We’ve released an eBook titled “The Financial Leader’s Monthly Action Plan.” Each month, we are posting excerpts here on our blog. For the month of September, the theme is “Navigate the maze of indirect rates."
For government contractors, a healthy cash flow is the lifeblood of their business. While "Days Sales Outstanding" (DSO) tracks the efficiency of collecting receivables, understanding how well indirect rates recover the cost of performance is equally important. This holds true not only for cost-reimbursable contracts but also for fixed-price and time & materials contracts. Accurate and realistic indirect rates paint a true picture of a company's health and profitability.
However, navigating indirect rates can be like traversing a complex maze. Over the year, these rates fluctuate, making it challenging to analyze them accurately in the early months. By mid-year, the general trend becomes clearer, and significant deviations from targets should be investigated.
The turning point arrives in the third quarter. This is when the window for meaningful course corrections narrows. To effectively adjust, the cost bases need to be stable, and the cost pools must have sufficient data to reveal reliable trends. Jumping to conclusions based on outliers early on can lead to misguided decisions. Conversely, waiting too long can make it difficult, if not impossible, to reverse course.
So, how do you master this maze? Here's a roadmap:
Embrace the predictive power of six months
Six or seven months of actual data provide enough ground to predict year-end rates with reasonable accuracy. By the end of Q3, if significant variances exist without corrective actions, it might be too late to impact the outcome.
Keep it simple
Your rates should be focused on cost recovery and contract acquisition, rather than striving for flawless cost allocation. Regulations acknowledge that cost allocation is an approximation, and often, the difference in accuracy between complex and simple rate structures is negligible.
Overly complex structures require more resources to maintain, introduce error risks, and can hinder clients' understanding of your value proposition.
Streamline for efficiency
A simple rate structure simplifies both input (e.g., accounts payable) and output (e.g., billing) processes. This reduces administrative burdens and improves transparency for your clients.
Be proactive
Don't wait for issues to emerge. Regularly monitor your rates, identify trends, and proactively address deviations from targets. This proactive approach ensures you stay on track for a healthy cash flow and profitability.
Bottom line
By following these guidelines and understanding the nuances of indirect rates, government contractors can ensure their financial well-being and secure future successes. Keep in mind, the process is more than just cost recovery; it's about leveraging data-driven insights to make well-informed decisions and drive long-term profitability.
Suggested Resources
Continue developing your knowledge of indirect rates by checking out these resources:
Want to learn more? Download the entire eBook here.
