Government Contract Financing Options
Cash flow is the number one challenge for government contractors, especially small businesses. The government's payment cycle can stretch 30-60 days after invoice submission, and the upfront costs of contract performance can strain working capital.
Fortunately, the Federal Acquisition Regulation provides several financing mechanisms that help contractors fund contract performance. Understanding these options — and negotiating them into your contracts — can make the difference between profitability and cash flow crisis.
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Progress Payments (FAR 32.5)
Progress payments are the most common form of government contract financing. They allow contractors to receive partial payment for costs incurred during contract performance, before the final product is delivered and accepted. This is particularly important for long-duration contracts where the contractor would otherwise need to finance months or years of work before receiving payment.
Large businesses receive progress payments at 80% of total costs incurred. Small businesses receive a preferential rate of 85% of total costs incurred. These rates are set by DFARS 232.501-1 and cannot be exceeded without a deviation. The remaining 15-20% is paid upon delivery and acceptance of the final deliverable.
Progress payments cover direct costs (labor, materials, subcontracts) and allocable indirect costs (overhead, G&A) incurred in contract performance. Costs must be reasonable, allocable to the contract, and in accordance with generally accepted accounting principles. Profit is not included — progress payments reimburse costs only.
As the contractor delivers products or services and submits delivery invoices, the government reduces (liquidates) the outstanding progress payment balance. The liquidation rate is typically the same as the progress payment rate. The goal is for progress payments to be fully liquidated by the time the contract is complete.
The government protects its progress payment investment through a title clause (giving the government title to all work in progress), limitations on how funds can be used, and the right to reduce or suspend progress payments if the contractor fails to make adequate progress.
Performance-Based Payments (FAR 32.10)
Performance-based payments (PBPs) are the government's preferred financing method because they tie payments to measurable accomplishments rather than costs incurred. Instead of reimbursing a percentage of costs, the government pays a fixed amount when the contractor achieves specific milestones.
The contract establishes measurable events (milestones) with associated payment amounts. When the contractor achieves a milestone and the government verifies it, the payment is made. Milestones can include completion of design reviews, delivery of prototypes, passing of test events, or completion of training. Total PBPs can equal up to 90% of the contract price.
PBPs offer several advantages: higher payment percentage (up to 90% vs. 80/85%), reduced government oversight (no cost accounting review required), faster payment processing, and alignment of payment with performance. Contractors benefit from predictable cash inflows tied to their project schedule.
Effective milestones must be specific, measurable, and verifiable. Avoid vague milestones like “50% complete.” Instead, use objective criteria: “Completion and government acceptance of System Design Review deliverables.” Front-load milestones to provide cash flow during the early stages of performance when costs are highest.
Commercial Item Financing
FAR 32.2 authorizes financing for commercial item acquisitions under FAR Part 12. Commercial financing is different from traditional progress payments because it does not require cost accounting compliance or government title to work in progress.
Commercial financing can take the form of commercial advance payments, commercial interim payments, or delivery payments. The terms are negotiated between the contractor and the Contracting Officer based on standard commercial practice. The key principle is that government financing terms for commercial items should be comparable to what the contractor offers its commercial customers.
For commercial items, the government may provide financing up to the contract price. However, the contractor must demonstrate that the financing terms are consistent with its commercial practices and that the government is not assuming more risk than commercial customers. This makes commercial financing particularly useful for companies that routinely offer payment terms to commercial customers.
Advance Payments (FAR 32.4)
Advance payments are the rarest form of government contract financing. They involve paying the contractor before any work is performed or costs are incurred. Because of the risk to the government, advance payments require approval at the highest levels of the agency.
Advance payments are considered only when: the contract involves a high national priority, no other form of financing is adequate, the contractor cannot obtain private financing on reasonable terms, the government's interest is adequately protected through collateral or other security, and the agency head (or designee) approves the advance.
The government protects advance payments through special bank accounts controlled by the government, liens on the contractor's property, restrictions on how funds can be used, and periodic reporting requirements. The contractor must deposit advance payments in a special account and can withdraw funds only for contract-related expenses.
In practice, most contractors will never encounter advance payments. The other financing methods described in this guide are far more common and accessible.
Assignment of Claims (FAR 32.8)
The Assignment of Claims Act (31 USC 3727) allows contractors to assign their right to receive payment under a government contract to a bank, trust company, or other financial institution. This is one of the most practical financing tools for small businesses because it enables them to obtain loans or lines of credit using government receivables as collateral.
The contractor enters into a financing arrangement with a bank. The contractor then assigns its right to receive contract payments to the bank by providing written notice to the Contracting Officer and the disbursing office. The government then makes payments directly to the bank, which credits the contractor's loan account.
The assignment must be made to a single financial institution, the contract must not prohibit assignment (most do not), the contractor must provide proper notice using the format prescribed in FAR 32.802, and the assignment must cover the entire amount payable under the contract (partial assignments are not permitted).
Many banks are unfamiliar with government contract assignments. Work with a bank that has experience in government contract financing. SBA's 7(a) loan program and the SBA's Surety Bond Guarantee Program can also help small businesses access financing for government work.
Prompt Payment Act
The Prompt Payment Act (31 USC 3901-3907, implemented in FAR 32.9) is every contractor's backstop for cash flow. It requires federal agencies to pay proper invoices within specified timeframes and to pay interest penalties automatically when payments are late.
General supplies and services: 30 days from the later of receipt of a proper invoice or acceptance of goods/services. Construction contracts: 14 days. Meat, dairy, and perishable products: 7 days. The clock starts when the agency receives a “proper invoice” that meets all requirements.
Interest accrues automatically on late payments at the rate set by the Secretary of the Treasury (published semi-annually). The contractor does not need to request interest — the agency is required to pay it. Interest begins on the day after the payment due date and continues until the date of payment.
A proper invoice must include: contractor name and address, invoice date and number, contract number and order number, description of supplies or services, quantities and unit prices, applicable payment terms, and any other information required by the contract. An invoice missing required elements is not “proper” and does not start the payment clock.
Prime contractors must pay subcontractors within 7 days of receiving payment from the government for the subcontractor's work. If the prime pays late, it must pay interest at the same Treasury rate. This flow-down provision protects small business subcontractors from primes who delay payments.
Related Guides
Government Invoicing
How to submit proper invoices, WAWF procedures, and resolving payment issues.
DCAA Accounting
Compliant accounting systems required for cost-type contracts and progress payments.
Startup Guide to GovCon
Cash flow management and financing strategies for startups entering government contracting.
Frequently Asked Questions
What is the difference between progress payments and performance-based payments?
Progress payments (FAR 32.5) are based on costs incurred — the contractor submits invoices for costs spent, and the government reimburses a percentage (80% for large businesses, 85% for small businesses). Performance-based payments (FAR 32.10) are tied to measurable performance milestones, not costs. The contractor receives a fixed payment when it achieves a defined deliverable or milestone. Performance-based payments can be up to 90% of the contract price and are preferred by the government because they reduce oversight costs and align payment with results.
How does the Prompt Payment Act protect contractors?
The Prompt Payment Act (31 USC 3901-3907) requires federal agencies to pay invoices within 30 days of receipt of a proper invoice (or acceptance of goods/services, whichever is later). If the agency fails to pay on time, it must automatically pay interest at the rate set by the Treasury Department. The contractor does not need to request interest — it is mandatory. For construction contracts, the payment deadline is 14 days. Contractors should ensure their invoices meet all "proper invoice" requirements to start the 30-day clock.
Can small businesses get advance payments on government contracts?
Advance payments (FAR 32.4) are rare in government contracting and require high-level approval — typically by the agency head. They are authorized only when no other financing method is adequate, the contractor cannot obtain private financing, the contract involves a high national priority, and the government's interest is adequately protected. Small businesses may have a slightly easier case for advance payments if they can demonstrate that the contract work cannot begin without upfront funding and no alternative financing is available. However, advance payments remain uncommon.
What is assignment of claims and how does it help with financing?
Assignment of claims (FAR 32.8) allows a contractor to assign its right to receive payment under a government contract to a bank or financial institution. The bank then receives the government's payments directly. This enables the contractor to obtain a line of credit or loan using the government contract as collateral. The Assignment of Claims Act requires that the assignment be made to a single financing institution, the contract must not prohibit assignment, and the contractor must provide proper notice to the Contracting Officer and the disbursing office. This is one of the most practical financing tools available to small businesses.
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