January 2, 2021
In contract management, advance payments play a vital role. The Contract Manager of a construction project must be familiar with the mobilization and secured advances which are the most common forms of advances in a project. In construction projects, clients pay advances in various forms to the contractors to ease out their cash-flow for the project, as well as to reduce the capital expenditure at the beginning or during the project.
Advance means paying someone before the intended work actually done.
Usual forms of advances paid to the contractors in a construction contract are
While the contractors are benefitted through advance payments, Every advance must have some guarantees to cover the risk of the client.
Generally, Mobilization advances are 5% to 20% of the contract value, but the percentage can vary depending upon the specific requirement of cash quantum for the contractor at the beginning of the project to start the works. Mobilization advances are generally paid against submission of Bank Guarantees (BG) or Corporate Guarantees (CG) by the contractor for an equivalent amount.
In some cases where the percentage is high (usually more than 10% of the contract value), a part of it is paid to the contractor at the beginning of the project and the remaining in phases. In that case, conditions are mentioned in the contract to be fulfilled by the contractor before they get the remaining part. E.g.-Mobilization of a few resources as agreed in the contract, or execution of 25% of the contract value, etc.
On the other hand, the secured advance is the payment released to the contractor by the client throughout the project duration against received materials at the project sites. Usually, this percentage varied from 60% to 90% of the invoice value and paid against non-perishable materials only. The clause should be explicitly written in the contract. The intention is to help the contractor to ease out the cash-flow without waiting for the materials to convert to the bill, which is generally a longer process.
As secured advances are paid to a contractor based on the materials actually received at the site, no bank guarantee is required by the client for this payment. The paid SA amounts are recovered from the running account (RA) bills when the materials are utilized and the bill for the corresponding works is raised by the contractor.
Here are some pro-tips for the contractors for efficiently managing their cash-flow through advances.
Tip 1: Mobilization advances can be interest-bearing or interest-free.
If it is interest-free you should take it from the client as soon as possible after the project starts.
If it is interest-bearing then first prepare a month-wise cash flow (income and expenditure details) for the entire project duration and take the mobilization advance in phases, i.e., exactly at the intervals when you have a negative cash-flow and really need fund support. This will reduce the interest part on the advance.
Tip 2: The Contract Managers should keep a track of the utilization of the MA taken in a project, separately for each installment. Copy of the invoices (if new assets purchased) should be kept with this as evidence.
This can be helpful if the client asks for a utilization certificate before paying the next installments, or maybe for an audit.
Tip 3: The Contract Managers should get to know about the fund status of the client and submit only an equivalent amount of Bank Guarantee (BG) to the client up to which presently the mobilization advance will be released by them. This will ensure proper utilization and avoid idling of BG.
Tip 4: Mobilization advances (MA) are recovered from the running bills. When a substantial amount of the paid mobilization advances are recovered by the client, withdraw the submitted Bank Guarantee (BG) of the full amount of MA, and instead, submit a reduced value of BG.
This will free up the BG limit of your organization which can be utilized elsewhere.
Tip 5: For secured advances against the running items like cement, steel, flooring items etc. the Contract Managers should ensure to:
• Keep entry registers including quantity and value on a regular basis on receipt of the materials.
• Keep track of the reconciliation statements every month and tally the same with the recoveries made till that month.
This will ensure that advances paid against only the used materials being recovered from the running bills of the contractor.