Do Large Contracts Create Value for a Small Business?Most small business owners dream of the day they sign a contract with another business that doubles or triples their revenue or even more. Large contracts are sometimes seen as the "pay dirt" that will turn their business investment into gold. These contracts are often the result of a long process, hard work and many hours of checking and rechecking to make sure the dream is real.
So when do large contracts actually create lasting value for the business, and what should the "dream deal" look like?
Any contract or business development project will create value only if it creates ongoing new net cash flow that is in excess of the cost of capital required to implement the project.
New Net Cash Flow refers to:
If the New Net Cash Flow of the project is significantly positive then it is adding value to the business. Otherwise its benefit to the business and project viability must be seriously questioned.
- The future net profits of the project or contract.
- Plus the non-cash costs (such as depreciation).
- Less the capital required for the project (including increases in working capital such as inventory and financing).
- Less the cost of acquisition of the project (including staff resources in finding and securing the contract).
- Less cost of contract finalisation at completion of contract.
Some of the key pitfalls to look out for when evaluating a large contract include:
What will the "dream deal" look like for your business?
- Are new people required to service the contract and have they been included in the cost?
- Will the contract "swamp" the company or affect its ability to meet demands by other customers?
- Can the contract be financed within existing facilities or does the contract require bank support?
- Has the real return on investment been calculated over the entire life of the project?
- Is the real return on investment greater than the average cost of capital for the business?
Its easy for dreams to become nightmares. Large contracts can limit the ability for a business to perform or expand in other areas. If not planned, budgeted and managed correctly, expected profits can soon turn into a see of red ink from unexpected costs to the business. The first step in preventing this from happening is to know the real benefits of the project right from the start.
The key benefits of a large contract that are likely to make it a "dream deal" include:
A "dream deal" will not only have these as very clear benefits, the contract should also increase the value of the business. For this to occur the contract must also:
- Add significant net cash to the business over the life of the project.
- Create certainty for the business and reduce its future risk.
- Strengthen the business in either existing or new markets.
Even if the project finishes and the revenue and profits disappear from that particular customer, the contract may still be a "dream deal" if new cash flows in other markets or areas of the business have been created.
- Generate an increase in ongoing sustainable future profits.
So a "dream deal" will not only result in an improved cash position over the longer term, but also lead to sustained and increased future profits.
What are the key questions to answer when evaluating large contracts?
The decision to proceed with a project must look at the following key questions
- Will the project result in ongoing profits for the business over an extended period of time?
- Will the contract increase the certainty of the business over a 3-5 year period?
- Can the business finance the contract?
- Will the contract place unnecessary risk on the rest of the business?
- What is the New Net Cash Flow of the contract?
Are your large contracts adding value to your business?
Do you have large contracts that are causing you grief? Are you unsure if your major deals are adding value to your business? Do you have any large contracts you are working on and want to make sure you they will increase the price of your business?
Maxell Consulting has helped many small businesses answer these questions quickly and effectively, giving you the confidence to strike the deals you need to grow the value of your business.
Contact us now to see how we can help you answer your questions.