Cost-Plus or Fixed-Price Contracts, Which Is Better?

When it comes to managing construction projects, one of the most essential decisions you'll have to make is deciding what sort of contract will regulate the relationship between you, your clients, and your subcontractors. Cost-Plus Contracts and Fixed-Price Contracts are two popular types of building contracts. Each provides various benefits and problems. In this post, we'll go over both contract kinds, allowing you to make an informed decision on which is ideal for your building projects.

What are Cost-Plus Contracts?

A Cost-Plus Contract is a contract in which the contractor is reimbursed for real project expenses as well as an agreed-upon profit margin. This fee can be a set amount or a percentage of the overall cost.

How Does a Cost-Plus Contract Work?

This contract compensates the contractor for labor, supplies, and overhead costs, as well as a profit margin. This model provides the contractor with greater flexibility, particularly in dealing with unforeseen challenges that may develop over the course of a project. 

Advantages of Cost-Plus Contracts:

• Flexibility: This type of contract works best when the project's scope isn't clear or when changes are likely to happen during building.

• Transparency: Because the contractor has to keep detailed records of prices, clients can see where their money is going.

• Fair Profit Margins: Contractors can only charge what it really costs to do the job, which protects their profit margins no matter how big or small the job is.

Disadvantages of Cost-Plus Contracts:

• Potential for Cost Overruns: Since the contractor gets paid back for the work plus a fee, they may want to go over budget. This can make it hard for clients to know up front how much the whole job will cost.

• Time-consuming: Cost-Plus contracts need ongoing record-keeping and budgeting to keep track of all costs. This can make things more complicated and take more time for everyone involved.

• Lack of Motivation to Be Efficient: If contractors know they will make money no matter how efficiently they work, they might not be driven to keep costs low.

Read more: Cost-Plus Contracts 101: Key Terms, Benefits, and Best Practices

What are Fixed-Price Contracts?

When the worker signs a Fixed-Price Contract, they agree to do the work for a set price. This price is set up front and doesn't change, no matter how much it actually costs.

How Do Fixed-Price Contracts Work?

In this case, the contractor needs to figure out how much the whole job will cost, including materials, labor, and overhead, and then give the client a price. The price is set in stone, even if costs go up more than expected after the deal is made.

Advantages of Fixed-Price Contracts:

• Clients have peace of mind because they know exactly how much the whole job will cost from the start. This makes budgeting easier.

• Incentives for Efficiency: Contractors have a financial reason to keep costs low because they can pocket any money they save from expenses that are lower than expected.

• Easy to manage: Fixed-price contracts are easy to handle because the money is agreed upon early on in the job.

Disadvantages of Fixed-Price Contracts:

• Lack of Flexibility: Fixed-price contracts can be hard to change if the project's scope or costs change without warning. Any change usually needs to be negotiated again.

• Risk for Contractors: If the contractor cuts costs too much, they could lose money on the job because they have to stick to the price they agreed to.

• Less Transparency: Since the total cost is set from the beginning, clients may not fully understand how their money is being spent. 

Which Contract is Better for Your Projects?

The answer depends on various factors, such as the scope of the project, budget flexibility, and risk tolerance.

When to Choose Cost-Plus Contracts

If your project is complex, with many unknowns or changes expected during the course of the work.

If you’re working on a project where transparency is key, and your client wants to see exactly where every dollar is spent.

If you want the flexibility to adjust the scope of the project as it progresses.

When to Choose Fixed-Price Contracts

If the project scope is well-defined, with little expectation for changes.

If your client prefers to know the exact cost upfront to avoid any surprises.

If you can accurately estimate project costs and are confident in your ability to manage the project efficiently.

Read more: Best Practices for Tracking Expenses in Cost-Plus Construction Contracts

Common Questions About Cost-Plus and Fixed-Price Contracts

Can a Fixed-Price Contract Be Changed?

Yes, although it is more challenging to change a fixed-price contract once it has been agreed upon. Any changes to the scope of the project usually require a formal contract amendment.

Are Cost-Plus Contracts Always More Expensive?

Not necessarily. While Cost-Plus Contracts can sometimes lead to cost overruns, they also provide more flexibility, especially for projects with uncertain costs. It all depends on how well the project is managed and the level of transparency between the client and contractor.

How Can I Avoid Overruns with a Cost-Plus Contract?

Careful monitoring of the project and detailed record-keeping are key to avoiding cost overruns in Cost-Plus Contracts. Ensure that both you and your client agree on a realistic budget before starting the project and track expenses diligently throughout the work.

How to Manage Your Construction Costs Effectively

Cost management is very important for the success of your project, no matter if you choose a Cost-Plus Contract or a Fixed-Price Contract. No matter what kind of deal you have, as a contractor you should always be ready for costs that you didn't expect. Cost planning, project scheduling, and budget forecasting are all important parts of managing a building project well.

If you feel like the financial and accounting parts of your project are too much for you, you might want to hire professionals who specialize in building to do your bookkeeping. We at Construction Cost Accounting offer professional bookkeeping services that are specifically designed for the construction business. This will help you keep your project's finances on track.

We know the difficulties that come with working in the construction business, and our team can help you keep good records, keep track of your costs, and easily handle the money side of your project. You can focus on what you do best—giving your clients great projects—while saving time and money by working with us. 

Conclusion

Which one you choose between a Cost-Plus Contract and a Fixed-Price Contract relies on the needs and goals of your project. Cost-Plus Contracts give you options and clear information, but there is a chance that the costs will go up. Fixed-Price Contracts, on the other hand, make things more predictable but limit your options.