Budgeting and Forward Pricing Rates

For many companies, this time of the year is the beginning of budget season. Budgeting is one of the primary tools used in financial planning and tracking, and it sets forth a reasonable expectation of what a company anticipates spending and making in the coming year or years. The process also allows companies to develop indirect rates that can be used in setting market prices, developing cost proposals and invoicing contracts.

Budgets and forecasts are not only used by internal management, they are often required by outside users, such as financial institutions and government auditors. Lenders want to know that a company has a reasonable expectation of repaying debt, while the government auditors want confidence that a company can provide goods and services for their proposed pricing quotes. While it is important to know the cost of running a business, it is also important to understand the correlation between those costs, revenue and profitability. Indirect rates, developed during the budgeting process, are the ratio of indirect costs to direct costs and are used in developing cost proposals and billings on cost-type contracts. The rates used cannot be arbitrary, but must be justifiable and supported by figures developed during the budgeting process.

Typical budgets are done on an annual basis and follow the company’s fiscal year. The budgeting process can be time-consuming and therefore starts several months prior to the year being budgeted. Some companies will develop multi-year forecasts in anticipation of future contract bids. The data used in compiling the budget should include all known expenses, like current employee salaries, office lease expense and existing contract obligations, as well as reasonable estimates of more variable expenses, like anticipated new hire salaries and expenses associated with anticipated new contract awards. Forecasted revenue should also be a reasonable estimate, derived from sources such as existing contracts, anticipated awards and historical trends. After compiling all of the necessary data and estimates, the forecast will provide management with expected revenues, profitability and indirect rates for the coming year or years.

Once the budget is finalized and prior to the beginning of the forecasted fiscal year, the indirect rates should be forwarded to the cognizant DCAA office or Administrative Contracting Office (ACO). The submission should include all indirect rates, including the Pool and the Base descriptions and values. Once received by the DCAA or the ACO, the rates become the Provisional Billing Rates for that year and should be used for billing cost-type contracts in that year. The rates should also be used in all pricing proposals.

The budgeting process can seem daunting, but it does not have to be. Given enough time and thoughtful input, the budget is a very useful planning tool. For more information regarding Provisional Billing Rates, see FAR 42.704 or feel free to give us a call.

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