Time and materials contracts are flexible, open-ended agreements that bill clients based on the number of labor hours and materials used to complete a project. Labor is typically charged hourly, and clients are responsible for directly covering the cost of materials. This type of contract is popular in the construction industry for its ease of implementation.
For this reason, contractors must ensure they know the ins and outs of this billing method. This article will explore how T&M contracts function, the vital components of the contract itself, how they differ from fixed-price construction contracts, and the advantages and disadvantages of using them.
Time and Materials vs. Fixed-price contracts
Instead of a fixed price that covers the entire project, under a time and materials contract, contractors must negotiate hourly labor rates, cost of materials, and markup percentages. In this way, material costs are passed directly to the client for payment, and labor is charged hourly.
| Fixed price | Time & Materials |
|---|---|
| Set price for all services | Cost accrue as work is completed |
| Project owners know the exact cost of the project | Total project costs are unknown |
| Gives contractors more control of profitability | Less control over profitability |
| Ideal for projects with a clear scope of work | Ideal for undefined project scopes |
Time and material contracts ensure that contractors are fairly compensated for all work, while project owners can cover costs as needed without having to front all costs before work begins. Contractors are still obliged to provide a rough estimate on labor and materials, but owners must realize that the actual cost of a project can vary significantly from this initial estimate.
Structuring a job this way leaves many project details unclear; there is no way to tell total project costs or timelines at the outset of a project. For this reason, T&M contracts are best used for projects with an unknown scope of work, such as a home renovation or new building construction.
How Time and Materials contracts work
This type of contract ensures that contractors are fairly compensated for all work performed, and project owners can cover costs as needed instead of fronting all costs at the start. For instance, take an older building that requires foundation repairs.
Everything from ground conditions to any required plumbing or electrical repairs to the total extent of the damage means that the complete project scope is impossible to determine. In this situation, a time and materials contract will allow added flexibility. Adjustments can be made as the project progresses.
Project owners may choose to utilize a T&M contract for its plasticity. Owners can extend or reduce work at their discretion. The scope can be scaled back if actual costs exceed what they are comfortable with-more on this later.
On the contrary, if they wish to expand the project, the scope can easily be adjusted to accommodate the added work. Project scale and costs are entirely at the discretion of the project owner. Meaning project owners take on most of the risk.
Parts of T&M contract
Scope of work
Although many overarching details will be left unknown, any work that can be identified must be laid out with extreme detail in the scope of work. A sufficient scope of work will set clear expectations and divide responsibilities. A great scope of work will list all tasks, materials needed, expected timelines, and deliverables.
What every scope of work needs:
- Work required, including objectives and deliverables
- Who is taking on the responsibility and risk
- Schedule and timelines
- Additional requirements and project details, such as admin and management processes
- Attachments and visuals, such as design drawings and technical specifications
Payment terms
Payment terms will specify the payment plan for reimbursing contractors. This will include major milestones, payment dates, payment methods, and late payment fees.
Price
This section will serve as the core of a T&M contract by laying out the rates and percentages of the work to be performed. In addition, this section includes the negotiated labor rates, markup percentages, and additional fees, such as late payment fees or other penalties for non-payment.
Furthermore, it’s not uncommon for agreements to provide details on what is and is not a project cost. This is crucial since it defines the costs that qualify for reimbursement. For instance, any materials or equipment purchased that is directly related to the project will qualify.
In contrast, any costs incurred due to negligence will not qualify for reimbursement. Therefore, contractors must understand this portion of a time and materials contract to ensure they have a complete picture of what costs they are and are not on the hook for.
Not to exceed clause
Many project owners will decide to include a Guaranteed Maximum Price or Not-to-Exceed clause. This clause defines the maximum amount that the owner is willing to pay. Either for the entire project, portions of the project, maximum labor hours, or particular material purchases.
A Guaranteed Maximum Price clause is not set in stone. While some owners will hold it more sacred than others, it primarily serves as a mechanism to better anticipate costs.
Some construction projects will have no choice but to exceed this amount to execute the job correctly. If a project exceeds this ceiling price, contractors are typically required to provide a revised estimate that factors in the cost increases.
If the project calls for it, contractors and project owners should negotiate a new Guaranteed Maximum Price to keep the project moving forward with adjusted cost totals. However, in most cases, project owners will not have unlimited funds to work with. As a result, projects can and will end early due to project costs hitting the Guaranteed Maximum Price.
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Change orders
Due to the open nature of T&M contracts, changes in design, unknown work site conditions, and supply chain factors are all expected. There should be no confusion regarding the creation, review, negotiation, and execution of change orders.
However, since total project costs are unknown, the impact of the change order is also left unknown. For this reason, contractors must track the time spent working on the change. Pay close attention to any material or equipment costs incurred due to the change. When in doubt, document. Leave a paper trail for every change order that includes as much detail as possible.
Dispute resolution
This portion of the agreement is for all stakeholders to agree to a process for resolving disputes. This will likely include an obligation for contractors to immediately notify all relevant stakeholders–suppliers & subcontractors–of an upcoming or ongoing dispute.
Additional contract sections
Every project comes with different requirements, needs, and expectations. For this reason, secondary sections can be included if the owner and contractor choose to do so. Some of these additional sections are listed below:
- Subcontractors – This section determines who assumes responsibility for any additional subcontractors added to the project.
- Materials and equipment – Dictates who is responsible for acquiring and purchasing materials.
- Job site conditions – Safety, clean up, and overall site procedures for site management.
- Termination – Any circumstances under which either party may terminate the contract.
Time and Materials contract example
Looking at an example, let’s assume a contractor has won a bid to remodel a client’s kitchen. The exact contract language may sound similar to the following:
Kitchen Remodelers and Client are to enter the following contract, whereby Kitchen Remodelers shall provide labor and materials for the construction and remodel of the client’s kitchen at Location.
The meat and potatoes of the contract will come down to the labor rate percentages and payment plan. For instance, it may read:
The client agrees to pay Kitchen Remodelers for labor at a $40 hourly rate, Materials, Equipment, Sub fees, and any additional cost of work, plus a contractor’s fee of 15%. The contract price shall not exceed the Guaranteed Maximum Price of $80,000.
In this example, the client and contractor have agreed on an hourly labor rate of $40/hr plus a materials markup percentage of 15%. This is followed by a guaranteed maximum price, stating the total dollar amount the client is unwilling to pass to complete the project.
Advantages and disadvantages of T&M contracts
Advantages
- Great for undefined contracts
- Benefits jobs with fluctuating material prices
- It doesn’t require extensive estimating upfront
- The high degree of flexibility
- Contractor assumes a low amount of risk
From the contractor’s perspective, T&M contracts offload much of the risk and guarantee that costs are covered. For this reason, they are simple to carry out with the added benefit of flexibility to change specifications or work required as needed.
As mentioned, this allows contractors to work on a project for as long as needed. There is no time or cost restraint as the project owner fronts all costs. Additionally, if contractors negotiate a markup percentage to be applied to material costs, they can elevate profit margins and ensure profits are covered should material costs rise.
Disadvantages
- Lower control of job profitability
- Requires extensive tracking
- Undefined cost totals
- Clients may run out of funds halting the project
- Can foster an inefficient work culture
Contractors bidding for a job with a time and materials contract may put themselves at a disadvantage. The reason why? Clients may shy away from projects with undefined costs and higher levels of risk. Project owners and contractors alike prefer to know exactly how much they are going to spend. T&M contracts, by design, remove any hard cost totals, making them riskier for project owners who want to keep a tight budget.
Moreover, since the project scope is open-ended, there is no real need to push for higher productivity. This can foster an inefficient working environment since profits cannot be improved by working fewer hours or using materials more wisely.
There is no incentive to cut costs or time since it will not generate higher profits for the contractor. In comparison, the contractor enjoys more profit under a fixed-price contract if cost totals come in under budget. Under a time and materials contract, however, contractors will not see any substantial increases in profit for jobs that come in under estimates.
How to bill and price time and material contracts
Time and materials billing is relatively easy to implement; contractors can easily invoice for any direct labor hours logged, and the client covers material costs directly. Since material prices consistently fluctuate, contractors are expected to find the lowest-priced materials that still meet quality requirements.
In addition, contractors must provide a rough estimate of labor and materials required to complete the job. However, contractors must include their “all-in” costs when estimating labor costs. All-in costs will include the full labor burden that a laborer costs the company to be out on the field.
The full labor burden will include workers comp, FICA, administrative costs, and much more. If this information is omitted, it will skew your job costing numbers to the point that they will be so inaccurate that they are rendered unusable. To calculate labor rates, sum up all hourly rates from every worker. Then multiply that number by labor burden and markup percentage (if applicable).
- The sum of all hourly wages x Labor burden + Mark up percentage = Labor rate
From here, contractors can use the following time and materials pricing formula to calculate the total invoice amount.
- (Labor hours x Labor rate) + Total material costs = Total invoice amount
Contractors must meticulously document labor, equipment, and material purchases to ensure they are fairly compensated. Construction management software will help track and organize all of this data.
In addition, software built specifically for contractors can instantly merge all job-costing data. This goes a long way in creating professional invoices in half the time it would take if done by hand.
Managing time and materials contracts with Knowify
With Knowify, you’ll never have to worry about taking precious time away from the field to perform painstaking administrative tasks.
Knowify allows contractors to easily track labor and material costs, generate in-depth reports, and create professional invoices in one easy-to-use platform. Then, automatically pull labor rates (including labor burden), labor hours, and material purchases, and apply markup to create a professional and accurate time and materials contract
If you routinely work with T&M contracts, book a 30-minute demo to see how you can save hours of time using Knowify’s collection of tools built specifically for specialty trade contractors.
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