Engaging in government projects may seem appealing to construction companies offering the promise of steady long-term projects. However, the potential financial risks associated with taking on federal contracts should not be overlooked. According to the Small Business Administration’s data, even though 23% of government contracts are reserved for small businesses, many face challenges meeting the requirements. Let’s delve into five challenges that you as a small contractor should be aware of before pursuing such opportunities. It is essential, for construction businesses involved in government contracts to grasp the significance of these pitfalls.

Top 5 Financial Risks of Landing Federal Contacts

  1. Slow Payments
  2. Additional Upfront Costs
  3. Compliance and Regulation Costs
  4. Additional Requirements Such as Bonding and Insurances
  5. Complexity and Costs Associated with the Bidding Process

1. Delayed Payments Causing Cash Flow Challenges

Getting paid on government contracts can often take additional time despite the Prompt Payment Act of 1988 mandating payment within 30 days. Delays are still common, according to the U.S. Government Accountability Office (GAO). These delays pose a challenge for contractors and other small businesses. Such delays in working capital can lead to cash flow issues that make it difficult to pay subcontractors and cover expenses promptly. Being financially prepared for these delays is crucial. Having a plan in place, such as AR factoring or obtaining a line of credit is essential.

2. High Working Capital Requirements

Federal projects often require significant upfront investment. The Associated General Contractors of America recommends that contractors typically need working capital equal to 5-10% of their annual revenue. While that is ideal, it is not always possible, especially if you have other contracts in the works.

3. Added Compliance Costs and Regulatory Burden

Government contracts come with strict regulatory requirements that increase your compliance costs and regulatory burden. And these costs are increasing. In fact, Thomson Reuters’ Cost of Compliance Survey confirms that 61% of firms saw their compliance costs increase in recent years.

These costs include time and resources spent on documentation, reporting, and maintaining compliance with federal regulations.

4. Stringent Bonding and Insurance Requirements

Performance and payment bonds are mandatory for federal projects over $100,000, as per the Miller Act bonding requirements. The Small Business Administration notes that obtaining these bonds can be expensive and difficult to receive for small contractors.

>> IN DEPTH READING: Miller Act Bonding Requirements

Additionally, government projects often require higher insurance coverage — yet another financial strain.

5. Bidding Process Complexities and Costs

The federal bidding process is complicated and resource intensive. A study by the Fails Management Institute found that the average cost of preparing a government contract bid ranges from $3,000 to $5,000. Understanding the government contract bidding process is crucial for small contractors to avoid making costly mistakes. It you are aggressive lowballing your bids to obtain contracts can result in thin margins or worse, negative margins, if the project’s costs are higher than anticipated.

Is Taking on Federal Contracts Smart for Construction?

While government contracts offer opportunities, they also present significant financial risks for small contractors. Careful planning and well-thought-out financial fallback strategies are essential for success in this sector. One effective solution to mitigate these risks is having a fallback option like Accounts Receivable factoring. It is designed to help fill in those cash flow gaps that arise when working on government contracts.

>> RELATED READING: Duty to Proceed Clauses in Government Contracts Can Kill Your Business

Which Factoring Company Offers Federal Contract Financing?

When assessing a factoring company, you need to find one that has all the basic factoring features, services and benefits, while still having the added expertise of working with federal contracts. The CapitalPlus team is registered and active with the U.S. Federal Government Systems Award Management (SAM) and has the expertise to navigate the Assignment of Claims Act. This specialized knowledge positions us to provide tailored financial solutions for government contractors.

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