As the ResNet's pipeline has suddenly grown much larger, I spend some hours reflecting on the threats and opportunities of doing ER 2020 projects from a financial point of view. The structure of payments from the Commission is very special:
- You receive a large advance at the beginning of the project: 60% of the budget.
- You start spending at month 1.
- At the end of each year, you then claim a refund for the money that you have spent during that year, up to a maximum of 85% of total payments from the Commission for this project.
- About 5 months after the end of the project, you receive the final 15%.
- Recall that the budget is divided into two: 80% are direct costs – money that we need to spend to sustain the project. The remaining 20% are indirect costs – money that is given to us against increased fixed costs, but we do not need to show the Commission how we spend it. The Commission uses a different point of view to explain this: indirect costs are 25% of direct costs. In other words, if you have 80 EUR of direct costs, your indirect costs are 80 x 0.25 = 20 EUR, and your budget is 80 + 20 = 100 EUR. This is the same thing as saying that indirect costs are 20% of the budget, because they are, well, 20 EUR over a total of 100 EUR.
- The large advance is a financial advantage.
- On the other hand, three quarters of the 20% marginality that Edgeryders charges to projects are paid very late: in a three years project they come at month 41. This is a potential source of financial stress if running the projects entails extra fixed (non-reclaimable) costs, for example a larger office.
This chart simulates the cash balance over time of the ResNet under the following assumptions:
- 1.3 M (representing POPREBEL + NGI Forward), both starting at the same time, both lasting three years.
- the rate of spending is constant (not realistic: spending is higher towards the end of the project. But this only means that the simulation is more taxing than the reality, so it's ok). This means that, at the end of Year 1, we have spent 33% of the budget. However, we can only claim 25%: 100% - 60% advance, already received - 15% reserved for the final payment. So, we receive 25% of the budget at month 17, and then nothing else until the project is over.
- The projects entail additional, non-claimable fixed costs ("indirect costs", in the language of the Commission). I simulated then at 0%, 8%, 16% and the whole 25% of direct costs.
Look what happens:
The cash flow balance is initially highly positive, but it goes negative towards or at the end of the project (except when extra fixed costs are very low), and stays negative until the last payment is in. In the worst case scenario the negative balance hits a maximum of 195K EUR! The height of the curve at its rightmost point is the "profit", which we can reinvest after the project is over.
Now imagine that we get a second batch of projects for an equivalent sum and of the same length, but now they start 12 months after the first batch (January 2020). Here is the new situation, from early 2019 to spring 2023:
Much better! Now in the "low- and medium fixed costs" scenarios the cash balance stays positive. What's happening here is that the final payment for the first batch of projects (month 41) is used to finance the second batch of projects. Of course, in the worst case scenario (green curve) there is nothing to finance: the final payment for batch 1 just re-establishes a zero cash balance for the projects of batch 1, leaving batch 2 unfinanced (until month 53).
This is just a back-of-the-envelope exercise. Still, it has lessons:
- Cash flow planning via magic budget is important, and we will do it carefully.
- It is better to array projects over time rather than start several at the same time.
- Let's be conservative with the fixed cost, it will work wonder for the cash balance towards the end of the project.
- Let's balance the growth of the research pipeline with shorter consulting projects, where we get the marginality in shorter cycles. We can then use this marginality to finance in part the extra fixed costs entailed by research.
- Let's keep winning projects, so that the new advances finance the end part of the old projects.