Advance Payments in Construction Contracts: Ultimate guide for 2 Types of Advances.

In construction projects, advance payments play a crucial role in facilitating the smooth execution of contracts. These payments, often made before the commencement of work, help contractors cover initial costs, mobilize resources, and mitigate financial risks. In this article, we will explore the benefits, risks, and best practices associated with advance payments in construction.

Benefits of Advance Payments

1. Project Mobilization: Advance payments enable contractors to mobilize quickly, covering initial expenses such as site preparation, equipment procurement, and labour hiring. This ensures that the project can kick off without unnecessary delays.
2. Cash Flow Management: Construction projects often require significant upfront investment. Advance payments help contractors maintain a healthy cash flow, allowing them to meet financial obligations promptly and avoid delays in project execution.
3. Risk Mitigation: For contractors, advance payments act as a form of insurance against project cancellations or delays. It provides a level of financial security and minimizes the impact of unforeseen circumstances.
4. Competitive Advantage: Offering flexible payment terms, including advance payments, can make a contractor more attractive to clients. This competitive advantage can lead to winning more projects in a highly competitive industry.

Types of Advance Payment

In the construction contract, there are two types of advance payment known so far. They are Mobilization advance and Secured advance also known as Material advance.

Mobilization Advance:

A Mobilization Advance is a payment made by the client to the contractor to help cover the initial costs associated with setting up and mobilizing resources for a construction project. This advance is typically provided to the contractor at the beginning of the project, enabling them to start activities such as site preparation, equipment mobilization, and hiring of personnel.

The purpose of the mobilization advance is to assist the contractor in overcoming the initial financial burden of starting a project before any progress payments or milestones are achieved. It helps ensure that the contractor has the necessary funds to begin work promptly and efficiently. The amount of the mobilization advance is usually a percentage of the total contract value and is specified in the contract documents.

Also, read: 5- Types Of Estimates in Construction Projects

Secured Advance:

A “Secured Advance,” also known as a “Material Advance,” in the context of construction contracts, refers to a form of financial assistance provided to the contractor to procure or secure necessary materials for a construction project. This advance is aimed at helping the contractor overcome the initial costs associated with purchasing materials before the project progresses to a stage where progress payments are made.

The secured advance is similar to a mobilization advance, but it is specifically earmarked for obtaining materials. It ensures that the contractor has the funds needed to acquire construction materials such as steel, concrete, or other essential components before the actual construction work begins. Like mobilization advances, secured advances are typically recouped by the project owner through deductions from future progress payments.

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Limits of Advance Payment

• For mobilization advance, the limit of payment is usually 10 to 15 % of the contract price.
• For secured (material) advance, the limit is 75 to 100% of the materials brought to the site.

Method of Payment

1. Mobilization Advance:
   • To receive mobilization advance, it is mandatory to submit a Bank Guarantee to the client as outlined in the contract norms.
   • The guarantee should be an irrevocable or unconditional bank guarantee from a reputed Financial Institution.
   • The amount in the guarantee shall be as same as
   • The guarantee is submitted to say that the contractor can perform the work under any condition specified in contract documents. In the event of the contractor’s failure to fulfil the contractual obligations, the guarantee is activated, allowing the client to recover the advance amount or the value of the unperformed work from the bank.
2. Secured Advance:
   • This advance is only paid when the contractor has obtained the construction materials at the site for incorporation in the assigned construction work.
   • The construction materials bought and stored at the site are categorized as either perishable or non-perishable materials. Perishable items are exempted from the advance payment. For example, cement is not paid for secured advance.

Advance Payment Recovery

Both types of advance payment are recouped with the progress of the construction work.

1. Mobilization Advance:
   • The recoveries of advance are done in the percentage of the advance amount through running account bills (RA bill).
   • As the physical progress is 80 per cent of the total work, the recovery of the advance shall be 100 per cent.
2. Secured Advance:
   • This advance is recouped from the progressive running account bills of the contractor as the project advances.
   • The recovery process is conducted as the materials are incorporated into the construction activities.

Example of Advance Recovery:

The contractor is carrying out the construction work worth of Rs. 80,005,000, and claimed his 1st RA bill of Rs. 2,002,553. Also, the firm has claimed an advance by submitting the Bank Guarantee of 10% of total contract amount and Secured advance of Rs. 1,000,000 for construction materials at site.

Also, read: Running Account Bills (RA Bill) in Construction Contract