Like its name suggests, in a Time and Material (T&M) contract the project owner will pay you for all your time (labor) and materials, plus a markup, for the project. Your fee structure is tied to the amount of time and materials spent on the project, versus a fixed fee like you find in a lump sum project. Best for projects in which the scope of work or project duration are unknown, T&M contracts provide flexibility and protection for your bottom line.
Key Takeaways
- While the goal of the project is agreed upon by you and the owner, the steps to complete the project are not fully defined.
- You will be reimbursed for materials purchased and hours billed for the project along with a markup rate.
- Be wary of cash flow constraints and set up a preferred cadence for payments from the owner so you are not paying out of pocket for the work.
What is a T&M Contract?
T&M contracts include all costs of materials, an hourly or daily rate (depending on contract terms) and your markup on the work. They don’t provide an unlimited budget for the project as you and the owner will establish an estimate for the scope of work with a ‘not to exceed’ clause. Most commonly used for projects where the full scope of work is not defined, it is essential to understand the current scope, estimate accordingly and be crystal clear with the owner about the unknowns. These could include anything from holes in construction documents, procurement unknowns to scope not yet defined.
When you strip the contract down though, it comes to two easily definable terms, materials and time (or labor).
- Materials: cost of the actual materials purchased (including shipping, taxes, etc.) along with a markup.
- Labor: costs that can be defined as a daily or a fixed hourly rate based on the worker type. Be sure to calculate all wages, overhead, indirect costs plus a profit markup.
👉🏻 Need a refresher on the other contract types? Check out our guide to the 8 types of construction contracts.
Pros + Cons of T&M Contracts for Construction
Pros
- You will be compensated for all work performed and all costs incurred
- Profitability will be maintained throughout the full project at prescribed rates
- Any unforeseen work or additional scope will also follow the same reimbursement
- Your pre-construction work will not be extensive so you can save some upfront costs
- Transparency of costs can lead to stronger relationships and more work with owners
Cons
- It’s all in the details, and you need to make sure you track EVERYTHING diligently. Detailed cost tracking is essential and can be a pitfall for those who aren’t’ organized.
- Cash flow is an issue as there isn’t an upfront cost paid by the owner to you or your subcontractors. Upfront costs will be high until payment is received from the owner.
- Managing expectations can be difficult as accurate estimates aren’t provided due to the undefined scope.
Uses for a T&M contract
When an owner needs to fasttrack a project but there is uncertainty in the scope and project duration, T&M contracts are used because they make negotiations over finances much easier. Even though the full scope of work is not clearly defined, the pre-construction phase must still be handled appropriately. Based on the construction documents and information provided you must determine labor rates, identify materials and quantity and provide an estimated duration to complete the work.
These contracts are often easier to negotiate as your financial risks are minimal because you know the reimbursable costs throughout the project. They also protect you from unknown expenses and unfinished project plans because you’re reimbursed for those new costs as the scope adjusts throughout the course of construction.
How Is T&M Different From Cost-Plus?
The two contracts are relatively similar, but the main differentiator is how the profits are tabulated. For cost-plus contracts, you charge for expenses plus an additional fee (which is your profit), while with a T&M contract, fees are marked up. Your profit is predetermined in cost-plus while it is based on the costs (time and material) incurred during T&M projects.
How a T&M Contract Affects Cash Flow and Profitability
For this type of contract, it’s critical to be diligent when tracking all expenses incurred both hard and soft costs. If you are not keeping track of all expenses and reporting them to your owner in the said paid period, costs will be incurred by you versus reimbursement from the owner. Instead of having the owner front the bill for large expenses, you are forced to pay for material (or labor costsL from employees to consultants, etc.) upfront, which can be a strain on cash flow.
Due to the absence of a fixed fee for materials and labor, this type of contract also ensures that you won’t be harmed by estimating errors. For example, instead of paying $X for the duration of the contract for steel, when costs change, your billing will change with the cost of steel. This is extremely beneficial when there is instability in the market and material pricing is in flux.
Common Issues with T&M Contracts
The most common issue with T&M contracts is cost tracking. You need to be diligent in keeping track of all materials purchased and hours spent by staff, as this will directly impact your bottom line. If you lose a receipt or an employee doesn’t properly track and report their time, your profit will be negatively impacted.
T&M contracts are open-ended in nature so be prepared for a not-to-exceed clause to be inserted to protect the owner from runaway costs. This clause will protect the owner but can negatively affect your profit, because when scope gets changed/added, this not-to-exceed clause may not change. The language inserted into this part of the contract needs to not only protect your markup/profit but should also set future negotiations up for success when there’s additional work needed that’s not clearly defined at the project’s kick-off.