Proposed Changes to Progress Payment Rate - Public Meetings Rescheduled

Last August, the Defense Department proposed significant changes in the way that progress payment rates are established. Currently, FAR 52.232-16 sets customary progress payment rates of 80 and 85 percent for large and small businesses while the Defense Department bumps the small business progress payment rate to 90 percent. The change proposed back in August leaves the small business progress payment rate alone but drops the rate for non-small businesses from 80 percent to 50 percent with provisions to increase the base amount to 90 percent by meeting certain incentives (see Proposed Changes to Progress Payment Rate).

The idea behind these changes were to increase the effectiveness and efficiency of certain areas including (i) on-time deliveries, (ii) contractor quality, (iii) contractor business systems, (iv) increasing subcontracting opportunities for small businesses, and (v) improved estimating systems. The objective, while addressing valid DoD concerns, met with a lot of opposition. Initially DoD scheduled a public meeting in the DC area to obtain views of interest parties (see Proposed Changes to Progress Payment Rate - Public Meeting). Later on (in October 2018), the entire proposal was withdrawn and the public meeting was cancelled (see Proposed Changes to Progress Payment Rate - Withdrawn).

Withdrawn perhaps, but not forgotten. DoD withdrew the proposal to give it time to conduct additional outreach with industry regarding contract financing methods. but since the proposed rule is predicated upon a provision in the 2017 NDAA (National Defense Authorization Act), there will need to ultimately be some kind of change to contract financing reform.

The Defense Department has now rescheduled its public meetings (two in January and one in February) to obtain views of experts and interested parties regarding revising policies and procedures for contract financing, performance incentives, and associated regulations for DoD contracts. The fact that the Department is scheduling three meetings instead of one previously, gives some indication of the level of interest in this matter.

Pre-registration is required so hurry over to these registration instructions if interested in attending.

Proposed Changes to Progress Payment Rate - Withdrawn

Back on August 24th, we reported a proposed rule by the Defense Department that would significantly slash the progress payment rate from 80 to 50 percent unless contractors were able to achieve certain milestones such as contract delivery, no significant corrective action requests, no significant business system deficiencies, meeting subcontracting goals, among others (see Proposed Changes to Progress Payment Rate).

Two weeks ago, we reported on a scheduled public meeting to obtain the views of experts and interested parties regarding the proposed changes (see Proposed Changes to Progress Payment Rate - Public Meeting Scheduled). We reported then that this proposed change has been meeting with a lot of concern and resistance. The Defense Department has valid concerns. Many contractors do not seem to care about improving their business systems, meeting subcontracting goals, or acknowledging corrective action reports because there is no penalty for failing to comply. Defense is trying to incentivize contractors to do the right things by disrupting their cash flows if they don't toe the line.

Well, contractors seem to have won this battle. Today, the Defense Department withdrew the proposed rule and cancelled the public meeting (see Performance-Based Payments and Progress Payments (DFARS Case 2017-D019)). According to DoD, the proposed rule was withdrawn in order for DoD to conduct additional outreach with industry regarding contract financing methods.

This isn't the end of the story however. The proposed rule was based on a provision in the FY 2017 NDAA (National Defense Authorization Act) so eventually, there will be some kind of change to existing policy.

Proposed Changes to Progress Payment Rate - Public Meeting Scheduled

About a month ago, we brought you news about the Defense Department's proposed changes to progress billings (see Proposed Changes to Progress Payment Rate). Essentially, the proposed rule drops the standard progress payment rate from 80 percent to 50 percent, however, contractors have the opportunity to score a higher rate when they achieve certain goals, like having acceptable business systems with no deficiencies, meeting contract delivery dates, closing out corrective action requests, meeting small business subcontracting goals, etc.

The goal here is to incentivize contractors to "fix" things that would otherwise have no adverse consequences. The downside is that the proposed rule will require a significant amount of effort to implement and track. It goes without saying that if contractors cannot achieve the full 80 percent rate, there will be a significant impact on their cash flow and in some cases, their ability to continue as a Government contractor. Think about it. If you have a $5 million contract stretching over two years, you will be floating the Government an interest free loan of a few million. Do you have that kind of financial resources available?

This has been a highly controversial move by DoD and so the Department has decided to schedule a public meeting next month in the DC area to obtain the views of experts and interested parties in the private sector (that includes current and prospective Government contractors) regarding the proposed changes. To attend, one needs to be pre-registered. Instructions for registering are found here. If you have a vested interest in the outcome, attending might be worthwhile. We can't imagine that there will be too many in attendance that will have come in support of the proposed rule.

Proposed Changes to Progress Payment Rate

Significant changes are coming to progress payment contract financing for DoD Contracts.

Currently, FAR 52.232-16 sets customary progress payment rates of 80 percent and 85 percent for large and small businesses, respectively. DFARS (DoD FAR Supplement) 252.232-7004 gives small businesses an added boost to 90 percent.

A proposed change just published, leaves the customary rate for small businesses intact but reduces the 80 percent rate to 50 percent but provides incentives for contractors to increase the rate to 90 percent. These incentives are designed to increase the effectiveness and efficiency in five "domains"

1. On time or accelerated contract deliveries
2. Contractor quality
3. Contractor business systems
4. Increasing contract opportunities for small buisnesses
5. Receipt of timely quality proposals (i.e. good estimating systems)

So how does DoD propose to incentivize these goals? By adding percentages to the base rate as follows:

• 10% for meeting the contract delivery dates for contract end items and contract data requirements lists or performance milestone schedules
• 10% for not having open level III or IV corrective action requests (corrective action requests are sent to contractors when an item or process is in nonconformity and a remedy is required. These are usually associated with quality assurance activities)
• 10% when all applicable business systems are acceptable and have no significant deficiencies.
• 7.5% when at least 95 percent of the time during the preceding Government fiscal year, when responding to solicitations that required submission of certified cost or pricing data, met the due date in the request for proposal and complied with the Proposal Adequacy Checklist
• 5% for meeting small business subcontracting goals during the preceding Government fiscal y ear.
• 2.5% for providing subcontracting opportunities for the AbilityOne program.

You can read more about this proposed change including how to participate in public meetings on the subject here.

Milestone Payments and Adequate Accounting Systems

Progress payments for construction projects are typically based on a percentage of work complete. FAR (Federal Acquisition Regulations) 52.232-5 provides for progress payments monthly as the work proceeds ... on estimates of work accomplished which meets the standards of quality established under the contract, as approved by the contracting officer. The FAR clause also requires

• an itemization of the amounts requested, related to the various elements of work required by the contract covered by the payment requested
• a listing of the amount included for work performed by each subcontractor under the contract
• a listing of the total amount of each subcontract
• a listing of the amounts previously paid to each subcontractor
• additional supporting data in a form and detail required by the contracting officer

The form and content of the progress payment requests and the substantiation accompanying it vary from Agency to Agency but common among them is a signature block where the contractor and the Government agree with the percentage complete for specific tasks. For example, mobilization might be one of the progress payment line items. When mobilization is completed, the contractor and Government will agree and the contractor can bill for 100 percent of that line item.

The question often arises concerning the importance of an adequate accounting system when progress payments based on performance (as opposed to progress payments based on costs) are part of the contract. Since progress payments are based on a percentage of work complete and have nothing to do with actual costs incurred, why the focus and importance on an accounting system that can record costs by job?

The Government has an answer for this. The Government position is that the two should correlate, i.e. percentage complete should correlate to actual costs incurred. The contractor when doing their scheduling should also be allocating the associated costs with each activity. It is the job of the contracting officer to approve the schedule and the associated costs with each activity. The contractor should then be tracking and reporting their actual cost incurred as well as progress. If cost exceed its anticipated percentage complete, that is a warning sign that the contractor could be in trouble and the contracting officer will (or should) begin asking questions.

It is not difficult to establish an accounting system that is acceptable for Government contracting purposes. If you need help, give us a call.

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.