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Contract Financing
Contract is a form of payment; or rather it is an unauthorized government distribution of funding to a contractor before accepting supply of goods or services offered by the government. Contract financing excludes debit payments, payments for incomplete acceptance or charter or rental payments. This is because payments of invoices on cost style contracts do not qualify as contract financing. Therefore, contract financing primarily applies to fixed price contracts. The primary intention of contract financing is to help the contractor in handling costs incurred during the performance of the contract (DOD, 2012).
In addition, provision of this financing covers the amount needed for quick and efficient performance of the contract. The order of preference for contract financing suggests that for every government financing provided the contractor should not acquire private contract financing without the government's warranty. In addition, except for situations such as non-profit educational, research organizations or the management and operation of government facilities, advance payment is the most preferred method (DOD, 2012). Other methods include private financing without government guarantee, customary contract financing, loan guarantees, unusual contract financing and advance payments.
From a business perspective, any prudent buyer may opt to pay the seller upon delivery of goods or services. This is because payment upon delivery is cheap and offers maximum motivation for the seller to deliver the goods or services. This is the principle used by the government, whereby it prefers advance payments where the government pays in advance for work in progress (DOD, 2012). The government provides contract financing on fixed prices, non-commercial contracts for deliveries scheduled to start within six months or after awarding of the contract. In addition, provision of contract financing is in the form of customary contract financing. Under customary financing, the commonly used financing method is the customary progress payments based on cost.
Performance-Based Payments (PBP) fall under customary contract financing and the government prefers this form when the contracting officer finds them suitable, and the contractor accepts its terms. However, PBPs do not apply for all contracts. An individual or organization cannot use two financing methods simultaneously. This means that this company should choose one method that suits them best. For instance, the company cannot use both Progress Payments and Performance-Based Payments. However, there is room for modification on either financing approach the company chooses (DOD, 2012). For instance, this happens through changing the approach, and when this happens the new approach requires adequate consideration.
Performance Base Payments
PBPs are financing payments based on the achievement of accomplishments defined and valued in advance by the involved parties. This is the appropriate method the company should adopt because it is recoverable in case of default. PBPs cannot exceed 90% of the contract price, and this is the maximum that the company can provide. In addition, for the company to establish this approach, the true progress, determination of accomplishment and financing values are given prior the beginning of the contract. This approach will offer expected results for the company because it has potential advantages such as enhanced technical and scheduled focus, reduced oversight cost, wide contractor participation and improve contractor's cash flow.
Expected Advantages of PBPs
Enhanced Technical and Scheduled Focus
This is an expectation that PBPs can enhance the focus on technical and schedule performance because of the effort needed to develop a PBP arrangement, and the attention required to complete the PBP events during the execution of the contract. The company can achieve this if the PBPs are properly structured, which will reinforce the contractor's motivation and the contractor may accomplish the work promptly and efficiently (DOD, 2012). However, if the PBP schedule lacks meaningful events, or the valuation does not reflect the successful performance of the contract, and the structuring is inadequately completed criteria, the PBP arrangement can misdirect a contractor's focus.
Reduced Cost of Oversight and Administration
The company should expect that since there is prior establishment of PBP event values, this approach will not require the oversight of the contractor's accounting system on the government's side. However, this expectation does not consider that supervision of a contractor's accounting structure is done on the company as a whole, but not contract specific (DOD, 2012). In addition, unless a contractor had no other contracts such as cost type contracts or contracts using progressive payments, which require accounting systems, PBPs did not result to reduction in the oversight of the accounting system.
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