What Is A Time And Materials Contract? (With Benefits)

Updated 1 March 2023

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Companies might bill clients using a fixed-price contract and such agreements and contracts might result in profit and losses depending on the project. When projects are unpredictable and undefined, companies might use the time and materials contract (T and M contracts) that account for all resources and labour costs. Learning more about T and M contracts can help you determine if it is the right contract type and ensure you earn profits on your project. In this article, we discuss what a T and M contract is, help you understand its components, learn the time to use these contracts and explore its pros and cons.

What Is A Time And Materials Contract?

A time and materials contract is a written agreement between a contractor and a client. This contract contains payment information that contractors might use to charge their clients. Contractors can charge based on the hours and resources the team members required for completing a project from start to finish. While the construction industry prefers a T and M contract, individuals in other industries might use this contract. A client agrees to pay a set rate for labour hours and materials. The contract's content includes maximum labour hours, guaranteed maximum price, labour rate and material cost.

Before entering a T and M contract, both parties agree on meeting a project's goal and identifying the hourly wages for employees and contractors. Such a contract is helpful for projects with an undefined timeline or scope. Typically, a T and M contract has no fixed price for a project and both parties agree on predetermined rates for material and labour. This contract specifies the project's scope but might not specify the project's duration. Contractors charge the client a price they establish for labour, the number of hours worked and materials required to complete a project.

Components Of A Time And Materials Contract

The goal of any contract is achieving the goals and meeting the project requirements. Some essential components of a T and M contract are:

Labour rate

The labour rate component details the labour hours and charges they might pay to every individual involved in the project. The labour rate can help a company create a budget for labour expenses. Some aspects of labour rate included in this section are:

Hourly wages
Overhead costs
General expenses
Profit
Administrative expenses

Maximum labour hours

A T and M contract includes detail about the maximum labour hour rate that protect contractors and clients. Maximum labour hours show the maximum number of hours the client agrees to pay. Often, it might mean that if a contractor exceeds a specific number of labour hours, they cannot bill the client for these hours. This allows a contractor to complete projects on time.

Materials markup

The materials markup section provides details about the material cost for each piece that contributes to the project's outcome. It primarily includes retail prices of resources plus the contractor's markup rate. Typically, a client might negotiate the markup rate to obtain better deals. A markup of 15% to 35% might get added to the actual cost of supplies that the client pays.

Not-to-exceed (NTE) clauses

To ensure that a client is aware of the project's maximum cost, a T and M contract includes an NTE clause. This clause can protect a client as contractors cannot bill over the maximum amount for the project. It allows a contractor to ensure the timely completion of projects. If a contractor plans to exceed this maximum cost, they can work with clients to discuss the desired increase in the cost.

When Is An Ideal Time To Use A T And M Contract?

While this contract is helpful for various industries, some situations where a company might use this contract are:

When a company is new to the industry

Contractors who are new to the industry might still learn about the hidden costs, expenses and unexpected overhead costs. Such a contract enables these contractors to predict expenses and bill them upon project completion. It helps a contractor gain relevant experience by accurately estimating projects to prevent future overestimation and underestimation.

When a project has dynamic requirements

When a contractor works on a project with constantly changing demands and dynamic requirements, creating a T and M contract might be helpful. This allows a client to make changes, shift the project's timeline and remove certain aspects of a project. This contract helps increase the project's progress.

When every party collaborates effectively with each other

T and M contract involves working collaboratively between clients and contractors. It can help clients and contractors project labour and material costs to determine the profitability of a project. As the contract includes the NTE clause, it helps with better collaboration.

When projects are unpredictable

A T and M contract might be helpful when a client has not established its goals and project requirements. It enables a contractor to start the project even though a client has not comprehended its end goals. Contractors can use this contract to determine projected costs as the client discovers the project's timeline, requirements and specifications.

When a company knows about the associated risk

As T and M contracts have increased risk, it is essential for both clients and contractors to assess and discuss the potential risks. Some items to discuss before a project include productivity tracking, project estimation and any other changes the client might decide during the project. Knowing the legal requirements regarding the T and M contract is essential before starting a project.

Pros Of T And M Contracts

Some pros of using T and M contracts are:

Improves client relationship

Clients who have a positive experience working with a particular organisation are likely to hire the organisation for future projects. They might even recommend the services to other companies looking for similar services. T and M contracts ensure transparency and clients might appreciate such contracts.

Increases transparency

A T and M contract encourages transparency from the start because both parties work together to establish rates that work for them. Clients can even cross-verify bills that a contractor might submit. It allows them to address concerns they might have before the project ends.

Provides flexibility in billing

A T and M contract considers a project's resources and hours, providing billing flexibility. Contractors might add additional hours if the project takes longer to complete a task. This billing flexibility is valuable when projects involve materials, such as lumber and gasoline, with fluctuating costs.

Ensures adjustable deadlines

While a T and M contract provides details about the expected end date of a project, these deadlines tend to be adjustable. These agreements allow clients to extend the project scope when a business faces new requirements. It allows contractors to spend time on tasks to produce results.

Cons Of A T And M Contract

Here are some cons of using a T and M contract:

Increases cost dispute

The final bill might surprise clients because a T and M contract does not provide a fixed cost. A company can prevent costly disputes from happening by providing updates to clients and maintaining accurate records. A guaranteed maximum price can help clients keep realistic expectations when it is time to make payments.

Increases financial risk

As the project outlines projected costs, a client might face financial risks. To reduce the financial risk, contractors or clients might incorporate the maximum labour and material cost value. Also, clients prefer a fixed-price contract because the financial risk is lower and budgeting is easier.

Increases expenditure variance

T and M contracts include only projected costs, which means contractors might want to keep detailed records of their expenditures. These records can support the invoice sent to the client after project completion. This can even reduce the project's efficiency.

Tips For Using A T And M Contract

Incorporating the best practices can reduce the risk for both clients and contractors. Follow these tips when creating a T and M contract:

Track every project expense. To ensure accurate billing, it is an excellent idea for clients and contractors to keep track of labour hours worked, material consumed, subcontractor fees and hours worked and invoices generated. It helps ensure accurate information when the contracts send the bill to clients upon project completion.
Verify license. Before signing or agreeing to the T and M contract, ensure employees have licenses to work as it reduces liability and risk. This helps clients certify the employees have relevant experience in the construction industry or other industries.
Mention the labour hours and maximum price. Including details about the hours and the maximum price paid can protect the interest of contractors and clients. If the client wants to exceed these maximums, all parties agree before changing the contract.