Time after time many subcontractors get burned on a time and materials construction contract. As with many other construction contracts, there are advantages and disadvantages. Depending on your needs and your operational workflow, one may be more ideal.
Fixed Price Construction Contracts
In a fixed price contract, the contractor and owner agree to a lump sum price. Based on the design and schedule, the contractor develops an estimate on the labor and materials for the cost of construction. The profitability of the contractor rests labor productivity and the ability to execute the job according to the estimate, or even better, lower than estimated. Because the design and plans must be complete to provide an accurate estimate, a project under a fixed price contract usually takes much longer to start.
Time and Material Construction Contracts
On the other hand, a time and materials construction contract, the owner agrees to pay the contractor the cost of materials, labor, and the contractor’s overhead and profit. Some may refer to a time and materials contract as a cost plus contract.
Many times a time and material construction contract is ideal for an owner because it provides complete transparency into their costs. The owner verifies invoices and timesheets to ensure correct costs. There is no dispute into how much items cost. Similarly, contractors benefit from the immediacy of their work and thus revenue recognition. Although, there is a limit to the profit, the contractor is guaranteed to recover any expenses and earn a profit on the job.
Labor Rates – This may include separate labor rates for each category or single fixed rate to cover all laborers. When determining the labor rate, contractors must remember to reflect the employee’s actual labor rate as well as additional costs. The fully burdened rate to include insurance, taxes and benefits for the employee will determine the true labor rate.
Material Markup – The customer usually pays retail pricing on materials. Some instances the contractor has established wholesale pricing with the supplier and charge an additional material markup to the customer.
Not to Exceed – The owner may establish a maximum amount on the project to avoid overcharges. This protects the owner in terms of establishing a budget and scope on the project. More importantly it helps prevent excessive costs and provides an incentive for the contractor to work more efficiently. If maximum labor hours are not set, a dishonest contractor may not work as productively in order to keep billing additional hours.
Additional items of consideration in a Time and Materials construction contract
Every construction contract assumes a large amount of risk. However, there seems to be a greater amount of risk to both companies. There is a high risk for the owner. Proceeding without a plan or estimate at the beginning of the project can make the costs rise quickly. The owners are responsible for the costs, so this can delay the completion of the project until the owner secures additional funding. On the other hand, this can also put the contractor at risk and liable for any costs that the owner cannot pay.
Time and material contracts seem reasonable enough: owner pays for costs. However, disputes may arise if the owner does not understand the nuances of construction. They may dispute the need for certain tasks and reluctant to pay for certain items. The contractor deems them a requirement for safety while the owner may question the necessity.
Mostly, time and material contracts can put contractors at a disadvantage in terms of profit. The profit on a time and materials contract is fixed and predetermined and agreed upon by the owner. If the contractor must ensure that the “plus” in the “cost plus” contract adequately covers his or her fixed costs. Any errors in that calculation can reduce their profits. For every project on a time and materials contract, the contractor receives a fixed profit, which does not provide any strong growth acceleration. However, this may not be ideal for ambitious contractors.
Many contractors begin taking on projects on a time and material basis. Even in a straight forward process, its important that contractors begin to have their paperwork organized. The invoices and timesheets must be pristine in the event the owner would like to verify their accuracy. The correspondence must be accurately documented in order to reduce any questions on payment. The contractor must account for for all operating expenses to ensure they inclusion in overhead costs.
While the owners are paying for time and materials, the contractor should still track time and materials on their own. Tracking labor hours and material usage on certain tasks and projects will provide the contractor with solid historical information. This can provide insightful data in order to deliver stronger estimates on projects to help set more reasonable expectations on costs for time and material contracts or even begin to move into the world of fixed contracts.