In this blog post, we present the first half of our white paper, The hidden impact of operational inefficiencies on cash flow and capital costs, which outlines the core challenges and sets the context for managing working capital i project-based businesses. Download the full white paper to explore proposed solutions and example anlaysis that bring these challenges into focus. We hope you enjoy the read and find it informative and thought-provoking.
In today’s volatile business environment—characterized by fluctuating interest rates, rising input costs, tariffs, and ongoing supply chain disruptions—effectively managing capital tied up in operations has become a strategic priority. This is especially true for companies that work with complex deliveries of goods or services over extended periods, typically managed within a project delivery structure. These organizations—such as engineering firms, defense contractors, energy developers, and infrastructure builders—face heightened exposure to external risks and internal complexity.
For these project-driven businesses, the ability to manage capital-intensive projects efficiently is no longer optional; it’s central to strategic execution. Unlike standardized “off-the-shelf” sales, projects introduce greater uncertainty and risk due to their bespoke nature. However, companies that proactively manage capital efficiency within their projects can not only improve operational execution but also significantly reduce their overall capital costs.
While much attention has been on the Profit & Loss (P&L) metrics, and isolated working capital components in the balance sheet, project-related financial metrics must be viewed in conjunction since they are interconnected in timing. Despite this, these perspectives are often both less explored and utilized in project performance assessments.
Ultimately, the core of capital efficiency in projects lies in managing cash in and cash out, both at the individual project level and across the entire project portfolio. This is fundamentally a question of timing: scheduling of milestones, invoices, purchases, production, resource allocation, customer availability, etc. Yet, the timing within project structure is inherently less predictable and impacted by several internal and external factors, making it further challenging to manage. Mismanaging these challenges can quickly disrupt performance and consequently erode profitability with increasing costs.
Effective working capital management has long been a cornerstone in achieving capital efficiency, primarily with a focus on the classic components: Inventory, Accounts receivable (AR), and Accounts payable (AP). For a comprehensive overview on the market development of these aspects, we refer to our previous publication: Capital efficiency outlook.
These accounts are the foundation of operating working capital for “off-the-shelf” companies, where goods are sourced or produced, held as inventory, sold to customers, and payments are collected via invoice. In contrast, for project-based organizations, the primary focus of this white paper, operate under distinctly different conditions. Here, the landscape of working capital are broader and more complex, requiring a more sophisticated approach to managing both operational and financial challenges.
There are a few key differences in the financial process that we must establish to understand how to manage projects and the relationship between financial and operational performance. In project-based settings, additional financial accounts become relevant. While the accounts involved can vary, their defining feature is their association with long-term and milestone-driven projects. Typically, these accounts are aggregated under Contract assets and Contract liabilities in the balance sheet. They represent the financial state of ongoing projects, reflecting the total accumulated assets or liabilities tied to project progress.
Figure 1. Differentiating Classic Working Capital Management and Project-Based Organizations
Unlike for “off-the-shelf” companies, the relationships between financial accounts in project settings are often more dynamic and interdependent. For instance, Accounts receivable might be tied to milestone-based invoicing rather than at product delivery, while Accounts payable can be dependent on deliveries tied to a specific project phase. Inventory plays a slightly lesser role in the project setting but is often replaced by other accounts to represent partially completed work. These “in between” accounts reflect progress made, rather than the more definitive accounts. The logical reasoning is that the projects are executed over time, where work is continuously in progress.
Some of the more common project-related accounts are:
The distinct operating conditions of project-based organizations also affect the P&L, particularly in how revenue and costs are recognized. Briefly summarized, revenue is recorded based on the value of work performed, rather than the value of what has been delivered. As a result, work may be recognized as revenue event before the customer has been invoiced. This has implications for operational and financial performance and requires additional focus when designing and interpreting performance metrics.
While the balance sheet and P&L outline the performance at a point in time or accumulated over time, cash flow is what is particularly relevant for project-based companies. It captures the actual movement of funds throughout a project's lifecycle and directly influences financing requirements. At project completion, the net cash flow: cash in minus cash out, represents the realized results. As such, cash flow is directly related to the financing needs and, by extension, the financing costs.
Given these dynamics, cash flow should be the primary lens through which project performance is assessed. This perspective will guide the analysis throughout the remainder of this paper. While we acknowledge that both operational and financial conditions may vary, where the value of ongoing work may be considered as both assets and liabilities, the ultimate measure remains unchanged: cash is king.
Running a company requires capital to purchase goods, services and acquire necessary resources, whether it’s personnel, intellectual properties, or manufacturing lines, to name a few examples. Managing capital is essentially the same as managing your cash flow and ensuring a proper balance between cash in and cash out.
Effective cash flow planning is therefore essential to ensure financial health and operational efficiency, especially in project-based organizations. In this context, the relationship between working capital, operational performance, and cash flow requires a disciplined and well-designed approach to secure a profitable business. This section explores the importance of cash flow planning in project environments, its direct impact on operational performance, and how overlooking it can lead to higher-than-anticipated costs.
The impact of capital costs on project
Working capital management is a significant part of a company’s cash flow performance. Balancing customer payments, inventory, and supplier terms with available capital to secure a sustainable cash flow. In a project context, these aspects become even more complex due to the various timing and long-term characteristics impacting project performance. Utilizing setups such as milestone- or pre-payments in the planning phase provides tools and methodology to structure and balance the project cash flow performance.
Before delving further into project execution, we need to highlight the often-overlooked aspect of capital costs. These are financial costs tied to the capital acquired to finance operations, such as loan interests, shareholders’ expected return or dividends. Capital costs are directly related to the duration of required financing, as rates are based on the period of outstanding liabilities. This becomes particularly relevant in project performance, where time is one of the most critical factor.
Figure 2. Key components of WACC and their impact on capital costs
The impact of capital costs is often overlooked in the initial scoping and forecasting of the project but should be a fundamental part of the financial planning.
Effective cash flow planning is the foundation of financial health in project-based organizations. Therefore, it's crucial to have robust processes that account for all factors. These processes should not only ensure accurate calculations but also be flexible enough to handle changes and deviations during project execution.
We will later summarize concrete actions to mitigate the risks and impact of capital costs in projects, but for now, we will focus on cash flow planning and cost forecasting. The process of cash flow planning and forecasting is common practice with established processes. However, the process can vary largely from organization to organization. From our experience, what appears similar on the surface is vastly different upon closer inspection.
Understanding the risks of overlooking capital costs in cash flow planning and follow-up
While it’s clear that solid and adaptable processes are essential, we must also address why they matter. Project-based organizations with multi-period planning—spanning quarters or years—are significantly impacted by capital costs, which erode profits if cash flow planning and follow-ups are inadequate.
Figures 3 and 4 provide a simple yet clear example of the hidden impact of neglecting capital costs in long-term project cash flow planning. The graphs depict four key milestone payments, cash out from ongoing costs and supplier payments, and the net cash flow performance over time. Net cash flow determines the project’s end profitability when considering all costs and revenue.
Two key aspects of financial planning are often overlooked:
In figure 3, the graph shows the difference in costs and net cash flow impact when capital costs are either included or excluded based on additional financing needs. In this example, the project experiences negative cash flow for most of its timeline, therefore requiring additional capital to finance the project’s operations.
Including capital costs in cash flow planning reveals the first commonly missed aspect, that actual project costs are higher when the cost of capital is factored in. For this two-year project example, calculated with a 12% WACC, net profit drops from 15% to 10%, reducing profitability by 33%.
Figure 3. Difference between including or excluding capital costs in cash flow calculations in projects
In project environments, change is almost inevitable – whether due to supplier delays, evolving customer requirements, internal resources shortages, or other disruptions. Regardless of the case, the financial planning process must continuously track how these changes influence financing needs and, consequently, capital costs.
Figure 4, illustrate how the previous example (Figure 3) is impacted by changes during project execution. In this new example, milestone deliveries are delayed and consequently also the payments from the customer. This situation increases the project’s capital costs further.
A dynamic cash flow tracking process allows us to keep track of these new changes and make further informed business decisions. A static cash flow tracking would miss the fact that estimated profitability has now further decreased from the previous 10% to 8% (down from 15% excl. WACC) and a total decrease of almost 50% in project profitability.
With these two examples (static and dynamic perspective), we highlight how neglecting the capital costs of project cash flow planning can conceal financial costs directly related to operational performance, ultimately harming the project’s profitability. We will explore how to mitigate these issues later, but first, let’s turn to another core aspect of capital costs in project-based contexts: delays caused by administrative processes.
Figure 4. Comparison between original cash flow planning and dynamic adaption to new circumstances
In project-based organizations and long-term projects with lots of functions and resources involved, the administrative steps and processes are many and could feel never-ending. Regardless of the number of steps and processes, they will have a profound impact on cash flow and capital costs. Delays or prolonged steps will accumulate across the project timeline with limited options to make up for them in later stages. Whether small or large, these delays ultimately come at a cost.
When one considers delays in projects, it is usually related to something like prolonged manufacturing, unavailable material, faults, or issues. Managing these delays is essentially about optimizing operations and production. We will not dive into this topic for now but rather focus on the more often overlooked aspect of administration. Administrative and process-related issues can be many in various shapes or forms, but some of the more common ones can be classified into:
Figure 5. Example of operative and administrative inefficiencies in project process
As illustrated below in figure 6, several administrative issues can accumulate to days of additional negative cash flow and prolong the need for additional financing and consequently increase capital costs beyond initially calculated.
In the example below, the project is delayed by an additional 30 days due to administrative and process inefficiencies. For a project averaging 100 MSEK in tied up net working capital, the additional capital costs for the project is approx. 1 MSEK using a 12% WACC as interest rate.
What can then be done to minimize the issues and consequently reduce the project’s dependency on external financing and related capital costs? One key aspect is to optimize the operational efficiency by, for example, extending production capacity, reducing sourcing lead times, or improving resource flexibility. The operational efficiencies are an entire chapter on its own and usually require large investments or changes in operational processes (procurement policies, contract renegotiations, etc.). The impact can be significant, but it also often requires investments in resources and time.
Figure 6. Example of additional capital costs from administrative delays
The financial impact of delays is often related to fines or additional rates to the customer, but we also must consider the additional financial costs of additional financing over time.
Managing the administrative issues is usually simpler than the operational ones. The issues are often related to internal systems and processes, giving you both ownership and ability to make impact changes without external interference. Still, there are challenges with aligning internal functions, managing suboptimization, and navigating internal politics. However, solving the issues usually requires less investment and time yet can have a significant impact on projects’ financial performance.
Download the white paper The hidden impact of operational inefficiencies on cash flow and capital costs, explore proposed solutions and example anlaysis that bring these challenges into focus.