Pricing Matters – Percentage of Profit?

What profit percentage should I use for my bids for government contracts?

It is well to begin by recalling the government’s position on profit. Federal Acquisition Regulation (FAR) 15.404-4 states: “It is in the Government’s interest to offer contractors opportunities for financial rewards sufficient to stimulate efficient contract performance, attract the best capabilities of qualified large and small business concerns to Government contracts, and maintain a viable industrial base.” ‘Sufficient financial rewards’ is usually interpreted as ‘reasonable profit.’ We can say then that not only are small (and large) businesses entitled to a reasonable profit, but it is in the Government’s interest that they receive a reasonable profit because they then have an incentive to perform efficiently and effectively on their Government contracts.

For the discussion of profit, we note that U.S.C. 2306(d) and 41 U.S.C. 254 (b) impose certain statutory limitations with respect to profit: Under a cost-plus-fixed-fee contract, the cap is 15 percent for fee for experimental, developmental, or research work, 6 percent for fee for architect-engineer services for public works or utilities, and 10 percent for other cost-plus-fixed-fee contracts.

The Federal Acquisition Regulation (FAR) addresses the subject of profit in Part 15. FAR 15.404-4 establishes six factors for the analysis of profit. They are:

  1. Contractor Effort. Measures the complexity of the work and the resources required. There are four subfactors that are to be considered in determining contractor effort. They are:
    a. Material acquisition. Measures the managerial and technical effort needed to obtain the required purchased parts and material, subcontracted items, and special tooling.
    b. Conversion direct labor. Measures the contribution of direct engineering, manufacturing, and other labor to convert the raw materials, data, and subcontracted items into the contract items.
    c. Conversion-related indirect costs. Measures the contribution of the contractor’s indirect costs to contract performance.
    d. General management. Measures the composition of the contractor’s other indirect costs and general and administrative (G & A) expense, their composition, and their contribution to contract performance.
  2. Contract Cost Risk. Measures the degree of cost responsibility and associated risk that the contractor will assume as a result of the contract type contemplated and considering the reliability of the cost estimate in relation to the complexity and duration of the contract risk.
  3. Federal Socioeconomic Programs. Measures the contractor’s support to Federal socioeconomic programs, such as small disadvantaged businesses, women-owned businesses, veteran-owned businesses, etc.
  4. Capital Investments. Takes into account the contribution of contractor investments to efficient and economical contract performance.
  5. Cost-Control and Other Past Accomplishments. Considers the ability of the contractor to perform similar tasks effectively and economically.
  6. Independent Development. Recognizes independent development efforts by the contractor that are relevant to the contract end item without Government assistance.

In addition to the preceding factors, each agency may include ‘Additional Factors’ in its structured approach or take them into account for profit analysis. It is to be noted that each of the factors may provide additional profit opportunities for the contractor.

The U.S. Department of Defense has a method to calculate profit. The method is called Weighted Guidelines. It is contained in DD Form 1547. The Weighted Guidelines method is based on the following contractor risk factors: technical, management cost control, performance risk, and contract type risk. In addition, working capital, facilities capital, and cost efficiency are important components of the method. The Defense Acquisition University (DAU) course CLC 104 Analyzing Profit or Fee provides excellent practice with the DoD Weighted Guidelines method.

In the final analysis, there is no magic answer for determining the profit percentages to be used in proposals for government contracts. The profit percentages should be based on the FAR factors identified and described above. At the same time, it should be remembered that profit percentages exist in the market place where competitive forces are usually in play. The profit analysis factors, as well as the interplay between competition and profit, will make for situations and outcomes that are continuously fascinating and exciting for both participants and observers.

Pricing Matters is a regular feature by Ronald Marta.  Watch for future posts on a wide range of pricing issues.


More about Procurement Technical Assistance Centers (PTACs)

Ninety-eight PTACs – with over 300 local offices – form a nationwide network of procurement professionals dedicated procurement professionals working to help local businesses compete successfully in the government marketplace. Funded under the Defense Logistics Agency’s Procurement Technical Assistance Program through cooperative agreements with state and local governments and non-profit organizations, PTACs are the bridge between buyer and supplier, bringing to bear their knowledge of both government contracting and the capabilities of contractors to maximize fast, reliable service to our government with better quality and at lower costs.


Pricing Matters – Accounting Policies and Procedures

“What are accounting policies and procedures?”

Written accounting policies and procedures can facilitate significantly the accounting system audit. This article will offer guidance with respect to establishing and documenting accounting policies and procedures.

The first question to be asked is, “What are accounting policies and procedures?”

Simply put, they are written statements. Accounting policies provide broad conceptual guidance. They express “what” is to be done. Procedures tell “how” the policy statements are to be implemented. Procedures are subsidiary to policy statements.

Why are accounting policies and procedures important? They provide a basis for what is or is not done in the company, as well as how things are or are not done. They make for the soundness and reliability of the accounting system. They also make for the consistency over time of the accounting system.

FAR Part 9 states that contractor qualifications should include “the necessary organization, experience, accounting and operations controls, and technical skills” for a government contract. Also, more and more today, government solicitations contain the requirement that an offeror must have an acceptable accounting system in order to submit a bid for the procurement. Written policies and procedures will go a long way to assure that the accounting system is acceptable. Moreover, they can be an invaluable tool if a company’s accounting system is ever audited.

To some degree, accounting systems will vary from company to company. However, there remain common elements. Below is a checklist of topics that should be addressed in a company’s accounting policies and procedures. All the elements share the need for proper internal controls.

  1. Flowchart of Accounting and Reporting System. The flowchart can provide a valuable overview of the system.
  2. Type of System. The description should identify the system, for example, manual, electronic, etc., as well as specific characteristics.
  3. Chart of Accounts – Establishes the basic structure of the accounting system. It is essential that the chart of accounts be in the government format.
  4. Costs – Must be grouped in the government format, especially, direct, indirect, and unallowable costs.
  5. Budgeting – Valuable tool for tracing a business’s progress against plans. Can also help with important decisions, such as hiring of staff and making major purchases.
  6. Accounting for Revenue – Timely preparation and distribution of invoices, prompt processing of payments, and accuracy of records are imperative.
  7. Accounting for Assets
    • Cash Management. Planning and control are critical.
    • Accounts Receivable – Valuation, probability of collection, discounts.
    • Inventories – Cost determination.
    • Property, plant, and equipment – Acquisition costs, valuation.
    • Capitalization – Types of assets and dollar thresholds.
    • Depreciation – Asset cost, service life, residual value, and method of cost allocation.
  8. Accounting for Liabilities – Key ideas: recording, payment, valuation.
  9. Purchasing – Major concerns: Process and responsibilities.
  10. Timekeeping – System should be able to track labor costs from time cards to jobs/contracts.
  11. Payroll – Validity and accuracy of transactions are critical. Related to payroll are employee hiring and new employee orientation, job descriptions, salary adjustments, performance appraisals, and disciplinary actions.
  12. Office Tasks and Reporting – For small businesses, division of duties can be critical.
  13. Bank Statements – Who has responsibility for reconciliations and what is the frequency of the reconciliations?
  14. Records Management – Procedures to manage records should be clearly defined.
  15. Financial Statements – Types and uses of statements should be primary focus.

One final note: written Accounting Policies and Procedures should be reviewed periodically and updated as necessary.

 

Pricing Matters is a regular feature by Ronald Marta.  Watch for future posts on a wide range of pricing issues.


More about Procurement Technical Assistance Centers (PTACs)

Ninety-eight PTACs – with over 300 local offices – form a nationwide network of procurement professionals dedicated procurement professionals working to help local businesses compete successfully in the government marketplace. Funded under the Defense Logistics Agency’s Procurement Technical Assistance Program through cooperative agreements with state and local governments and non-profit organizations, PTACs are the bridge between buyer and supplier, bringing to bear their knowledge of both government contracting and the capabilities of contractors to maximize fast, reliable service to our government with better quality and at lower costs.