Contract Financing - Advance Payments

One of the little know financing arrangements in Government contracts is the Advance Payment provisions found in FAR 32.4. A couple of years ago, we posted a two-part series on some of the requirements necessary to justify advance payments. We'll summarize some of that content here but the focus of this posting is what might happen after a contractor receives advance funding. If you're fortunate enough to qualify and choose to jump through a few hoops, its a great way perform on a Government contracting without having to commit capital to the project, which is great if the company has no capital to begin with.

First, lets take a look at where FAR thinks that advance payments "may" be appropriate. This list is not intended to be all-inclusive but to give the contracting officer some ideas of circumstances that would justify advance payments.

• Contracts for experimental, research, or development work with nonprofit educational or research institutions.
• Contracts solely for the management and operation of Government plants.
• Contracts for acquisition, at cost, of property for Government ownership.
• Contracts of such a highly classified nature that the agency considers it undesirable for national security to permit assignment of claims under the contract.
• Contracts entered into with financially weak contractors whose technical ability is considered essential to the agency. In these cases, the agency shall closely monitor the contractor's performance and financial controls to reduce the Government's financial risk.
• Contracts for which a loan by a private financial institution is not practicable (e.g. rates too high).
• Contracts with small business concerns, under which circumstances that make advance payments appropriate often occur.
• Contracts under which exceptional circumstances make advance payments the most advantageous contract financing method for both the Government and the contractor.

Contracting officers are advised to authorize advance payments sparingly and advance payments are the least preferred method of contracting financing. Generally, advance payments should not be authorized if other types of financing are reasonably available to the contractor in adequate amounts. Loans and credit at excessive interest rates or other exorbitant charges are not considered reasonably available financing.

There are some statutory requirements. The contractor must give adequate security, the advance payments cannot exceed the unpaid contract price and the agency head must make a determination in writing that advance payments are in the public interest or facilitates the national defense.

There are some other (non-statutory) standards as well. The advance payments will not exceed the contractors interim cash needs based on analysis of the cash flow required for contract performance, advance payments are necessary to supplement other funds or credit available to a contractor, the recipient is otherwise qualified as a responsible contractor, and the Government will benefit from performance prospects or there are other practical advantages.

Advance payments are often deposited into a special bank account and withdrawals are closely supervised by the Government. Contractors are usually required by contract terms to furnish a periodic accounting of all funds disbursed from the special bank account.

One of the Government's greatest concerns when authorizing advance payments to contractors is that contractors will use the funds for other purposes - perhaps they have another contract that needs funding or perhaps the President takes the money and retires to the Bahamas. That's why the Government will request periodic audits of the funds. Audit procedures might include

1. Direct confirmation of the special bank account fund balance
2. Reconciliation of the confirmed bank balance with contractor's records and most recent statement of accountability of funds furnished the Government.
3. Proof of the disbursement and deposit transactions reflected on bank statements with disbursement and deposit transactions shown in the contractor's records.
4. Evaluation of the use of the funds withdrawn from the advance fund bank account to insure propriety thereof. Funds improperly used, including payments of unallowable costs, should be redeposited by the contractor.
5. Determining whether Government payments are properly deposited within a reasonable time.
6. Determining whether advances made to subcontractors are in accordance with basic agreements and are properly authorized and approved.
7. Determining whether the amount of the fund is excessive considering the needs of the contractor to finance performance of the contracts.

The prospect of an audit should not be dissuasive in requesting advance payments. Other forms of contract financing such as progress payments and public vouchers are also subject to audit.

Advance Payments under Government Contracts - Part II

In yesterday's Part I of this two part series on Advance Payments, we discussed the availability of this particular financing option and how the Government considers it a last resort. Today we want to focus on where and when such financing may be useful and appropriate as well as provide you a flavor of what you will be expected to "deliver" as part of your request, should you decide to go in that direction.

The Government has provided us examples of cases where advance payments may be considered useful and appropriate. If you are considering a request for advance payment, one of these examples should fit. These include

• Contracts for experimental, research, or development work with nonprofit educational or research institutions.
• Contracts solely for the management and operation of Government-owned plants.
• Contracts for acquisition, at cost, of property for Government ownership.
• Contracts of such a highly classified nature that the agency considers it undesirable for national security to permit assignment of claims under the contract.
• Contracts entered into with financially weak contractors whose technical ability is considered essential to the agency. In these cases, the agency shall closely monitor the contractor's performance and financial controls to reduce the Government's financial risk.
• Contracts for which a loan by a private financial institution is not practicable if
• loans with reasonable interest rates or finance charges are not available
• contracts involve operations so remote from a financial institution that the institution could not be expected to suitably administer a guaranteed loan
• Contracts with small business concerns, under which circumstances that make advance payments appropriate often occur.
• And finally, the catch-all - Contracts under which exceptional circumstances make advance payments the most advantageous contract financing method for both the Government and the contractor.

Contractors can apply for advance payments either before or after contract performance. Requests must be in writing and contain the following information. This is usually the key to sucessfully obtaining advance payments.

• A reference to the contract or solicitation
• A cash flow forecast showing estimated disbursements and receipts for the period of contract performance. Some contracting officers have required monthly forecasts, others quarterly. Whether monthly or quarterly, you can be certain that it will be analyzed and subjected to some form of audit.
• The proposed total amount of advance payments.
• The name/address of the financial institution at which the contractor expects to establish a special account as depository for the advance payment
• A description of the contractor's efforts to obtain unguaranteed private financing
• Other information appropriate to an understanding of the contractors financial condition and need, the contractor's ability to perform the contract without loss to the Government and financial safeguards needed to protect the Government's interest. 

Financial safeguard to protect the Government can take many forms. In one case the Government required that the advance payment be put in an escrow account and funds could only be disbursed for specific expenses (such as payroll). In another case, the Government added a provision that all expenditures from the fund be co-signed (or approved) by the contracting officer.

There are a lot of hoops to jump through when requesting advance payments and sometimes there are strings attached. Nonetheless, obtaining advance payments may make the difference between successful performance and failure or default.

Advance Payments under Government Cotnracts

There are many methods of payments under Government contracts; progress payments based on cost, progress payments based on milestones, public vouchers, invoices, DD250s, to name a few. Advance payments is another method that is not well known, is rarely used, but is provided for by regulations (The Government estimates that it entertains about 500 requests per year).

The Government does not really like to enter into advance payment agreements. The current regulations state that advance payments shall be used "sparingly" and "advance payment is the least preferred method of contract financing (see FAR 32.402(b)). Nonetheless, in certain circumstances, from a contractor's perspective, it may be the only viable method of financing a contract. One big disadvantage for a contractor is that it will have to pay interest on the advance and that interest will not be an allowable cost (it will come out of profits).

There are statutory requirements and regulatory standards that must be met before advance payments will be authorized. The statutory requirements include:

• The contractor gives adequate security
• The advance payments will not exceed the unpaid contract price and
• The contracting officer certifies that advance payment is 
• in the public interest or
• facilitates the national defense.

 The regulatory standards include:

• The advance payments shall not exceed the contractor's interim cash needs based on
• analysis of the cash flow required for contract performance
• consideration of the reimbursement or other payment cycle, and
• to the extent possible, employment of the contractor's own working capital
• The advance payments are necessary to supplement other funds or credit available to a contractor
• The recipient is otherwise qualified as a responsible contractor
• The Government will benefit from performance prospects or there are other practical advantages.

Tomorrow we will take a look cases where, according to the Government, advance payments are "useful and appropriate". Also, we will discuss the data required from contractors. Concerning the latter, it is significant and will require a lot of effort and perhaps, expert help.