Operational Excellence

What You Need to Know About Time and Materials Contracts

Written By: Joe Demski
May 9, 2022
7 min read

The United States construction industry comprises 745,000 unique employers and 7.6 million employees who build $1.4 trillion worth of new structures each year. Contracts are foundational documents critical to defining the roles of stakeholders, assigning legal and financial liability, and setting project goals. There are numerous options when it comes to construction contracts, and time and materials contracts are among the most popular.

Across the construction industry, the phrase “time and materials” is used to describe payment structures organized around an owner or employer paying a contractor and subcontractors based on the actual time spent working and an accurate account of the materials costs used to complete a given project.

In this article, learn more about what you need to know about time and materials contracts.

What are Time and Materials Contracts?

Time and materials contracts (T&M contracts) are a standard method for billing a project according to the actual time contractors and subcontractors spend working and the cost of materials required to execute the project as defined in the scope of the contractual agreement.

Time and materials contracts are a flexible and scalable method of billing a construction project and provide contractors the assurance to know they are being paid accurately for the actual work their project teams are completing. By ensuring that construction projects are billed more accurately, contractors are much more likely to secure higher profit margins and revenues for the jobs they complete.

Time and material contracts may be contrasted with a fixed rate or fixed-price contract in which an owner agrees at the onset of a project to pay a single lump sum for all the construction-related activities tied to the completion of the project.

When negotiating a T&M contract, a construction service provider will provide an employer with a rough project scope for the work according to an hourly wage, daily cost, or weekly fee for the labor and materials needed to execute the project.

Once the work begins, both the owner and contractor will then be incentivized to complete due diligence to ensure the work is proceeding as planned and costs are not escalating out of control for reasons not accurately defined in the initial project scope and grounds outlined in the contractual agreement.

Adopting a time and materials contract for a construction project is a popular choice for construction contractors and service providers seeking to complete projects that will take months or years and which are likely to feature an evolving scope of work.

A time and materials contract ensures work is completed at a fixed hourly rate not to exceed conditions at a set ceiling price as defined by the project requirements. Additionally, it ensures that all materials purchased by a contractor costs are reimbursed in the final price paid.

What Should be Included in Time and Materials Contracts?

Time and materials contracts are a means of ensuring that a construction project is completed and paid according to the actual work completed and materials needed to execute the task.

The following items are likely to be included in a T&M contract:

  • Cost of Labor: An accurate T&M contract will include labor rates for all contractors, subcontractors, and administrators connected to the execution, management, and billing of the construction project.
  • Definition of Labor Requirements: To protect employers from shouldering runaway costs associated with executing a construction project, a time and materials contract will specify details such as the maximum number of labor hours a project can involve or operational details such as the specific hours or days when work can be completed.
  • Cost of Materials: A construction project will be billed according to the actual cost of materials in addition to the contractor’s markup (typically between 15-35%) including freight costs to deliver them to a job site.
  • Time and Materials Not-to-Exceed Clause: Generally a not-to-exceed clause is added to a T&M contract as a means to ensure that a project’s cost will not exceed an agreed-upon maximum cost by the time the agreed-upon scope of work is completed.
  • Milestone Payments: To maintain liquidity during what could be a lengthy project execution phase, milestone payments are used to provide payments to contractors and subcontractors at different agreed-upon stages during a project’s progress.

Time and materials contracts tend to be more popular with complex projects that will be completed over various stages and include the input of several different types of contractors or subcontractors.

In this way, the T&M contract can be seen as a means of creating a more accurate record of the work, materials, and equipment that is used to execute a project instead of simply creating an estimate at the onset of a project and hoping that the valuation offered upfront ends up being accurate down the line after the work is completed.

Advantages and Disadvantages of Time and Materials Contracts

Each and every contract comes with different advantages and disadvantages depending on how it is written, what items it includes, and what the specific financial and economic situations are connected to all stakeholders connected to a project. Time and materials contracts are no different.

Advantages

Time and materials contracts offer contractors the assurance needed to be sure that they will be accurately reimbursed for all labor and materials expenses according to actual usage and allocation. Additionally, using a T&M contract helps to ensure that profit margins are predictable and cannot be compromised due to cost increases due to factors such as supply chain dynamics and inflation which contractors are not well-positioned to avoid. Furthermore, using this contractual method is often considered a better choice when confronting the uncertainty that has become such a prevalent aspect of the construction industry in recent years.

Disadvantages

In many cases, employers tend to prefer fixed-price contracts over time and materials contracts because they provide a clearer picture of cost upfront making budgeting somewhat easier to plan for. Often, contractors who find themselves bidding against fixed-rate contracts are at a disadvantage because there is no way to be sure what the final cost of the project will be. In some cases, using a time and materials contract places a burden on contractors by forcing them to operationalize their methods of tracking employees' billable hours, material costs, and overall project success.

Should You Use a Time and Materials Contract?

A T&M contract is best suited for a long-term, very complex project. However, the project timeline and scope is not the only circumstance that influences selecting this over a fixed price or other contract type. According to the guidelines set forth by the U.S. Federal Acquisition Rules, a time and materials contract may only be used in situations when the accurate scope and duration of construction cannot be estimated using other methods.

Due to this criteria, it is important to emphasize that the time and materials contract method is only legal under certain circumstances and in fact is not legal in all jurisdictions or states.

FAQs

What do time and materials mean in a contract?

Time and materials are used to describe the hourly rate a contractor is paid for a specific job and the physical resources such as lumber, concrete, and nails needed to complete a given construction task.

What is a time and material contract in project management?

In project management, a time and materials contract is a document used to describe the scope and duration of a project in respect to the hourly rate being paid to contractors, subcontractors, and project administrators as well as the specific amounts and costs associated with the physical resources or materials included to complete a task.

When should a time and materials contract be used?

Under U.S. Federal Acquisition Rules, a time and materials contract may only be used when the scope and duration of a project cannot be accurately estimated using fixed-price contracts. Furthermore, time and materials contracts are not legal in all states and contractors must perform due diligence to ensure that a time and materials contract is legal in the jurisdiction where they are seeking to perform a project.

Written By: Joe Demski

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