While many industries operate around a fixed price or point-of-sale billing structure, the construction industry tends to be a bit more complicated because of its long-term, project-based nature. Every construction project is unique and comes with its own set of requirements and challenges. Because of this, contractors may use a number of billing styles and methods, which then requires the use of construction accounting software in order to track, create and manage those billings.
A construction contract is a legally binding document that stipulates how and when payments will be made once a project is executed. The contract type is usually defined by how disbursements will be made, and will include other pertinent project information like duration, liability, quality requirements, and more.
While there are a number of variations that can be made to meet the specific needs of a project, this blog will focus on the most common construction contract types and billing options.
Fixed Price / Lump Sum
Fixed price contracts (also referred to as lump sum contracts) are the most basic type of construction contract because they outline one total price for all construction-related activities. Sometimes, incentives are built into these contracts for early completion, but they may also include penalties (called “liquidated damages) for projects that are completed late.
- Pros: Fixed price contracts simplify the bidding process by naming one total price in lieu of submitting multiple bids. Because the project price is already set, finishing under-budget results in higher profit margins.
- Cons: Because there’s one set price that’s agreed upon, any unexpected changes or setbacks cut directly into profit. Therefore, it’s critical to try to account for every variable upfront, which can be difficult to predict, especially on larger and more complex projects.
Under a cost-plus billing structure, the owner agrees to pay the contractor for the project costs plus a fee, which may either be a fixed fee or calculated as a percentage of costs.
- Pros: This billing structure provides the most flexibility, and allows owners to make design changes along the way while also providing the contractor with assurance that they’ll be paid for any extra time or materials those changes require.
- Cons: Cost-plus contracts require contractors to front and justify costs, which can sometimes be difficult to account for, and owners may be reluctant to reimburse for indirect costs like mileage or administrative expenses. And because the owner is ultimately responsible for payment of any unforeseen costs, this structure provides owners with the least control over costs.
Time and Materials (T&M)
With a time and materials billing structure, the contract price is based on the cost of materials, plus an established pay rate.
- Pros: T&M billing is easy to use for small projects, and a good option when the scope of work is unclear or undefined. It’s attractive for builders because it means they’re not completely limited by budget, although price caps are commonly established to mitigate the owner’s risk.
- Cons: Tracking and logging the cost of time and materials can be tedious, but failure to do so results in lower profit margins. Also, because this billing type pays by the hour or by the day, there’s no real incentive to finish a project early unless the contract includes a stipulation to pay a bonus for finishing ahead of schedule.
AIA Progress Billing
Named after the American Institute of Architects (AIA) that produces its official forms, AIA progress billing invoices the customer based on the percentage of work that’s completed during that billing period. This type of billing is common in projects that last a long time as it allows the contractor to fund themselves and the project while it’s in progress.
- Pros: AIA contract documents are widely-used, standardized forms that are applicable to many project types, and they can be customized to include specific terms like retainage rates or interest rates on late payments.
- Cons: While the AIA standard contract documents can be customized, the contractors may have to pay for these modifications to be made, which can be expensive. Additionally, any changes to standard documentation invites the potential for legal risk and, therefore, should be reviewed by legal counsel.
Understanding the different types of construction contracts and billing models is critical to determining the right fit for you and your project. Premier Construction Software supports cost-plus billing, progress and time & materials with built-in automation to streamline your billing process into seconds. To learn how Premier Construction Software can help streamline your AR billing needs, click here.
Kathryn Dressler is a content strategist with more than 10 years of experience across the spectrum of marketing services, including blogging, social media, public relations, copywriting and editorial services.