The financial need to cost a service contract

It is not a simple exercise to model a contract for your service-based company. There are a myriad of operating expenses, capital expenditure and labour costs that need to be fully costed to guarantee a profitable price is tendered during contract negotiations.

Each financial element of the contract must be thoroughly modelled and costed.

Why use a financial model to model a service contract?

It is not possible to undertake a back of the envelope calculation for a service contract, because service contracts often last for at least three years. It is vital to account for rising operating and labour costs, as well as the depreciation and repairs and maintenance costs associated with your capex to service the contract. Further, your Company needs to be aware of all financial and contract assumptions pertaining to this contract.

Activity-based costing is the very essence of building a financial model for a service-based contract. Your Company must understand the importance of accounting not just for the direct costs underpinning the contract’s delivery, but also indirect costs such as overhead, existing labour or capital equipment that can be apportioned to the contract. It is wise to build this detail into your model, which is demonstrated in the following screen shots.

A thorough financial model will solve this financial need

A service contract pricing model will assist your service-based company to better price contracts, based on budgeted and forecasted expenses, in order to deliver forecasted return on sales, profit margin and cash flows.

The full life-cycle of the contract can be modelled via activity-based costing. The model can forecast an increase in service activities and potential headcount increases, associated wage cost increases (i.e. employment insurance, other social security costs), inflation increases, and other operating expenses. This will enable contract stakeholders to better understand forecasted margins and returns based on a specific contract price and service volume.