Provisional Billing Rates — Getting Paid Before the Year Closes

At a Glance

Who it applies to

Contractors billing indirect costs on cost-reimbursement, T&M, and other flexibly priced contracts

What it obligates

Propose supportable rates, bill at those rates, and revise them when they no longer approximate the final rates

Governing authority

FAR 42.704 (billing rates), administered through the cognizant federal agency official

Who sets them

The contracting officer or the cognizant auditor, on the basis of your proposal and recent experience

The stakes

Bill too high and you owe a give-back at settlement; bill too low and you finance the government interest-free

What It Is

You cannot wait until a fiscal year closes and an audit concludes to get paid for indirect costs — that would be a two-to-four-year wait for cash you spent this month. FAR 42.704 solves the timing problem with billing rates: the contracting officer or the cognizant auditor establishes rates, on the basis of information resulting from recent review, previous audits or experience, or similar reliable data, at levels that will approximate the final rates for the period. You then bill indirect costs on your interim vouchers using those provisional rates. The mechanism has three features worth internalizing. First, they are explicitly interim. FAR 42.704 requires the billing rates to be adjusted, upward or downward, as necessary when it becomes apparent that they will not approximate the final rates — so a rate is not a fixed entitlement, and a mid-year revision is a normal event, not a failure. Second, everything billed on them is provisional. When the final indirect cost rates are settled under FAR 42.705, all vouchers for the period are trued up: if your final rates came in below your billing rates, you have overbilled and owe the difference back; if they came in above, you are entitled to the shortfall, subject to any contract ceilings and funding limits. Third, they interact with your working capital in a way that is easy to get backwards. Deliberately setting a low billing rate to look conservative or to avoid a future give-back means you are lending the government money at zero interest for a year or more — a genuinely expensive choice for a small firm. Setting a high rate for cash flow means you are spending money you will eventually have to return, often after you have already distributed it as profit. The disciplined answer is neither: propose a rate you can support from a realistic forecast, and then monitor actual-to-provisional variance frequently enough to catch a divergence while there is still a year left to correct it.

When It Applies

• At the start of every fiscal year on any contract where you bill indirect costs.
• When you first win a cost-reimbursement, T&M, or other flexibly priced contract and have no established rates.
• Mid-year, whenever actual experience diverges materially from the rates you are billing at.
• After a significant business change — a large award, a lost recompete, a headcount change, a new facility — that moves your base or your pools.
• As an input to a final rate settlement, since the difference between billed and final rates is what gets trued up.

Key Features

The SDVOSB Angle

The provisional-rate true-up is one of the most common ways a growing SDVOSB gets financially blindsided. The pattern is predictable: a firm sets billing rates from a forecast in January, wins a large contract in April that dramatically expands its direct labor base, and never revises the rates. Because the base grew while the indirect pools did not grow proportionally, the actual rates for the year come in well below the billing rates — so at settlement the firm owes back a large sum on cash it long ago spent and, in a closely held company, likely distributed. Because a small firm's base is small, the swing is proportionally violent in a way it never is at a large prime. Three defensive habits. First, forecast rates against a realistic revenue and headcount plan and re-forecast after any material award or loss, not just at year-end. Second, compute actual year-to-date rates monthly or at least quarterly and compare them to the provisional rates; a variance of more than a couple of points should trigger a rate-revision request to the contracting officer or ACO rather than a hope that it evens out. Third, hold the variance rather than distributing it — treat an over-billed indirect balance as a liability on your own books from the month you identify it. Firms that do this treat rate settlement as an accounting event; firms that don't treat it as a crisis.

How to Comply

1. Build the proposed rates from a documented forecast of pools and bases for the coming year, not from last year's actuals alone.
2. Submit the proposal to the contracting officer or cognizant federal agency official and get the rates established in writing before you bill against them.
3. Compute actual year-to-date indirect rates at least quarterly — monthly if you are growing fast — and compare to the provisional rates.
4. Request a rate revision under FAR 42.704 as soon as it is apparent the billing rates will not approximate the final rates.
5. Reserve the over-billed indirect balance on your own books instead of treating it as available cash or distributable profit.
6. Keep the workpapers supporting each proposed and revised rate; they become the starting point for the incurred cost submission.

Watch Out For

• Setting billing rates once at the start of the year and never revisiting them, which is how large give-backs happen.
• Treating cash received on a provisional rate as earned profit — it is provisional until the final rates settle.
• Deliberately low-balling the rate to be 'conservative,' which finances the government at your expense for a year or more.
• Forgetting that a large new award grows your base and mechanically lowers your rates, even if nothing about your costs changed.
• Assuming the government will notice and adjust the rates for you — the FAR obligation to keep rates approximate runs to both parties, but the exposure is yours.
• Billing at rates that were never formally established, which invites disallowance of the indirect portion of every voucher.

Run the Numbers

Frequently Asked

Primary Sources

• FAR 42.704 — Billing rates
• FAR 42.703-1 — General (indirect cost rates)
• FAR 52.216-7 — Allowable Cost and Payment (clause)
• FAR Subpart 32.6 — Contract Debts

Plain-English reference, not legal, accounting, or tax advice. Cost allowability and accounting determinations are fact-specific, and the FAR, the Cost Accounting Standards, and the statutory dollar thresholds quoted here are amended and escalated for inflation over time. Always read the current FAR text and the cost and payment clauses in your specific contract, confirm the applicable thresholds and your accounting treatment with the contracting officer or cognizant administrative contracting officer, and consult a qualified government-contract accountant or counsel before relying on a cost position, signing a certificate, or submitting a claim.

Related Cost Rules

How It Plays by Contract Type

How You Get Paid

Forms You’ll Use

People You’ll Deal With

Terms Used on This Page

In the FAQ Knowledge Base