Advance payments are meant to provide financial aid to the vendor by providing initial funding for jump-starting the project. It also shows financial commitment and project approval from the client.
Advanced payments are beneficial to the supplier, but are very risky for the client because the prepaid goods or services may not get delivered as planned. What if the vendor disappears with the advance payment? This would attack and distort the project's time and cost objectives.
In order to mitigate this project risk, the project manager may request a sort of surety before supplying the required advance payment. Most project managers would settle for an Advance Payment Guarantee (APG) from a reputable bank.
But banks often confuse the main goal of an APG on projects. Many times, the banks take care of operational risk while ignoring the aspirations of managing project risk.
For instance, banks in Nigeria, where I work, may request a 100 percent cash backed prerequisite for an APG. The insistence of 100 percent cash backup connotes seizure of the funds, which are meant for the project (as provided by the client).
It's good risk management on the bank's part. If the vendor flees with the advance payment, the bank would live up to its guarantees by taking the seized funds back to the client.
To a discerning mind, this antagonizes the essence of project risk management. The funds from an advance payment are primarily meant to be an inflow into the project to mitigate the initial funding challenges of the project. But the vendor would be exposed to sourcing the same funds that had been provided by the client, which would delay the project.
Any bank that is familiar with risk management should be willing to cater to the peculiar needs of the project objectives. There could be other ways of monitoring advance payment disbursement to the vendor as opposed to seizure of the entire funds while still expecting performance with the seized funds.
What do you think? Do you use APGs on your projects? What issues do you face? How do you mitigate the risks of advance payments?
Read more about risk management.
Check out PMI's Communities of Practice for more information about Financial Services Industry and Project Risk Management.