Tuesday, October 14, 2014

What Do Progress Payments Have To Do With Financial Capability Assessments?

The purpose of the Government's financial capability reviews of contractors and prospective contractors is to determine whether the contractor's finances are adequate to perform the contract. Financial capability reviews are performed by either a price analyst situated in one of the many procurement organizations, by DCMA (Defense Contract Management Agency) price analysts or, to a much lesser degree these days, by DCAA (Defense Contract Audit Agency) auditors. Many of the price analysts performing financial capability reviews these days are poorly trained and do not understand the nuances of cash flow projections. Most of them are not accountants and could not tell you the difference between a debit and a credit or explain the fundamental double-entry accounting equation. Yet they are reviewing and analyzing financial statements and rendering judgments on whether contractors have sufficient resources to perform whatever contract they are bidding on.

Lets face it. Many small contractors have very limited financial resources. They are out scrounging for capital. They worry about meeting payroll. Their financial statements, if they even have financial statements, will not paint a rosy financial picture. Start-ups will not have any financial history upon which a financial capability determination can be based. An analyst or an auditor will have a difficult time trying to ascertain whether such companies have sufficient financial resources to perform the work.

The key to understanding the sufficiency of financial resources is the cash flow forecast. A cash-flow forecast, simply put, is a schedule of incomes and expenses, detailed by source of revenue or category of expense. And here is where progress payments and cost reimbursements come it. Both progress payments (fixed price contracts) and cost reimbursements under cost-type contracts represent a form of contract financing and should enter into cash flow projections. So, for example, a contractor works for a month after which it can submit a progress payment request for the costs incurred. That progress payment is normally paid within 30 days (sometimes sooner). So a contractor needs only two to three months of working capital to perform the contract. We know of several instances where Government analysts failed to consider available contract financing in their financial capability determinations. Of course it didn't help that the contractor failed to bring it up. In one case, it was equally unhelpful that the contractor did not even know what a cash-flow forecast was or what it was for.

Contractors (and prospective contractors) expecting a financial capability review should prepare a cash-flow forecast prior to the audit. There are plenty of examples on the web. It is not necessary however to spend a lot of money for a slick model. Just show on a spreadsheet, by month, here's where I'm going to get cash and here's where I'm going to need cash. If at the end of each month expenses exceed income and there is not sufficient cash in the bank to cover the deficit, contractors will need to be prepared to disclose to the auditor its plans for covering the shortfall.

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