Progress payments

What Are Progress Payments?

Progress payments are partial payments made by a client to a contractor as work on a long-term project or contract advances, rather than a single lump-sum payment at the end. This financial mechanism falls under the broader category of Project Finance. Progress payments are typically based on the completion of predefined stages, the incurrence of costs, or a percentage of the overall work completed. They help manage Cash flow for both the Contractor and the Client, ensuring that the contractor has sufficient Working capital to continue the project without significant financial strain.

History and Origin

The practice of making incremental payments for large, extended projects has deep roots, evolving alongside the complexity of major undertakings, particularly in the Construction industry and government contracting. As projects grew in scale and duration, demanding substantial upfront investment in materials, labor, and equipment, waiting for full completion for payment became economically unfeasible for contractors. This necessity led to the formalization of payment schedules tied to work progression. In U.S. federal contracting, for instance, regulations like the Federal Acquisition Regulation (FAR) explicitly define and govern the use of progress payments to facilitate the execution of contracts that involve significant lead times or expenditures¹⁰, ¹¹. The American Institute of Architects (AIA) also developed standardized forms (like the G702 and G703) to streamline progress payment applications in the construction sector, reflecting a widespread industry adoption of this payment method⁹.

Key Takeaways

Progress payments are periodic partial payments made during the course of a long-term contract.
They are common in industries like construction, defense contracting, and large-scale manufacturing.
The primary purpose is to provide steady cash flow for the contractor, reducing the need for extensive upfront capital and mitigating financial risk.
Payments are typically tied to measurable progress, incurred costs, or agreed-upon milestones.
They often involve a specified retainage percentage, which is withheld until project completion and final acceptance.

Formula and Calculation

Progress payments are not governed by a single, universal formula but are typically calculated based on either costs incurred or the percentage of work completed. A common approach in many contracts is to pay a set percentage of the total project value or incurred costs as work progresses.

For a cost-based progress payment, the formula might resemble:

P_n = (C_{total} \times R) - P_{prev}

Where:

(P_n) = Current progress payment amount
(C_{total}) = Total allowable Cost overruns incurred to date
(R) = Agreed-upon progress payment rate (e.g., 80% or 85% for federal contracts⁸)
(P_{prev}) = Sum of all previous progress payments made

Alternatively, for a percentage-of-completion method, the calculation for each payment period might be:

P_n = (V_{contract} \times \%Completion_{current}) - P_{prev}

Where:

(P_n) = Current progress payment amount
(V_{contract}) = Total contract value
(%Completion_{current}) = Percentage of the total project completed for the current payment period
(P_{prev}) = Sum of all previous progress payments made

Each Invoice for a progress payment must detail the work performed or costs incurred during the period, allowing the client to verify the basis of the payment request.

Interpreting Progress Payments

Interpreting progress payments involves understanding their role in managing a project's financial health. For a contractor, consistent and timely progress payments indicate a healthy Cash flow and allow for the continuous funding of operations, including payroll and material procurement. Conversely, delays or disputes in receiving progress payments can signal financial issues for the Client or problems with the contractor's documentation or performance.

For the client, approving progress payments means validating that the work claimed by the Contractor has indeed been completed or costs incurred, providing a mechanism for oversight. It also allows the client to manage their own budget effectively, releasing funds as value is delivered, rather than committing the full amount upfront. The structure of these payments inherently ties financial outflow to tangible project advancement.

Hypothetical Example

Consider "BuildWell Construction" which has a $1,000,000 contract to build a new commercial office building for "Global Holdings Corp." The contract stipulates monthly progress payments at an 85% rate of incurred costs, with 15% Retainage withheld until final project completion.

In the first month, BuildWell incurs $100,000 in costs for foundation work, materials, and initial labor. They submit an Invoice to Global Holdings for a progress payment.

The calculation for the first payment would be:
Progress Payment = (Costs Incurred * Payment Rate)
Progress Payment = ($100,000 * 0.85) = $85,000

Global Holdings would pay BuildWell $85,000 for the first month's work. The remaining $15,000 (15% of the $100,000 incurred costs) is the retainage, which accumulates over the project and is released upon final satisfactory completion and acceptance. This arrangement ensures BuildWell has funds to continue work, while Global Holdings maintains a portion of the funds as a safeguard for performance.

Practical Applications

Progress payments are a fundamental component of financial management across various sectors, especially in large-scale projects. They are widely applied in:

Construction: From residential housing to major infrastructure projects, progress payments ensure that builders have the necessary funds to cover ongoing expenses like labor, materials, and Vendor payments⁷. This allows projects to proceed without the contractor having to finance the entire project upfront. Standardized forms, such as those provided by the American Institute of Architects (AIA), facilitate these applications, ensuring consistency and transparency in the billing process⁶.
Government Contracting: Federal, state, and local governments frequently use progress payments for long-term contracts for defense systems, public works, and IT services. This practice is detailed in regulations like the Federal Acquisition Regulation (FAR), which outlines the conditions, rates, and administration of these payments, often at rates like 80% or 85% of incurred costs for contractors⁴, ⁵.
Manufacturing and Supply Chain: For large orders of custom machinery, specialized equipment, or extended production runs, manufacturers often receive progress payments as components are acquired, assembled, or significant production milestones are met. This helps manage the Supply chain and reduces the financial burden on the manufacturer.
Software Development and IT Projects: For complex custom software development or IT system integrations that span many months or years, clients may make progress payments as specific modules are completed, tested, and approved, or as development teams meet agreed-upon delivery targets.

This payment structure provides mutual benefits, offering financial stability for the service provider and allowing the client to tie payments directly to tangible project advancement.

Limitations and Criticisms

While advantageous for managing project finances, progress payments are not without limitations or potential criticisms. One significant concern is the potential for disputes over the actual progress or the accuracy of reported costs. Determining the precise "percentage of completion" can be subjective, leading to disagreements between the Contractor and the client regarding payment eligibility. In federal contracts, for instance, strict accounting standards are applied to costs to prevent overpayment, yet disputes can still arise over allowable versus unallowable costs³.

Another limitation is the administrative burden. Both parties must diligently track progress, document expenses, and process Invoice submissions and approvals. Inefficient management of this process can lead to payment delays, impacting the contractor's Cash flow and potentially leading to project slowdowns or even legal action if a Lien is placed. Furthermore, while progress payments mitigate some Risk management for the contractor by providing funds, they transfer some risk to the client, who is paying for work not yet fully delivered or guaranteed. This is why mechanisms like Retainage and Performance bonds are often included in contracts utilizing progress payments to protect the client's interests.

Progress Payments vs. Milestone Payments

While often used interchangeably, progress payments and Milestone payments have distinct characteristics.

Feature	Progress Payments	Milestone Payments
Basis of Payment	Typically based on a percentage of work completed (e.g., 25% of the foundation finished) or costs incurred.	Tied to the full completion and acceptance of a predefined, significant stage or "milestone" of the project.
Frequency	Often regular, scheduled intervals (e.g., weekly or monthly) as work continuously advances.	Irregular, contingent on reaching specific, discrete project achievements (e.g., foundation completed, framing completed).
Verification	Requires ongoing assessment of the work's physical percentage or detailed tracking of costs and Accounts receivable.	Verification is generally simpler, focusing on whether a specific, tangible event has been fully achieved.
Risk Profile	Provides more continuous Cash flow for the contractor; client pays for partial work.	May involve larger, less frequent payments for the contractor; client pays only upon full deliverable completion.

Progress payments emphasize continuous funding linked to the flow of work, even if a specific "milestone" isn't fully achieved. Milestone payments, conversely, are more about discrete, verifiable achievements that unlock a specific payment, regardless of the continuous costs incurred between those achievements. Both aim to break down large project costs into manageable segments, but their triggers and calculation methods differ.

FAQs

What industries commonly use progress payments?

Progress payments are most common in industries characterized by long project durations and significant upfront costs. This includes the construction industry, shipbuilding, defense contracting, large-scale manufacturing, and major software development projects².

Are progress payments the same as advance payments?

No, they are different. An Advance payment is typically a payment made before any work begins, often as a down payment or upfront funding. Progress payments, however, are made as work progresses and are tied to the actual completion of work or incurrence of costs¹.

Why do companies use progress payments instead of a single lump-sum payment?

Companies use progress payments to manage financial risk and ensure steady Cash flow throughout a project. For the contractor, it prevents them from having to finance the entire project themselves before getting paid. For the client, it allows them to tie payments directly to demonstrated progress, ensuring funds are released only as value is delivered. This also helps detect issues early by monitoring work quality at each payment interval.

Can progress payments be withheld?

Yes, progress payments can be withheld or reduced under specific contractual conditions. Common reasons for withholding include unsatisfactory work, failure to meet quality standards, significant project delays, or disputes over the accuracy of reported progress or costs. Contracts often include clauses for Retainage, where a percentage of each payment is intentionally withheld until final project completion and client acceptance.