Federal contracts usually pay after delivery or after a period of performance. For contractors with long production runs, large upfront costs or thin cash reserves, the gap between spending money and receiving it can be the hardest part of the work. The FAR recognizes this and provides several forms of contract financing. Knowing what exists, and what the government expects in return, helps a firm decide what to request and how to plan.
The government’s starting position
FAR Part 32 states a clear preference: the government expects contractors to finance their own performance from private sources whenever possible, and it provides financing only when it is in the government’s interest, typically because the work requires significant costs before delivery and the financing is needed to obtain performance at a reasonable price. Financing is most common on fixed-price contracts for products that take months to produce. Services contracts billed monthly rarely need it, because payment follows performance closely. Cost-reimbursement contracts are handled differently, through interim payments of allowable costs as they are incurred.
Progress payments based on costs
The traditional form of financing is the progress payment. Under the progress payments clause, the contractor may request payment of a stated percentage of the costs it has incurred on the contract, with a higher customary rate for small businesses than for large ones. The payments are liquidated, meaning recovered by the government, as deliveries are made and paid for. The clause gives the government title to the work in progress and the materials bought for it as security, requires the contractor to maintain an adequate accounting system and allows the contracting officer to reduce or suspend payments if the contractor’s performance or financial condition raises concerns. Progress payments are requested on a standard form and are subject to review.
Performance-based payments
The FAR describes performance-based payments as the preferred financing method for fixed-price contracts that are not commercial and do not use cost-based progress payments. Instead of tying payments to costs, the parties agree in advance on events or milestones, such as completion of a design review or delivery of a prototype, and on the amount payable when each is achieved and verified. The approach rewards progress rather than spending, requires less accounting detail from the contractor and gives both sides a clear schedule. It does require careful negotiation of the events and their values before award.
Commercial item contracts, meanwhile, may include commercial advance payments or interim payments when such financing is customary in the commercial market for the item, for example in large equipment purchases. The terms are negotiated and must be in the government’s interest, with appropriate security.
Other tools
- Advance payments before any work is done are the least preferred method and are used rarely, with strict conditions and security
- Loan guarantees for defense production exist under specific authority but are uncommon
- Prompt payment rules, which require the government to pay proper invoices within a set period or pay interest, are not financing but reduce the gap
- Assignment of claims lets a contractor assign payments under a contract to a bank as collateral for a loan, under the procedures the FAR describes
Planning your cash flow
Request financing only when the solicitation provides for it or when you can show it is in the government’s interest, and recognize that it comes with accounting, reporting and oversight obligations. Many contractors instead arrange commercial lines of credit, factoring arrangements or SBA-guaranteed loans designed for contract performance. Which combination fits your firm is a question for a financial advisor and your lender. What the FAR provides is a set of options; what keeps a contract healthy is a cash flow plan built before the award, not after the first payroll comes due.