Financing government contracts with a guide for small business owners can be a fruitless search for a funding source who understands your situation. Factoring companies know how hard and frustrating it can be for a small business owner to find a good company who can finance government contracts.
Government agencies at all levels (federal, state and local) purchase a wide range of goods and services in the ordinary course of business. If appropriately managed, represent good customers for small business. A total of the government’s spending in the US, this will account for roughly one-third of the annual GDP. Making it, in aggregate, one should not ignore a large purchasing sector. Having a strategy and plan in place for financing and managing these government sales, from initial contract through payment, is essential for small business owners in ensuring these sales are both profitable, and sustainable.
Features of Government Sales
Selling to the government can differ from transacting other commercial business. On the one hand, the government’s ability to pay is generally assured. Meaning business owners are spared having to make a fundamental credit adjudication before doing business.
On the other hand, the government’s willingness to pay, or the timeliness of payment can be another matter. Often government agencies pay on a pre-defined payment schedule that can be difficult to negotiate. At the same time, vendors must follow strict protocols and documentation guidelines surrounding the fulfillment of a product or service throughout the production, delivery, and billing cycles.
Failure to adhere strictly to these requirements can result in payment delays, or in a dilution of collections vis a vis amounts invoiced. Also, given the sheer size of the government’s buying power, doing business with a federal, state, or local enterprise can quickly represent a significant percentage of overall sales, making careful management of this business-critical to the health of an entire company. For these reasons, small business owners should partner with a firm that specializes in doing business with the government.
Managing and Financing Government Sales
Given their breadth of services, and “ease of doing business,” finance companies with a government specialty are among the best alternatives available to small business owners in managing this business successfully. Being a finance company, these firms recognize the government’s ability to pay is mostly assured. Consequently, they have created and built specialty practices to enable small business to take on government work.
Firms with familiarity in navigating the rudiments and timing of government payments are often willing to extend financing not only against sales but often for the initial purchases of raw materials. They can also provide help with paperwork and compliance matters that affect the timing of payment. Together this represents a seamless, and ultimately an attractive way for a small business owner to safely take on government business while addressing the twin risks of doing so—the magnitude of the orders relative to overall company size, and extended payment terms.
An Example
Sales to the government are often conducted under a contract specifying which goods and services to purchase, along with terms of sale including pricing and timing. Let’s consider, for instance, the case of a cabinet maker who contracts to sell new units to a local federal government agency. The business owner is understandably pleased because the contract represents a significant increase in overall sales.
Upon execution of the agreement, the owner must now purchase raw materials, finance labor for construction and delivery of the finished product. After completion, the only thing the owner needs to do is wait for some period before receiving payment. Quite often 30-90 days following final delivery. While the national profit margin embedded in the overall contract appeared attractive to the owner at the outset, the returns under this arrangement are at risk of being eroded if the enterprise has to source cash sufficient to buy goods and make payroll throughout the manufacturing, delivery, and payment cycle. Taken to an extreme, absent proper financing, this work could prove detrimental to the overall health of the entire business –under what otherwise appears to be an attractive contract.
Engaging Financing Help
Finance companies with a specialty in government financing are positioned to specifically address the needs and requirements of small business owners engaged in these arrangements. Among the services available to our cabinet maker, are the following:
- Purchase Order financing for the purchase of raw materials
- Work in Progress financing for labor costs in constructing the units
- Accounts receivables financing against the final invoices
- Assistance in following for payment
Purchase Order Financing:
Small business owners can often begin the funding of a government contract through a “purchase order” financing. Under this type of arrangement, the lender purchases the goods directly on behalf of the business, providing up to 100% of the price. This arrangement typically works best under a pure distribution contract. Ideally, the shipment of goods is direct from the source location to the government agency. Shipment may also be to a third party bonded warehouse. This way the lender controls the movement of the goods while holding title to them. Hence a liberal lending formula, which may also include financing ancillary costs such as freight, taxes, and storage.
In situations where the business is taking these goods into a manufacturing process, the lender has to underwrite the company’s ability to perform, and credit may not be as readily available. Regardless, it is essential for business owners to begin discussions with a financing partner before the commencement of the activity. Ideally, even before executing on a government contract. This ensures that financing is in place for every step of the procurement, production and fulfillment cycle. They are starting at the very beginning until the completion of orders.
Work in Progress Funding:
Financing can also be found for production in the way of work in progress, or WIP funding. A narrower specialty compared to purchase order financing, it is arguably financing the point of highest risk in the entire selling cycle. Lenders will often look to stand in first place on any available collateral to bridge the timing gap between raw material and finished goods. They will typically assume the right to step into a manufacturing process, finish the products and sell at liquidation prices under any default event. This is a conventional approach, and when viewed from the side of the lender, not unreasonable. Owners with confidence in their manufacturing capability should feel comfortable with terms set out by the WIP lender. While it may be the most stringent part of financing a contract, it is also typically the shortest!
Accounts Receivable Financing:
Financing government accounts receivable through a finance industry specialist is well defined, and a widely accepted practice. In 1940, the US Government passed the Federal Assignment of Claims Act (FACA) making it easier for small business to provide goods and services to the government, by making it easier to finance the amounts due under any contract. Under this arrangement, the business assigns payment under the contract directly to the lender or finance company. Meaning the payments go directly to the lender. Doing so allows the finance company to service and retire the company’s debt without relying on the business to initiate repayment.
While FACA has the appearance of being in place to protect lenders (and it does), it has intended consequences. Once is to allow small business to borrow against these receivables at attractive advance rates and for longer terms than would otherwise be commercially available. Here too though, it is vital that discussions between the business owner and lender take place early in the process. That way, there is a clear understanding of financing management — also, good management of expectations and maximization of profits.
Collections Assistance:
Under an Assignment of Claims arrangement, the finance company is a party to the contract. Also, it typically has the rights to follow closely for repayment. Other rights to follow include ensuring completion of any necessary paperwork and following up with the Payor. Having a lending partner that directly receives payment from the customer can create a collaboration. Such collaboration is between the lender and the business owner. A collaboration that often can prove useful, reducing a collection burden on the enterprise.
Financing Government Contracts Summary:
- Government spending on goods and services represents a significant portion of overall spending
- Doing business with a government agency can be “good” and “bad.”
- “Good” in that government typically has unquestioned ability to pay
- “Bad” in the sense that large contracts or slow paying contracts could hurt the overall business
- Finance companies who are government financing specialists are ideal partners for a small business doing government work
- Finance companies can provide support for the entire production and delivery cycle. From raw materials purchase, financing of the manufacturing stage, and support after the sale through receivables lending
- It is important for the small business owner to engage a government finance company specialist early in the process. Ideally before executing a contract