How T&M Contracts Work (2024)

Accurately estimating any construction job is a challenge. If the estimate is too large, thecontractor loses the project to a lower bidder. Too small, and the project ends up in thered. Adding to the difficulty, the contractor’s costs can change between the estimateandthe completion of work. Materials costs could rise, laborers could drop out of theworkforce, new regulations could be imposed. That’s why some contractors propose atime andmaterials 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 hourlywage plus the cost of materials. The contractor might also include a maximum price for theproject — commonly called a “not-to-exceed” clause — as a guaranteeto protect the clientagainst runaway costs.

Fixed price vs. time and materials:

There are some important differences between fixed price and time andmaterials contracts. Fixed price contracts,in which the final price is determined before work begins, are more common than time andmaterials contracts. Fixed price contracts are best suited to projects that are wellunderstood by both the client and the contractor and, therefore, the time needed and costsrequired are predictable.

In fixed price contracts, if job specifications change after the workbegins, client and contractor must negotiate an amendment to their agreement. But a time andmaterials contract usually specifies only the purpose of the job along with hourly laborrates and materials costs. They’re suited to situations with less predictabilitybecause ifthe job specifications change no renegotiation is required; it just costs more in time andmaterials.

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, theyagree on hourly wages for the contractor’s employees, as well as for subcontractors.Thecontractor also specifies the materials to be used, along with a markup rate for materialprices.

When to Use Time and Materials Contracts?

Time and materials contracts are best when the scope of the job or its duration cannot bedetermined before work begins, as is sometimes the case in construction projects. Whenrenovating an old building, for example, removing walls may uncover rot or other damage notvisible before the job started. Another situation ripe for a time and materials contract iswhen the materials prices are likely to change. Perhaps lumber costs or gas prices arepredicted 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 afixed price for labor that includes wages, overhead, general and administrative costs and amarkup 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 maximumprice 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’scostsand overhead and deliver a profit to the contractor. To that end, these items are usuallyincluded in a time and materials contract.

• Labor rates: This should include the hourly wages for not only thelaborers and subcontractors, but also administrators who manage the project and billing.
• Maximum labor hours: To guard against runaway costs and protect theclient, a maximum number of labor hours can be specified. Any excess hours must beabsorbed by the contractor.
• Materials markup: The client will be billed for the actual cost ofmaterials (including freight), plus a specified markup, usually between 15% and 35%.
• Time and materials not-to-exceed clause (T&M NTE): A not-to-exceedquote for the entire project can be included so the client knows the maximum cost of theproject before work begins.
• Payment milestones: To protect the contractor’s workflow, in somecasesyou 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 anincentive 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 ofthe project.

The customer may also specify the quality or type of materials to be used — forexample, thegrade 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 itsadvantages and disadvantages.

• Advantages: With assurances that all costs will be covered, time andmaterials contracts are simple to implement and a low risk for the contractor. Profit ispredictable. Adjustments are easy when specifications or resource needs change.
• Disadvantages: Clients often prefer a fixed price contract becausetheir risk is lower and budgeting is easier. When bidding against a fixed pricecontract, the contractor with a time and materials contract may lose the bid. Trackingmaterials costs and labor hours is extra work for the contractor. With open-ended laborhours, the contractor’s laborers may not be motivated to work efficiently.Including anot-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 candocument that the extent or duration of the job cannot be determined or that costs cannot beestimated accurately. The contractor specifies separate fixed hourly rates for each class oflaborer. Materials include the necessary supplies, along with the costs of transporting themto the job site, as well as incidental services, such as cleanup work.

Contracts should include a (maximum) ceiling price. The contractor must cover any excesslabor costs. To ensure that the contractors work efficiently, the public entity responsibleprovides 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 andmaintain documentation. Receipts for materials should be retained and labor should bedocumented. 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 thelimit is nearing.

Free Time and Materials Contract Template

Every construction project is unique and requires a contract carefully drafted to match itsrequirements. But all contracts have certain aspects in common, and there are certainadditional 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 aproject, the billable rate for assigned resources and/or the tasks to be completed and thequantity and cost of materials required to complete the project. They also must followspecific project accounting ruleswhen recognizing revenue from contracts — ASC 606, if operating under U.S. GenerallyAccepted Accounting Principles (GAAP), or IFRS 15 in countries where International FinancialReporting Standard (IFRS) is required. Without the right software, these would belabor-intensive and time-consuming processes for any contractor.

With NetSuite’s accountingsoftware, accounts receivable departments can invoice clients when time andmaterials contracts are used. It also automates revenue recognition and helps companiescomply with appropriate standards. And NetSuite’s professionalservicessolution provides comprehensive project accounting functionality that makes it easyto track hours spent, materials acquired and the other accounting details required for timeand materials contracts.

Conclusion

Time and materials contracts work best when the scope and duration of a project isunpredictable before work begins. The simplicity of a time and materials contract ensuresthe contractor a profit but adds an administrative burden in terms of tracking time andcosts. However, good accounting software can automate much or all of that added burden.

Time and Materials FAQs

How do time and materials contracts work?

Time and materials contracts specify the scope of a project but are open-ended. They set outprices for materials and hourly rates for labor, and the client is billed at those rates foras many hours and as much material as is required to complete the project. To protectproject owners, time and materials contracts usually include a maximum price in the form ofa “not-to-exceed” clause.

When should a time and materials contract be used?

A time and materials contract should be used when the scope or duration of the project cannotbe accurately estimated. U.S. Federal Acquisition Rules, in fact, state that is the onlycase when time and materials contracts are allowed.

What does a time and materials contract mean?

Instead of a fixed price covering the entire project, a time and materials contract quoteshourly labor rates and materials costs. The client pays for this labor and the cost ofmaterials used to complete the project.

Is time and materials a cost type contract?

Yes. The client pays for the costs of the work, rather than a predetermined fixed price.

What is the difference between T&M and fixedprice?

In fixed price contracts, the contractor quotes a fixed price for the entire project andassumes the risk of overruns. In a time and materials contract, the contractor charges theclient for the cost of materials, plus a fixed hourly rate for labor. In a T&M contract,the client assumes more risk.