ES-III: Gaps between ORDER, DELIVERY & CASH-INFLOW

Order, Delivery and Cash-Inflow for a product or service are three related but different events impacting the finances of a company. They have a time lag with respect to each other; also, while in most cases they follow each other, at times, there may be risks associated with these. The impact of time lags as well as risks associated with the company’s finances must be understood by an entrepreneur. 

When a company gets an ORDER for its product/service, it is time to celebrate. But the order-in-hand is only the beginning of a journey. This does not get reflected in any of the financial statements of the company. The order-in-hand and order-in-pipeline (likely to materialise) are nevertheless extremely important and presented to the board as such. 

The minute the company gets an order, it has to plan DELIVERY against the order. Expenditure for fulfilment of delivery against the order would start immediately (sometimes even before the order is received). The financial statements (cash-flow statement) would just reflect this spending and not any income. It is at the time of delivery (also called SALES) that the income is to be reflected  as revenue in the Profit and Loss (P&L) statement of the company. Profit on sales calculated will appear in P&L and also reflected as current profit in Balance Sheet of the company. 

However, even when revenue is reflected in the P&L statement, it does not imply that the company has received payments against delivery or sales. CASH-INFLOW against delivery may occur at the time of delivery, but often (especially for B2B sales) may happen later. It is only when cash-inflow takes place, it is reflected in the cash-flow statement. Till then, the Balance sheet will carry the expected cash-inflow as Trade Receivables [1]. 

Even then the process is not complete. SALE may have some warranty commitment and provision against warranty may have to be made. This may be reflected in Balance sheet as a liability. Only on expiry of the warranty, the sale process is fully complete.  

Note therefore that the ORDER, DELIVERY and CASH-INFLOW are three events, which follow each other and carry certain risks;  a company may fail to deliver even after getting orders or the customer may fail to pay (cash-inflow not realised) even after delivery. The three events gets reflected in company’s cash-flow statement, P&L statement and Balance Sheet in different ways and at different times. The real celebration would be when the cash-inflow against a delivery for a specific order materialises, with the assumption that none of the warranty clauses will result into future spend for the company. Since expenses start on receiving orders and cash realised later, there will be finance cost associated with the working capital required to fulfil each order. If attention is not paid, finance cost may consume most of the profit. 

Realising all this is crucial for an entrepreneur, we will try to understand P&L statement, cash-flow statement and Balance Sheet of a company in the next blog (ES-IV). 

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[1] The company needs to have a board-approved revenue recognition policy. For goods, the recognition is at the time of delivery. For services, the delivery may be broken into milestones and revenue can be recognised on meeting the milestone.