During the process of setting a service agreement with your clients, it’s extremely important to touch upon all the relevant stages of the project and ensure that the contract is cash-flow positive. The agreement will set the foundation for your approach to the project’s cash flow and will help you mitigate risks along the way.
Overall, you always want to make sure the contract is built in a way that secures a prompt payment from your client and little to no hurdles to get there. Here are five major details that will impact your cash flow when making your service agreement.
#1 Proper Payment Terms
Including payment terms in a service agreement is non-negotiable; they’re the key to preventing disagreements and misunderstandings later on between both parties. The most important part of your payment terms should cover a deadline for when the payment is due. For this aspect, it’s best practice for small businesses to define the payment delivery terms by net days instead of a due date.
By saying you want to be paid with net 15 (that is to say, within 15 business days) the customer creates a more pressured reminder for themselves than if you give a specific date like May 30th. The latter is much more likely to slip their minds in the long run, while the former is a countdown for the days they have left.
It’s important to keep net payment days as short as possible without being too short. The reason for this is that, in the case a client is going to pay late anyway, you’re stretching out the amount of time it will take for you to receive the payment, which in turn will impact your cash flow majorly.
#2 Type of Billing
It’s no doubt that your billing type on each individual project will have a large impact on your cash position over time. There are two billing characteristics you should be paying attention to especially: billing frequency and what you’re billing by.
For example, when you bill by milestone completed, you’re setting up a system where the project gets done by sections, and it can’t continue to another section until the previous one is paid for. It’s needless to say that this is very good news for your cash flow. But it’s not the only option.
Let’s consider a scenario where the project has four major milestones. You might divide the billed invoices by 25% paid each time a milestone is completed. However, many businesses might decide to implement a billing system where a portion is paid up front, such as 15%. By requiring a deposit at the beginning of the project, you set the path for your cash flow throughout the completion of the project.
#3 Additional Work
It’s an indispensable part of your service agreement to outline the exact amount of work that is being paid for as a part of the contract, as well as the terms put in place in the case where a client wants even more work done. When a contract lacks terms put in place for additional work, you’re risking your cash position in the process.
Combat this possibility by clearly outlining every deliverable task that is being paid for, and then defining terms for any additional work that might be requested. This includes a statement on how additional work will be charged, how much and for how long. If you don’t put a limit to the hours and expenses of extra work you can sign onto at a certain price, you might end up with a higher cash outflow than inflow at the end of the project.
#4 Cancellation Fees
There will always be the possibility of a client wanting to terminate the contract before it is finished. If this possibility isn’t addressed in the service contract, there’s a high chance you’ll run into trouble when it’s brought up. Setting a cancellation fee can seem intimidating and hard to narrow down, but it’s essential as a means of protecting your cash flow.
Try and set terms that define a cancellation fee that protects your side of the offer, so that you end up losing as little as possible, should the situation arise. You can base the fee off a percentage of the payments that are left. You’ll most likely still lose some profit, but it’s the best possible choice to set clear terms initially than to risk losing even more than originally thought.
#5 Late Payment Charges & Consequences
When it comes to client contracts, it’s important to give payments a sense of urgency. This will often involve setting an interest charge for payments that aren’t made by the respective due date. Having this consequence written and explained in the service agreement will incentivize your client to be responsible with their payments from the get-go.
With late payments, especially if you allow the project to go on while expecting to be compensated later, your cash flow is taking a deep negative impact. In your terms, clarify the interest rate you expect to be paid in the case of a past due receivable. To counter this and make the client feel safe, set consequences for your side of the deal as well, such as a guarantee of discounts or refunds in a case of the service not being delivered on time. Of course, just make sure you don’t allow that to actually happen on your end.go back