Contract Financing
Contract Financing is covered in FAR Part 32 and is defined as the Government authorized payment of funds to the contractor prior to acceptance of supplies or services by the Government. Contract financing does not include invoice payments, payments for partial acceptance or lease or rental payments. Payments of invoices on cost-type contracts are not considered contract financing. Therefore, contract financing only applies to fixed-price contracts.
Purpose and Scope of Contract Financing
The purpose of contract financing is to assist the contractor in paying costs incurred during the performance of the contract. FAR 32.104(a)(1) states that when contract financing is provided it should be provided only to the extent actually needed for prompt and efficient performance.
“Customary contract financing” means that financing deemed by an agency to be available for routine use by contracting officers. Most customary contract financing arrangements should be usable by contracting officers without specific reviews or approvals by higher management.
“Unusual contract financing” means any financing not deemed customary contract financing by the agency. Unusual contract financing is financing that is legal and proper under applicable laws, but that the agency has not authorized contracting officers to use without specific reviews or approvals by higher management.
The Defense Contract Management Agency (DCMA) and Defense Contract Audit Agency (DCAA) use the Wide Area Work Flow (WAWF) to capture and route all financing payments processed by the Government. Most financing payments are paid out of the Defense Finance and Accounting Service (DFAS) – Columbus, and use the Mechanization of Contract Administration Services (MOCAS) system.
Non-commercial Contract Financing Payments
The following are types of non-commercial contract financing payments:
- Performance-based payments. These are the preferred method of providing contract financing. They are measured by objective, quantifiable methods, accomplishments of defined events, and other quantifiable results.
- Progress payments based on costs. These are incurred by the contractor as work progresses under the contract (see FAR 32.5).
- Progress payments based on a percentage or stage of completion
- Loan guarantees. These are made by Federal Reserve Banks on behalf of designated guaranteeing agencies. They enable contractors to obtain financing from private sources under contracts for the acquisition of supplies or services for national defense.
- Advance payments are payments made before work commences. Due to the high degree of risk associated with advance payments, they are the least preferred method of contract financing.
Commercial Contract Financing Payments
In the commercial marketplace, financing is the responsibility of the contractor. However, in some cases it is customary for the buyer to provide financing. If it is in the best interest of the Government, commercial interim payments and commercial advance payments can be authorized in accordance with FAR Part 32. The contracting officer can either state the form of financing available in the solicitation or allow the offeror to propose it.
Commercial advance payments are made before any performance of work under the contract.
Commercial interim payments are given to the contractor after some work has been completed.
Commercial advance and interim payments may be made under the following circumstances (FAR 32.202-1(b)(6):
- The contract item being financed is a commercial supply or service.
- The contract price exceeds the simplified acquisition threshold.
- The contracting officer determines it is appropriate/customary in the commercial marketplace to make financing payments for the item.
- The form of contract financing is in the best interest of Government.
- Adequate security is obtained.
- Prior to any performance of work, the aggregate of commercial advance payments does not exceed 15% of the contract price.
- The contract is awarded on the basis of competitive procedures.
- The contracting officer obtains concurrence from the payment office concerning liquidation provisions, when required.
Private financing can be obtained through the Assignment of Claims Act of 1940. This act allows the contractor to transfer (or “make over”) its claim for reimbursement under the contract to a bank, trust company, or other financing institution. This type of financing has the least risk for the government, as it requires no direct use of Government funds for the loans.
Here is a situation where a company may decide it is in its best interest to pursue commercial contract financing: ABC Company has landed a Government contract that will result in a significant increase in revenue. To fulfill the contract, ABC Company must immediately commit to additional personnel (increased payroll), training, materials, and related costs. ABC needs to make these financial commitments before receiving a single payment from its new customer, the U.S. Government. The Government can take 30 days to pay contractor invoices, and the amount of capital required to cover ABC’s immediate spending exceeds the balance available on its existing line of credit. In the meantime, ABC Company would have to cover all of its recurring expenses such as payroll, rent and supplier payments. This would not be a problem if the company had 60 days or so of operating capital. If not, ABC would need to obtain a business loan. While that may help, business loans can be difficult to get and take a long time to apply for. Also, business loans have set limits. From the Government’s perspective, it is usually preferable for a contractor to obtain private financing. However, this is not always practical. In such circumstances, the Government may provide financing for the effort.