move from a single project to the whole business. Each project’s cash need is limited, but they all draw on the same bank balance and overdraft. One project’s early purchases consume headroom that another needs, without appearing in either project’s report.

A two-ledger reconciliation

A simple reconciliation, prepared for each significant project at the same time as the cost report, brings the two pictures together. It has four parts.

1. The accrual line. Cost incurred to date, value of work completed and forecast cost at completion, copied unchanged from the cost report.

2. The cash line. Cash out to date, cash in to date, the net cash position to date, and the forecast peak cash requirement with the date it occurs. The date matters most, because a peak without a date cannot be planned for.

3. The bridge. The named items that explain the difference between the two lines, such as deposits, unbilled work, unpaid invoices, retentions and stock, each with a value. If the bridge does not reconcile, say so rather than forcing it.

4. Two tests.

• Headroom: does the business’s combined peak cash requirement, on its date, fit within available cash and facilities with an agreed safety margin?
• Divergence: is the gap between cost completion and cash completion widening, and is any decision now being considered one that improves the cost picture while worsening cash?

One rule completes it: any change approved on cost or schedule grounds that significantly moves cash, such as accelerating work, buying early for a discount or bringing scope forward, needs a separate check of its cash effect. These decisions often look excellent on the cost report and consume the most cash headroom.

Building a simple project cash forecast

A project cash forecast does not need to be complicated. For each significant job:

1. List the main costs and when each will actually be paid: supplier deposits, balances on delivery, subcontractor claims, weekly wages, materials on account terms.
2. List the customer payments and when each will actually arrive: deposits, milestone payments, progress claims after approval and payment terms, and retentions released after completion.
3. Lay them out month by month, or week by week for short, intense jobs.
4. Calculate the cumulative position to find the lowest point and when it occurs.
5. Add the jobs together with the business’s normal overheads to see the combined position.
6. Update it when schedules, scope or terms change.

Be realistic about timing. Customers often take longer to approve and pay claims than their terms say, and suppliers sometimes require payment earlier than expected. Testing a scenario in which customer payments arrive a month late is a simple way to see how much margin for error the business has.

Payment terms are the biggest lever

The single largest influence on a project’s peak cash requirement is usually its payment terms: customer deposits, milestone and progress payments, how quickly invoices are paid, retentions, and supplier deposits and credit terms. These are often negotiated by sales or purchasing staff with no visibility of the business’s overall cash position. Making payment terms a visible part of every significant job, and checking their cash effect before agreeing them, can do more for cash than any amount of cost control.

A worked example

This is an illustration. A fabrication business wins a $600,000 contract to build and install equipment over six months. Its estimated cost is $480,000, giving a margin of $120,000. Costs include $240,000 of bought-in equipment, for which the supplier wants 30% at order and the balance at shipment, and $240,000 of labour and materials spread evenly over six months.

The customer pays a 10% deposit at the start. The business then claims monthly for work completed, with the deposit recovered from each claim and 5% retained until twelve months after completion. Claims are paid the month after they are made.

The remaining $30,000 of retention arrives a year later, bringing the total to the expected $120,000 margin.

At the end of month three, the cost report shows the project about half complete, on budget and on track for its margin. The cash picture shows the business $172,500 out of pocket, mainly because the equipment balance was paid at shipment while the customer’s payments lag the work.

The owner renegotiates before signing similar contracts. The customer agrees to a 20% deposit, and the equipment supplier agrees to take its balance on delivery to site, a month later. Under these terms, the peak cash requirement falls to about $55,000 and moves to month four. The project’s margin is unchanged. Only the timing of cash has changed, and with it the business’s ability to take on more work safely.

How this applies to a small Australian business

Small project businesses often run several jobs on one bank account and overdraft. Practical steps:

• Prepare a simple cash forecast for each significant job, month by month, alongside the cost budget.
• Identify the peak cash requirement and its date before signing.
• Add up the peaks across jobs and compare them with available cash and facilities.
• Negotiate payment terms deliberately: deposits, milestones, invoice timing and supplier terms.
• Invoice promptly and follow up overdue amounts.
• Track retentions and claim them when due.
• Understand your rights: in the construction industry, each state’s security of payment laws provide rights to progress payments. Check how they apply to your work.
• Ask your accountant about GST timing, since some businesses can account for GST on a cash basis, and about suitable finance arrangements.

The articles on why the cash flow statement keeps a business honest and what the balance sheet says about cash, stock and customers who owe you cover the financial statements behind this.

Signals worth watching

• The gap between cost completion and cash completion widening across jobs.
• Growing amounts of work done but not yet invoiced.
• Ageing retentions.
• Supplier deposits rising as a share of purchases.
• Overdraft use rising while project margins look healthy.
• More revenue dependent on final acceptance rather than progress payments.

Common mistakes

• Treating the cost budget as the cash forecast.
• Assuming on-budget means cash-positive.
• Agreeing payment terms without checking their cash effect.
• Accelerating work or buying early without checking cash headroom.
• Ignoring retentions and slow invoicing.
• Looking at jobs one at a time rather than adding up their cash needs.

Frequently asked questions

Do we need special software? No. A spreadsheet with monthly cash in and out for each significant job, and a total across jobs, is enough for most small businesses.

Who should own the cash forecast for a project? The project manager should own the timing of costs and claims, and the owner or bookkeeper should combine projects into the business-wide view. Both should review it together each month.

How often should we update cash forecasts? Monthly at least, and whenever a significant change in scope, schedule or payment terms is agreed.

What if the customer will not change payment terms? Consider pricing the cost of funding into the job, arranging suitable finance in advance, negotiating supplier terms or, if the cash need is too large, declining the work.

Should we take on a profitable job we cannot fund? Only with a plan. Options include better payment terms, arranged finance, a partner sharing the purchase of major items or staging the work. Taking it on without a plan risks the whole business for one job’s margin.

Is profit or cash more important? Both. Profit shows whether the work is worth doing. Cash shows whether the business can survive doing it. Watch both.

Questions to ask

• When does our combined peak cash requirement fall, how large is it, and which jobs drive it?
• How long, on average, is the gap between incurring cost and being paid?
• Which recent decisions improved cost or schedule but worsened cash, and who checked?
• How much of our completed work is invoiced but unpaid, and how old is it?
• What would happen to our cash if our three largest jobs all ran ahead of schedule?
• Who is responsible for reconciling project reports with the cash forecast?

Bringing it together

Project cost reports measure whether work is efficient. Cash flow measures whether the business can afford it. Both are accurate, and neither is complete. For significant jobs, keep both ledgers, bridge them with named items, identify the peak cash requirement and its date, add up peaks across jobs and test them against available headroom. Treat payment terms as a major lever and check the cash effect of decisions that look good on cost. Profitable businesses fail when they mistake the cost report for the whole picture.

Source: KEVOS notes. Examples and figures in this article are illustrations. This article is general information, not financial, tax or legal advice.