STUDENT GUIDE. CON 170 Fundamentals of Cost & Price Analysis. Unit 3, Lesson 2 Contract Financing

Transcription

1 STUDENT GUIDE CON 170 Fundamentals of Cost & Price Analysis Unit 3, Lesson 2 Contract Financing October 2017 CON170, Unit 3 Lesson 2 Contract Financing - Page 1

2 STUDENT PREPARATION Required Student Preparation Read FAR Part 32, Part 232 Scan Contract Pricing Reference Guide, Vol 4 Ch 9 (9.4) Planned Academic Time Required: 5 hours Student performance will be informally evaluated during class discussions, and formally evaluated on Exam 1 CON170, Unit 3 Lesson 2 Contract Financing - Page 2

3 Lesson Presentation In this lesson, you will be introduced to several methods of contract financing available. We will also explore the situations where you may implement certain financing terms into your contracts. This lesson will explore methods of both noncommercial and commercial financing as well as explore some of the common clauses included in a contract that provides for contract financing. Contract financing is a critical element of contracting with the Government. Government financing can potentially offer contractors a tremendous value, enabling them to earn returns above and beyond their profit or fee. For commercial and noncommercial contracts over the Simplified Acquisition Threshold, DoD contracting officers must understand when and how to offer contract financing, and ensure the Government receives adequate consideration in return. An understanding of the terms pertaining to contract financing is important to understand BEFORE a contract is issued. This lesson will provide valuable information relative to most aspects of contract financing. Contract financing is the authorized disbursement of money to a contractor prior to acceptance of supplies or services. There are several different types of contract financing, as stated in FAR Part 32. CON170, Unit 3 Lesson 2 Contract Financing - Page 3

4 CON170, Unit 3 Lesson 2 Contract Financing - Page 4

5 Keep in mind that the purpose of contract financing is to assist the contractor only to the extent needed to perform, particularly on working capital expenses (short-term, not long-term capital investment). In contrast, for long-term investments, the Government offers a Facilities Capital Cost of Money incentive, which we will learn about in Unit 5. CON170, Unit 3 Lesson 2 Contract Financing - Page 5

6 Contract financing is not a matter to wait and think about after a contract has been awarded. The need for financing and the terms of contract financing must be discussed during the acquisition planning phase. Per FAR , the need for contract financing cannot be considered a handicap for award, or as an indicator of a lack of financial responsibility in a competitive acquisition. With respect to financial responsibility, FAR (a) indicates contractors can be considered financially responsible if they have adequate resources to perform the contract, or have the ability to obtain such resources. In support of the above, in April 2011, DPAP established a general policy, that in the event a contractor requests a change in financing arrangements after award, the contracting officer shall first conduct a present value analysis to determine the amount of consideration (if any) due to the Government. CON170, Unit 3 Lesson 2 Contract Financing - Page 6

7 For such cases, FAR (b) and (c) state: (b) Amount of new consideration. The contractor may provide new consideration by monetary or nonmonetary means, provided the value is adequate. The fair and reasonable consideration should approximate the amount by which the price would have been less had the contract financing terms been contained in the initial contract. In the absence of definite information on this point, the contracting officer should apply the following criteria in evaluating whether the proposed new consideration is adequate: (1) The value to the contractor of the anticipated amount and duration of the contract financing at the imputed financial costs of the equivalent working capital. (2) The estimated profit rate to be earned through contract performance. (c) Interest. Except as provided in Subpart 32.4, Advance Payments for Noncommercial Items, the contract shall not provide for any other type of specific charges, such as interest, for contract financing. Before we go further, review the following table to familiarize yourself with the following terms, definitions, and FAR references. Term Definition FAR Ref Customary contract financing 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 FAR Delivery payment Designated billing office specific reviews or approvals by higher management. A payment for accepted supplies or services, including payments for accepted partial deliveries. Commercial financing payments are liquidated by deduction from these payments. Delivery payments are invoice payments for prompt payment purposes. The office or person (governmental or nongovernmental) designated in the contract where the contractor first submits invoices and contract financing requests. The contract might designate different offices to receive invoices and contract financing requests. The designated billing office might be FAR FAR Designated payment office (1) The Government disbursing office; (2) The contract administration office; (3) The office accepting the supplies delivered or services performed by the contractor; (4) The contract audit office; or (5) A nongovernmental agent. The office designated in the contract to make invoice payments or contract financing payments. Normally, this will be the Government disbursing office. FAR CON170, Unit 3 Lesson 2 Contract Financing - Page 7

8 Liquidate Unusual contract financing To decrease a payment for an accepted supply item or service under a contract for the purpose of recouping financing payments previously paid to the contractor. 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. Parameters for unusual contract financing differ for commercial and noncommercial financing methods FAR FAR , , (d) Check for Understanding: Contract Financing Basics (Read from the beginning of FAR part 32 FAR , and answer the following.) 1. What is contract financing? 2. Is the Government entitled to additional consideration for allowing contract financing when the financing arrangements (implemented by the appropriate financing clause) are set at the inception of the contract? 3. After contract award, if the contractor requests financing, how would the Government calculate appropriate consideration? 4. The due date for making contract financing payments can be no shorter than days and definitely by. 5. What if we pay a financing payment to the contractor later than the 30 th day is there an interest penalty? CON170, Unit 3 Lesson 2 Contract Financing - Page 8

9 Commercial Item Purchase Financing To begin, we will review commercial item purchase financing methods. They are covered in detail at FAR subpart In contracting for commercial goods and services, pursuant to FAR , it is the responsibility of the contractor to provide all resources needed for performance of the contract. Thus, for purchases of commercial items, financing of the contract is normally the contractor s responsibility. However, in some markets the provision of financing by the buyer is a commercial practice. In these circumstances, the contracting officer may include appropriate financing terms in contracts for commercial purchases when doing so will be in the best interest of the Government. When financing is appropriate, FAR authorizes commercial advance payments and commercial interim payments under certain circumstances. Per FAR , a commercial advance payment means a payment made before any performance of work under the contract. Such payments cannot exceed 15% of the contract price. As a contract financing method, commercial advance payments are not subject to interest penalties under the Prompt Payment Act. Per FAR , a commercial interim payment means any payment that is not a commercial advance payment or a delivery payment. Such a payment is paid to the contractor after some work has been done. As a contract financing method, commercial interim payments are not subject to interest penalties under the Prompt Payment Act. Per FAR , the circumstances for providing commercial advance or interim payments are as follows: CON170, Unit 3 Lesson 2 Contract Financing - Page 9

10 While commercial acquisitions typically rely on private financing, contracting officers should investigate the need for commercial financing during the market research phase. The following slide states key areas to understand before making the commercial financing decision. When providing commercial item purchase financing, FAR requires the contracting officer to obtain adequate security from the contractor. CON170, Unit 3 Lesson 2 Contract Financing - Page 10

11 Adequate security for financing can be in several different forms, including the general financial condition of the contractor, a paramount lien (including specific elements the lien is upon), contractor assets, or performance bonds. See FAR for detailed information about the policies relative to Security for Government financing. In addition, DFARS states that an offeror s financial condition may be sufficient to make the contractor responsible for award purposes, but may not be adequate security for commercial contract financing. Therefore, when contemplating offering commercial contract financing, conduct and document additional analysis that the contractor s financial condition is sufficient for both award and for financing. After market research, and reviewing the authorizations for commercial financing, the contracting officer determines the most appropriate financing method, or agrees to allow contractors to propose its own financing terms. Before inserting such financing terms in the solicitation, contracting officers should review FAR and , in order to determine how proposals will be evaluated with respect to contract financing. As we learned in Unit 2 s Net Present Value lesson, we must account for elements such as the time value of money of cash flows, maintenance costs, and salvage values when comparing different financing arrangements. The following provisions and clauses apply to commercial solicitations and contracts when commercial financing is included. Finally, FAR provide instructions for the contracting officer with respect to approving commercial financing payments. CON170, Unit 3 Lesson 2 Contract Financing - Page 11

12 Now that we are familiar with commercial financing arrangements, it is time to examine the noncommercial financing arrangements. Non-Commercial Item Purchase Financing In a noncommercial environment, FAR explains that prudent contract financing can be a useful working tool in Government acquisition by expediting the performance of essential contracts and that Contracting officers must consider the criteria in this part in determining whether to include contract financing in solicitations and contracts. Resolve reasonable doubts by including contract financing in the solicitation. As stated earlier, contract financing should only be offered to the extent needed to achieve prompt and efficient performance and any/all contract financing arrangements must always aim to protect the Government s interest. To that end, FAR (a) goes on to explain specific considerations the contracting officer must make when contemplating a contract financing arrangement while FAR (b) describes some additional thoughts to be considered if the prospective contractor is a small business concern, which does not necessarily have any bearing on the need for or entitlement to contract financing. The following slides contain the list of contract financing methods as described within FAR and DFARS and the order of preference for using the methods described. We will explore each within the context of this lesson. CON170, Unit 3 Lesson 2 Contract Financing - Page 12

13 CON170, Unit 3 Lesson 2 Contract Financing - Page 13

14 Advance Payments. We will work our way up from the bottom of the order of preference list on the previous page. First, we ll explore Advance Payments. This is the least preferred method of contract financing. Per FAR (b), advance payments may be provided on any type of contract; but shall be done so sparingly, and should not be used if other reasonable types of financing are available. If indicators from the Government and contractor, and market research indicate advance payments may be appropriate, the contracting officer shall ensure the statutory requirements stated in FAR are accomplished in advance. Advance payments may be used for either noncommercial or commercial items. The table below provides basic elements for using advance payments with noncommercial and commercial contracts. Advance Payments Noncommercial Appropriate for FAR Part 14 & 15 Contracts Payments will not > the unpaid contract price Not subject to interest penalty provisions of the Prompt Payment Act May be provided on any type contract but should be used sparingly Least preferred method of contract financing See Statutory Requirements and standards for advance payments determination (FAR (c)) See Exclusions for advance payments authorized by law. (FAR ) Contract Clause FAR Commercial Appropriate for FAR Part 12 contracts Aggregate of payments shall not exceed 15% of contract price Not subject to interest penalty provisions of the Prompt Payment Act Not subject to Subpart 32.4 Advance Payment for Noncommercial Items CON170, Unit 3 Lesson 2 Contract Financing - Page 14

15 Unusual Contract Financing. After Advance Payments, the next least preferred type of noncommercial financing is Unusual Contract Financing. Per FAR , this includes any type of financing arrangement that is not addressed in FAR If the contracting officer believes use of Unusual Contract Financing is appropriate, he/she must obtain approval in advance in accordance with agency regulations. An example of an unusual contract financing arrangement would be allowing Progress Payments at rates higher than the current regulations allow (The Customary Progress Rates per DFARS are 80% for Large Businesses, and 90% for Small Businesses). Another example would be agreeing to provide a contractor greater than the 15% advance payment limitation for a commercial purchase. Both of these examples would require approval in advance, as indicated in agency procedures. Loan Guarantees. As we continue to work up from the bottom of the order of preference list, we come to Loan Guarantees. However, as previously mentioned, pursuant to DFARS , the use of guaranteed loans as a contract financing mechanism requires the availability of certain congressional authority and DoD has not requested such authority in recent years. As such, none is now available. Customary contract financing other than loan guarantees and certain advance payments. Next highest on the preference list is customary contract financing. There are several forms of customary contract financing but this lesson will focus on the three most common: progress payments based on a percentage or stage of completion, progress payments based on costs, and performance-based payments. CON170, Unit 3 Lesson 2 Contract Financing - Page 15

16 As of December 2016, the DFARS was amended to say that if you have or are preparing to enter into a fixed price contract with a performance period of greater than one year and exceeding the thresholds at FAR (d), DoD will no longer require the contractor to demonstrate actual financial need or the unavailability of private financing. This is because DoD has made a blanket determination that, under these particular circumstances, the use of customary financing (except for loan guarantees or advance payment) is in DoD s best interest. Essentially, the idea behind this is that it has been determined that the use of such customary contract financing provides improved cash flow as an incentive for companies to do business with DoD. As such, it is in DoD s best interest and therefore no additional documentation for its use in an individual acquisition is necessary. Progress Payments. Progress payments are addressed in many instances in the FAR. For example, see FAR , , ; and through -16 for just a few. Simply defined, progress payments are a form of contract financing used with fixed price contracts when acquiring noncommercial items, where the Government pays the contractor as reasonable progress is made, but before contract completion or delivery. There are two types of Progress Payments: Progress Payments based on a Percentage or Stage of Completion, and Progress Payments Based on Costs. Progress Payments based on a Percentage or State of Completion. At FAR (e)(2), we learn This type of progress payment may be used as a payment method under agency procedures. Agency procedures must ensure that payments are commensurate with work accomplished, which meets the quality standards established under the contract. Furthermore, progress payments may not exceed 80 percent of the eligible costs of work accomplished on undefinitized contract actions. According to DFARS (e)(2), the Department of Defense ONLY allows the use of progress payments based on percentage or stage of completion for construction, and shipbuilding, ship conversion, alteration, or repair. Typical progress payments are based on a percentage of cost, not work completed. CON170, Unit 3 Lesson 2 Contract Financing - Page 16

17 Progress Payments based on Cost. The other type of progress payment method to be discussed are those based on a percentage of cost incurred by the contractor. Further, per FAR (a) & (b), progress payments based on costs do not apply to cost reimbursement, or to contracts for construction, shipbuilding, ship conversion, alteration, repair when those contracts include progress payments based on percentage or stage of completion. CON170, Unit 3 Lesson 2 Contract Financing - Page 17

18 Progress Payments for costs incurred on a contract can include financing payments made by the prime contractor to a subcontractor under the conditions stated in FAR If a subcontractor contacts you as the Government contracting officer, seeking payment from a prime contractor, review FAR and review the situation with the prime contractor before taking any action on behalf of the subcontractor. Remember, the subcontractor s contract, including financing terms and conditions, is with the prime contractor, not the Government! The following chart provides an overview of the key tenets of progress payments. Notice that DoD s customary Progress Payment rates, stated in DFARS are different than the rates stated in FAR CON170, Unit 3 Lesson 2 Contract Financing - Page 18

19 Remember the distinction between customary and unusual contract financing presented in the chart earlier in this lesson. The customary Progress Payment rates are stated above. Any departure from these rates is considered to be unusual. While employing unusual progress payments may be acceptable, per FAR and 2, DFARS , and DFARS PGI , the contracting officer must obtain approval in advance and according to agency procedures. CON170, Unit 3 Lesson 2 Contract Financing - Page 19

20 Liquidation of Progress Payments Based on Costs. The following example illustrates how progress payments are made even before deliveries are made, how the payments accumulate, and how the progress payments are liquidated as deliveries are made. SCENARIO: You are the PCO for a $13M, single-year, FFP engine production contract with a Small Business. The cost was estimated at $12M with $1M profit. Each of the five engines will be delivered and accepted by the Government with a unit price of $2.6M each (including profit). There are four (4) progress payments that will occur over the first seven (7) months of the contract, illustrated in the chart below. In this scenario, each progress payment request is for $3M. Each delivery is worth $2.6M. Assume we use the Ordinary Method for liquidating progress payments, as described in FAR a. According to the FAR and DFARS, what is the progress payment rate for each progress payment? b. According to the Progress Payments Clause at FAR , and the DFARS DoD Progress Payment Rates clause at DFARS , what is the cumulative, maximum amount the contractor can be paid? CON170, Unit 3 Lesson 2 Contract Financing - Page 20

21 Contract is for 5 units, $2,600,000 each; total contract price $13,000,000 PP Rate 90% Max PP = $11,700,000 Unliquidated K Obligation Unliquidated Obligation Progress Payments $13M $13,000, $0.00 PP#1 request of $3M but paid in the amount of $2.7M $2,700, PP#2 request of $3M but paid in the amount of $2.7M Note 3 $2,700, PP#3 request of $3M but paid in the amount of $2.7M $2,700, PP#4 request of $3M but paid in the amount of $2.7M $2,700, Total Unliquidated PPs is $10,800,000 $10,800, Invoice Payments Note 1 Invoice #1 submitted for 1 $2,600,000 ea ($2,600,000.00) ($2,340,000.00) $260, Subtotal $13M $10,400, $8,460, $260, Invoice #2 submitted for 1 $2,600,000 ea ($2,600,000.00) ($2,340,000.00) $260, Subtotal $13M $7,800, $6,120, $520, Invoice # 3 submitted for 1 $2,600,000 ea ($2,600,000.00) ($2,340,000.00) $260, Subtotal $13M $5,200, $3,780, $780, Invoice #4 submitted for 1 $2,600,000 ea ($2,600,000.00) ($2,340,000.00) $260, Subtotal $13M $2,600, $1,440, $1,040, Invoice #5 submitted for 1 $2,600,000 ea ($2,600,000.00) ($1,440,000.00) $1,160, Subtotal $13M $0.00 $0.00 $2,200, Note 2 Note 1. Total amount of progress payments = $10,800,000; less than 90% Note 2. Total delivery invoice payments = $2,200,000; after liquidation applied. Note 3. Total amount of progress payments + total invoice payments = $10,800,000 + $2,200,000 = $13,000,000; total obligated amount *********************************************************************************** Turn to Exercise #1 at the back of this lesson and Complete the Progress Payments Knowledge Review before moving on. *********************************************************************** CON170, Unit 3 Lesson 2 Contract Financing - Page 21

22 Provisional Delivery Payments. Before moving forward to the next type of non-commercial financing addressed in FAR, it is important to note a financing method unique to DoD. Per DFARS , Provisional Delivery Payments are a method of financing which apply only when contractors deliver goods or services under an Undefinitized Contract Action (UCA), and are similar to progress payments. Under a UCA, when a contractor is receiving progress payments and requests payment for a delivered item, the contracting officer must take care to pay the contractor under a process similar to the liquidation process we learned for customary progress payments under a definitized contract. This process as outlined in the DFARS ensures the Government does not overpay the contractor, and maintains a financial incentive for the contractor to negotiate a definitized contract as soon as possible. CON170, Unit 3 Lesson 2 Contract Financing - Page 22

23 Performance Based Payments. The last form of non-commercial, customary contract financing we will explore is Performance Based Payments. Performance Based Payments (PBPs) are another form of customary contract financing where contractors are paid during the performance of the contract, but prior to acceptance of supplies and services by the Government. The policy and processes for using PBPs are stated in FAR part 32, and in the PBP Guide, The Better Buying Power Initiative, dated 2014, available on-line by searching the title. Unlike previously discussed forms of financing where payments are based upon costs incurred, PBPs are financing payments based upon the achievement of specific, measurable events or accomplishments that are defined and valued in advance by the parties to the contract (PBP Guide, Ch 1). For example, instead of paying a contractor progress payments at 80% of the costs incurred to build an airplane, PBPs would pay the contractor upon successful completion of critical project milestones, such as fabricating the fuselage, integrating the engines, and passing flight tests. As stated in FAR , PBPs link payments to successful performance, and are generally preferred over other forms of financing when the contracting officer finds them practical, and the contractor agrees to their use. The following slides present the FAR framework for PBPs. CON170, Unit 3 Lesson 2 Contract Financing - Page 23

24 Based on the policy stated above, FAR states the criteria for use of PBPs in Government contracts. CON170, Unit 3 Lesson 2 Contract Financing - Page 24

25 PBPs cannot be used with fixed-price contracts being awarded using the sealed bidding procedures under FAR part 14 (FAR ). Although PBPs are payments for completion of performance events, they are still considered a method of contract financing, and are not subject to the interestpenalty provisions of the Prompt Payment Act (FAR ). In addition, PBPs must not be confused with partial payments, which describe payments made to the contractor when the Government formally accepts delivery of a portion of a purchased quantity (for example, we accept delivery for 50 of the 100 tanks on a contract. By accepting the tanks, we obtain title and assume risk of loss, and we pay the contractor for the 50 we accept.) Partial payments are subject to the provisions of prompt payment. Notice, PBPs may not be used on a contract that already includes progress payments. In addition, PBPs that are not liquidated by contract deliveries must be repaid to the Government in the event of a termination. As stated in FAR , and the 2014 PBP Guide, PBPs can potentially offer benefits in several areas. Because PBPs are only made when the contractor completes significant events, the parties tend to focus on event completion. In addition, PBPs can offer higher payment percentages than progress payments, which can lead to better cash flow for the contractor. In some cases, if a contractor can obtain better cash flow, it may be willing to offer lower overall prices to the Government. Before using PBPs, we must first understand a few basic PBP principles, which are stated early in FAR part 32. Next, we must comply with the procedures for using PBPs as stated in FAR Part 32, and we must establish PBPs in a manner consistent with the key steps from DoD s latest PBP Guidance. FAR through provide guidance on the procedures for establishing performance based payments, events, and criteria. CON170, Unit 3 Lesson 2 Contract Financing - Page 25

26 CON170, Unit 3 Lesson 2 Contract Financing - Page 26

27 As indicated in the slide above, performance based payments are not a means to reward contractors for performance beyond what is required in the contract. It is simply a form of financing, which enables some contractors to earn more cash flow than customary progress payments, while providing less performance risk to the Government. Per FAR (e), they shall not be used for: - payments under cost-reimbursement line items; - contracts for architect-engineer services or construction, or for shipbuilding or ship conversion, alteration, or repair, when the contracts provide for progress payments based upon a percentage or stage of completion; or - contracts awarded through sealed bid procedures CON170, Unit 3 Lesson 2 Contract Financing - Page 27

28 DoD s latest guidance provides the following with respect to the use of PBPs: If PBPs appear to be appropriate for your acquisition, examine the regulatory procedures for implementing them. Notice, implementation of PBPs requires the contracting officer to first agree to a contract price on the basis of customary progress payments, and then converting to PBPs through the use of DPAP s PBP analysis tool. CON170, Unit 3 Lesson 2 Contract Financing - Page 28

29 As established by FAR (c) and (d), we cannot implement PBPs on the same contract as progress payments. However, we have flexibility to set PBPs based upon the entire contract value, or on a deliverable item basis. Whichever method we use, FAR mandates PBP values be established in a reasonable manner, and that we take caution to avoid payments which exceed the stated FAR limits. Other important aspects of PBPs to be aware of are listed on the following slides: CON170, Unit 3 Lesson 2 Contract Financing - Page 29

30 As you may have noticed, PBPs allow payment up to 90% of the contract price, or 90% of the delivery item price. As we learned earlier, a large business and a small business, with respective progress payment rates of 80% and 90% of costs, can gain a significant cash flow advantage with PBPs. However, because PBPs are not paid unless events are completed, the Government tends to gain enhanced technical and schedule focus. CON170, Unit 3 Lesson 2 Contract Financing - Page 30

31 The following slides summarize the latest DoD PBP guidance regarding the steps to take when establishing PBPs in a Government contract. A brief description of each step follows, as well. Step 1 Identify PBP Events. First, the Government acquisition team must identify the most critical events in the project schedule. Only the most critical events, which have a significant impact on the overall contract performance should be selected as PBP events. Selecting PBP events should be a team effort, with inputs from the different program team disciplines, including DCMA representatives. Per Chapter 6 of the PBP Guide, PBP events should be selected from key events already stated in the project s planning documents, and should not be selected simply to provide the contractor cash flow. Projects which have few meaningful milestones, and lengthy time periods between significant events are not likely good candidates for PBPs. CON170, Unit 3 Lesson 2 Contract Financing - Page 31

32 Step 2 Establish Completion Criteria. When establishing PBP events, there must be precise, established completion criteria that can be used to ensure an event has been completed and has earned the financing payment tied to it. You must ensure the completion criteria are objective and clear. It is best to avoid descriptions such as 95% complete, significantly completed, or submitted for completion as they are all open to interpretation. CON170, Unit 3 Lesson 2 Contract Financing - Page 32

33 Step 3 Evaluate the Monthly Expenditure Profile. The third step in the establishment of PBPs requires the Government team to analyze and understand the contractor s proposed expenditures throughout the project. The purpose of this step is twofold because it: a. Serves as the basis for establishing reasonable PBP event values in Step 4; and, b. Ensures the Government does not pay more for PBP events than actual costs incurred. The following slide outlines key considerations when evaluating the contractor s proposed, monthly expenditure profile. Step 4 Establishing PBP Event Values. After deliberate analysis of the contractor s expenditure profile in Step 3, we must establish reasonable values for each PBP event. The following regulations provide an outline for setting dollar values to each PBP event: a. FAR (b)(2)(i): recognize the contracting officer s goal is to provide PBPs as financing payments only to the extent actually needed for prompt and efficient performance. b. FAR (b)(2)(ii): establishes a limitation for PBPs not to exceed 90% of the contract price or line item price. c. FAR (b)(3)(ii): the contracting officer must ensure the PBPs do not result in an unreasonably low or negative level of contractor investment--avoid establishing PBPs which essentially result in advance payments. d. DFARS and 7013: (b)(i) At no time shall cumulative performance-based payments exceed cumulative contract cost incurred CON170, Unit 3 Lesson 2 Contract Financing - Page 33

34 Before moving to Step 5, pay particular attention to the cost limitation elements of PBPs. This regulatory cost limitation language is designed to protect the Government from the uncertainties in estimating costs through contract completion. The limitations require us to monitor actual expenses to ensure PBPs do not exceed actual expenses, or 90% of the contract or line item price. For example, in an FPI(F) contract, the Government will negotiate PBP event values based upon target costs, which are estimated at the time of contract award. If the contractor is underrunning the target costs upon completion of the first PBP event, the PBP payment could exceed actual costs incurred. The following graph illustrates an actual scenario where an FPI(F) contract s PBPs would have exceeded the contractor s actual expenditures for the project, which would have resulted in $55 million worth of advance payments. CON170, Unit 3 Lesson 2 Contract Financing - Page 34

35 To avoid such overpayment, the Government team must maintain visibility in to the contractor s actual costs incurred. The following parts of the regulations help us to do just that. a. DFARS Criteria for use The contracting officer will consider the adequacy of an offeror s or contractor s accounting system prior to agreeing to use performance-based payments. This regulation provides latitude for contracting officers to assess the adequacy of a contractor s accounting system. To assess the level of detail required in such an assessment, consider the following: i. Regarding the Administration and Payment of Performance Based Payments, FAR (c) states: The contracting officer is responsible for determining what reviews are required for protection of the Government s interests. The contracting officer should consider the contractor s experience, performance record, reliability, financial strength, and the adequacy of controls established by the contractor for the administration of performance-based payments. Based upon the risk to the Government, post-payment reviews and verifications should normally be arranged as considered appropriate by the contracting officer. If considered necessary by the contracting officer, prepayment reviews may be required. ii. The Accounting System Administration Clause at DFARS provides criteria for an accounting system, and states the contracting officer can disapprove the accounting system if there are significant deficiencies (as defined in the clause). Significant Deficiency is defined in the clause as a shortcoming in the system that materially affects the ability of officials of the Department of Defense to rely upon information produced by the system that is needed for management purposes. CON170, Unit 3 Lesson 2 Contract Financing - Page 35

36 Based on these references, the contracting officer s objective is to verify contractor s accounting systems do not contain significant deficiencies which could distort cost tracking and lead to inaccurate PBP cost statements required by DFARS clauses or b. DFARS and These are the clauses required when using PBPs either on a whole contract value or deliverable item value basis. In both of clauses, PBPs are limited to not exceeding actual costs incurred and contractors are required to provide actual cost documentation, as well as access to their cost records in order to verify PBPs comply with the cost limitation requirements. All in all, a contracting officer s actions in planning and implementing PBPs should be consistent with the following points: (1) In assessing the contractor s accounting system, the contracting officer must verify the system enables the contractor to adequately track costs in order to keep PBP requests within the cost limitations set by regulation (2) FAR 32 provides latitude for the contracting officer to determine how much analysis is required to determine a contractor s accounting system to be adequate for purposes of administering PBPs. A formal audit may not be required (3) With respect to using PBPs, the contracting officer s assessment of a contractor s accounting system should be comparable to the level of analysis for using progress payments, but not necessarily to the same level for using a cost reimbursement contract. Step 5 Establish a Special Contract Provision. Finally, after agreeing with the contractor on the PBP events and values, Step 5 is to establish a special contract provision to document the PBP plan in the contract. While contracting officers have some flexibility regarding implementation, generally, the provision will be in the form of a Special Contract Requirement in Section H of a DoD contract, and must include the following elements, based on the latest PBP Guide. CON170, Unit 3 Lesson 2 Contract Financing - Page 36

37 CON170, Unit 3 Lesson 2 Contract Financing - Page 37

38 Check for Understanding: Class Discussion- PBP Events Evaluate each event example below as either Acceptable or Not Acceptable. If you believe the event is not acceptable, explain what changes you would suggest in order to make it acceptable. You may consult chapters 6 & 7 of the DOD PBP Guide and FAR as needed. Example 1 Event: Completion of fabrication of forward fuselage Example 2 Event: Begin testing of avionics software. Completion Criteria: Aircraft arrives in test station #12 Example 3 Event: Award of Subcontract #xyz. Completion Criteria: Complete upon subcontractor signature on subcontract Example 4 Event: Fabrication complete for forward fuselage. Completion Criteria: Shop inspection record indicates an earned operation for fabrication as signed off by DCMA. (Cumulative to Event #22) Example 5 Event: Attendance at Management Status Review (MSR). Completion Criteria: ACO validates meeting minutes which show the contractor was in attendance at the MSR. CON170, Unit 3 Lesson 2 Contract Financing - Page 38

39 PBP Administration and Lessons Learned Chapter 12 of the PBP Guide offers helpful guidance with respect to administering contracts with Performance Based Payments. FAR (b)(1) requires the contracting officer to establish a complete, fully defined schedule of events or performance criteria and payment amounts. However, if a subsequent contract action significantly affects the price or event or performance criterion, the contracting officer must also consider an adjustment to the PBP schedule appropriately, to protect the benefits to both parties of using PBPs. In addition, this lesson includes several lessons-learned from across the DoD community with respect to using PBPs. CON170, Unit 3 Lesson 2 Contract Financing - Page 39

40 Summary In summary, PBPs are another form and sometimes very effective financing method that may be used on fixed price, noncommercial contracts. They provide potential benefit to the contractor in offering more cash flow over standard progress payments, and benefit the Government by linking payments strictly to completion of key milestones. PBPs are preferred over progress payments based on costs, but require additional effort by both parties to establish PBP events and values, and to ensure PBPs do not exceed regulatory cost limitations. *********************************************************************************** Turn to Exercise #2 at the back of this lesson and Complete the Performance Based Payments knowledge review before moving on. *********************************************************************** CON170, Unit 3 Lesson 2 Contract Financing - Page 40

41 Finally, before closing this important lesson, review the following slides which compare Progress Payments and Performance Based Payments, probably the two most common forms of contract financing you will encounter. CON170, Unit 3 Lesson 2 Contract Financing - Page 41

42 CON170, Unit 3 Lesson 2 Contract Financing - Page 42

43 All in all, contract financing can be an important component of government contracts that you may be tasked with awarding and/or administering. This lesson should have provided a good foundation for understanding the most important considerations as it pertains to contract financing. However, be sure to read and understand your contract and specific financing terms as included in your contract for any actions that you are responsible for. *********************************************************************************** Turn to Exercise #3 at the back of this lesson and Complete the final exercise. *********************************************************************** CON170, Unit 3 Lesson 2 Contract Financing - Page 43

44 Exercise #1: Progress Payments Knowledge Review Learning Objective Define the appropriate use of progress payments when acquiring noncommercial items. Introduction This lesson introduced the important concept of progress payments as a form of contract financing. Complete the following questions based on the classroom lecture, suggested resources, and slides. Assessment This activity is not scored or graded. Student Instructions: Review FAR Part 32, DFARS Part 232, and FAR to answer the following questions. Be sure you understand the information and ask questions of your instructors if you do not, rather than just copy the information from the FAR. You will have 30 minutes to complete this exercise. 1. How often and at what minimum amount may the contractor request progress payments? 2. Are the progress payment rates stated in FAR Part 32 different from the progress payment rates stated in DFARS 232? Which rates must a DoD Contracting Officer use? 3. How does the Progress Payments clause say the Government will compute the Contractor s progress payment?. 4. Within how many days of a Contractor s payment request to the Government should they be paid? CON170, Unit 3 Lesson 2 Contract Financing - Page 44

45 5. The total amount of progress payments shall not exceed what? What does this mean if we have followed DFARS customary progress rate and the Contractor is a small business? 6. Under what situations may the contracting officer reduce or suspend progress payments or increase the rate of liquidation? 7. What option does the contractor have regarding scrap resulting from production under this contract? 8. Who bears risk of loss? 9. How much visibility must the contractor give the contracting officer with respect to proper administration of this clause? 10. On what form must the contractor submit his progress payment request? CON170, Unit 3 Lesson 2 Contract Financing - Page 45

46 11. Review both the FAR and DFARS progress payment clauses regarding progress payments for Undefinitized Contract Actions (UCAs). For DoD contracts, progress payments may not exceed what percentage of costs incurred on work accomplished on a UCA? 12. Does late payment of progress payments incur penalty provisions of the Prompt Payment Act (which part of the clause gives you this information)? 13. What if a CO does not include the Progress Payment provision in a solicitation, and a contractor submits a bid contingent to progress payments being included? 14. Where does the clause describe how progress payments are liquidated? From FAR , what is the ordinary method of liquidation? (End of Exercise 1) CON170, Unit 3 Lesson 2 Contract Financing - Page 46

47 Exercise #2: Performance Based Payments Knowledge Review Learning Objective Define the appropriate use of performance based payments when acquiring noncommercial items. Introduction This lesson introduced the important concept of performance based payments as a form of contract financing. Complete the following questions based on the classroom lecture, suggested resources, and slides. Assessment This activity is not scored or graded. Student Instructions: Review FAR Part 32, DFARS 232, and the PBP clauses at FAR , and DFARS and to answer the following questions. Be sure you understand the information and ask questions of your instructors if you do not, rather than just copy the information from the FAR. You will have 30 minutes to complete this exercise. 1. This lesson states total performance based payments may not exceed 90% of the whole contract price or delivery item price. Which of the following references would you use to contractually implement this limitation? a. FAR b. DFARS or c. FAR (b)(2)(ii) d. A special contract provision, drafted by the Contracting Officer CON170, Unit 3 Lesson 2 Contract Financing - Page 47

48 2. Pursuant to the clause at FAR , how often may the contractor be able to submit requests for performance based payments? Do the DFARS clauses at and allow more frequent requests for PBPs? 3. Recognize the rights of the Government with respect to PBPs, as described in FAR , paragraphs (j), and (k)(1). (End of Exercise 2) CON170, Unit 3 Lesson 2 Contract Financing - Page 48

49 Exercise #3: Performance Based Payments vs. Progress Payments Learning Objective Describe the different commercial financing arrangements, including commercial advance payments, interim payments. Describe the different noncommercial financing arrangements and the order of preference. Introduction This lesson introduced the important concept of many different types of contract financing that may be offered on government contracts. Complete the following questions based on the classroom lecture, suggested resources, and slides. Assessment This activity is not scored or graded. Student Instructions: From what we learned in this lesson, answer the following questions. You will have 20 minutes to complete this exercise. 1. Rank order the following methods of noncommercial contract financing from the least preferred (6) to the most preferred (1). Advance payments Progress payments based on cost Performance based payments Private financing Loan guarantees. Unusual contract financing (although not currently used in DoD) 2. DFARS requires contracting officers to consider PBPs after first agreeing to a contract price based on customary progress payments. Contracting Officers may consider converting from progress payments to PBPs after award if it is in the Government s best interest. Examine the graph below, which shows the potential for PBPs to offer better cash flow than Progress Payments. As a CO, consider which financing method would you prefer between progress payments based on costs, or performance based payments? Which would the contractor (a large business) prefer? CON170, Unit 3 Lesson 2 Contract Financing - Page 49

50 LESSON SUMMARY TLO: 3.2 Given a contracting scenario, differentiate among financing arrangements, their order of preference, and the situations for use. ELO(s): ELO Describe the different commercial financing arrangements, including commercial advance payments, interim payments. ELO Describe the different noncommercial financing arrangements and the order of preference. ELO Define Advance Payments, and describe their appropriate use for noncommercial items. ELO Recognize unusual financing arrangements for noncommercial items. ELO Describe appropriate use of Progress Payments when acquiring noncommercial items. ELO Describe appropriate use of Performance Based Payments when acquiring noncommercial items. ELO Given a contractor need for contract financing, develop a negotiation strategy considering PBPs. ELO Given a PBP event, identify appropriate evaluation criteria. ELO Differentiate between a reasonable PBP expenditure profile, a termination liability schedule, and a front-loaded expenditure profile. ELO Differentiate between cumulative and severable PBP events. ELO Describe the purpose of cost limitation language contained within a PBP special provision. ELO List the steps for negotiating a successful PBP arrangement. CON170, Unit 3 Lesson 2 Contract Financing - Page 50