Accurately estimating any construction job is a challenge. If the estimate is too large, the contractor loses the project to a lower bidder. Too small, and the project ends up in the red. Adding to the difficulty, the contractor’s costs can change between the estimate and the completion of work. Materials costs could rise, laborers could drop out of the workforce, new regulations could be imposed. That’s why some contractors propose a time and materials contract.
What Is a Time and Materials (T&M) Contract?
With a time and materials contract, instead of quoting a fixed price for the entire project, a contract will describe the rough scope of the job along with a quote for a fixed hourly wage plus the cost of materials. The contractor might also include a maximum price for the project — commonly called a “not-to-exceed” clause — as a guarantee to protect the client against runaway costs.
Fixed price vs. time and materials:
There are some important differences between fixed price and time and materials contracts. Fixed price contracts, in which the final price is determined before work begins, are more common than time and materials contracts. Fixed price contracts are best suited to projects that are well understood by both the client and the contractor and, therefore, the time needed and costs required are predictable.
In fixed price contracts, if job specifications change after the work begins, client and contractor must negotiate an amendment to their agreement. But a time and materials contract usually specifies only the purpose of the job along with hourly labor rates and materials costs. They’re suited to situations with less predictability because if the job specifications change no renegotiation is required; it just costs more in time and materials.
How Do Time and Materials Contracts Work?
The contractor and client agree on the goal of the project and specify the finished product. It might not be feasible to define all the steps along the way. Within that framework, they agree on hourly wages for the contractor’s employees, as well as for subcontractors. The contractor also specifies the materials to be used, along with a markup rate for material prices.
When to Use Time and Materials Contracts?
Time and materials contracts are best when the scope of the job or its duration cannot be determined before work begins, as is sometimes the case in construction projects. When renovating an old building, for example, removing walls may uncover rot or other damage not visible before the job started. Another situation ripe for a time and materials contract is when the materials prices are likely to change. Perhaps lumber costs or gas prices are predicted to rise significantly over the duration of the job.
What Should Be Included in a Time and Materials Contract?
Besides specifying the goals of the project, a time and materials contract should include a fixed price for labor that includes wages, overhead, general and administrative costs and a markup for profit. Materials cost should include freight, taxes and a standard markup — usually between 15% and 35%. Where appropriate, the contract should also specify a maximum price by way of a not-to-exceed clause.
Parts of a Time and Materials Contract
The goal of any contract is to meet the project requirements, cover the contractor’s costs and overhead and deliver a profit to the contractor. To that end, these items are usually included in a time and materials contract.
- Labor rates: This should include the hourly wages for not only the laborers and subcontractors, but also administrators who manage the project and billing.
- Maximum labor hours: To guard against runaway costs and protect the client, a maximum number of labor hours can be specified. Any excess hours must be absorbed by the contractor.
- Materials markup: The client will be billed for the actual cost of materials (including freight), plus a specified markup, usually between 15% and 35%.
- Time and materials not-to-exceed clause (T&M NTE): A not-to-exceed quote for the entire project can be included so the client knows the maximum cost of the project before work begins.
- Payment milestones: To protect the contractor’s workflow, in some cases you may include agreed-upon milestones for progress payments.
Additional Items to Consider for a Time and Materials Contract
A time and materials contract should stipulate when the contractor will be paid. As an incentive to work efficiently, payment may be tied to reaching milestones in the project. Other options are periodic billing — perhaps weekly or monthly — or a lump sum at completion of the project.
The customer may also specify the quality or type of materials to be used — for example, the grade of lumber on a construction project.
Advantages and Disadvantages of Time and Materials Contracts
Opting for a time and materials contract rather than a fixed price contract has its advantages and disadvantages.
- Advantages: With assurances that all costs will be covered, time and materials contracts are simple to implement and a low risk for the contractor. Profit is predictable. Adjustments are easy when specifications or resource needs change.
- Disadvantages: Clients often prefer a fixed price contract because their risk is lower and budgeting is easier. When bidding against a fixed price contract, the contractor with a time and materials contract may lose the bid. Tracking materials costs and labor hours is extra work for the contractor. With open-ended labor hours, the contractor’s laborers may not be motivated to work efficiently. Including a not-to-exceed clause can help offset this problem.
Government Time and Materials Contracts
Time and materials contracts can be used for government projects only when the contractor can document that the extent or duration of the job cannot be determined or that costs cannot be estimated accurately. The contractor specifies separate fixed hourly rates for each class of laborer. Materials include the necessary supplies, along with the costs of transporting them to the job site, as well as incidental services, such as cleanup work.
Contracts should include a (maximum) ceiling price. The contractor must cover any excess labor costs. To ensure that the contractors work efficiently, the public entity responsible provides oversight on the project.
Billing With Time and Materials Contracts
With a time and materials contract, it is essential for an administrator to track costs and maintain documentation. Receipts for materials should be retained and labor should be documented. Unused materials that are returned should be subtracted from the total.
If the contract has a not-to-exceed clause, the contractor should notify the client when the limit is nearing.
Free Time and Materials Contract Template
Every construction project is unique and requires a contract carefully drafted to match its requirements. But all contracts have certain aspects in common, and there are certain additional elements that every time and materials contract should contain.
Managing Time and Materials Contracts With NetSuite
Companies using time and materials contracts must track how many hours are spent on a project, the billable rate for assigned resources and/or the tasks to be completed and the quantity and cost of materials required to complete the project. They also must follow specific project accounting rules when recognizing revenue from contracts — ASC 606, if operating under U.S. Generally Accepted Accounting Principles (GAAP), or IFRS 15 in countries where International Financial Reporting Standard (IFRS) is required. Without the right software, these would be labor-intensive and time-consuming processes for any contractor.
With NetSuite’s accounting software, accounts receivable departments can invoice clients when time and materials contracts are used. It also automates revenue recognition and helps companies comply with appropriate standards. And NetSuite’s professional services solution provides comprehensive project accounting functionality that makes it easy to track hours spent, materials acquired and the other accounting details required for time and materials contracts.
Time and materials contracts work best when the scope and duration of a project is unpredictable before work begins. The simplicity of a time and materials contract ensures the contractor a profit but adds an administrative burden in terms of tracking time and costs. However, good accounting software can automate much or all of that added burden.
Time and Materials FAQs
Time and materials contracts specify the scope of a project but are open-ended. They set out prices for materials and hourly rates for labor, and the client is billed at those rates for as many hours and as much material as is required to complete the project. To protect project owners, time and materials contracts usually include a maximum price in the form of a “not-to-exceed” clause.
A time and materials contract should be used when the scope or duration of the project cannot be accurately estimated. U.S. Federal Acquisition Rules, in fact, state that is the only case when time and materials contracts are allowed.
Instead of a fixed price covering the entire project, a time and materials contract quotes hourly labor rates and materials costs. The client pays for this labor and the cost of materials used to complete the project.
Yes. The client pays for the costs of the work, rather than a predetermined fixed price.
In fixed price contracts, the contractor quotes a fixed price for the entire project and assumes the risk of overruns. In a time and materials contract, the contractor charges the client for the cost of materials, plus a fixed hourly rate for labor. In a T&M contract, the client assumes more risk.