Accurately estimating any construction job is a challenge. If the estimate is too large, the contractor loses the project to a lower bidder. Too small, and the project ends up in the red. Adding to the difficulty, the contractor’s costs can change between the estimate and the completion of work. Materials costs could rise, laborers could drop out of the workforce, and new regulations could be imposed. That’s why some contractors propose a time and materials (T&M) contract.
What Is a Time and Materials (T&M) Contract?
A T&M contract is a project agreement where clients pay contractors based on their actual labor hours and materials used, rather than a fixed price for the project. Under a T&M agreement, contractors charge a predetermined hourly labor rate, plus material costs with an established markup.
T&M contracts are common for projects without a clearly defined scope or duration, adding some flexibility both before and during work. Many T&M contracts also include a not-to-exceed (NTE) clause that caps total costs so clients can set budget limits while maintaining the contractor’s ability to adapt as project requirements evolve.
Key Takeaways
- T&M contracts allow contractors to bill clients based on actual labor hours and material costs rather than a fixed project price.
- These agreements are common for flexible projects with unclear scope or duration or with material costs that can’t be accurately predicted upfront.
- T&M contracts protect contractors from underestimating complex projects while giving clients detailed breakdowns of actual labor and material costs.
- Managing these contracts requires careful documentation for labor and material costs to maintain accurate billing records.
- Most T&M contracts include an NTE clause that caps total costs, helping clients set firm budget limits while maintaining some project flexibility.
How Do Time and Materials Contracts Work?
First, the contractor and client agree on the goal of the project and specify the finished product. However, it might not be feasible to define all the steps along the way. Within that framework, they agree on hourly wages for the contractor’s employees, as well as for subcontractors. The contractor also specifies the materials to be used, along with a markup rate for material prices.
When to Use Time and Materials Contracts
T&M contracts are best when the scope of the job or its duration can’t be determined before work begins, as is sometimes the case with construction projects. When renovating an old building, for example, removing walls may uncover rot or other damage not visible before the job started. Another situation ripe for a T&M contract is when materials prices are likely to change. Perhaps lumber costs or gas prices are predicted 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 T&M contract should include a fixed price for labor that includes wages, overhead, general and administrative costs, and a markup 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 maximum price by way of an NTE clause.
Parts of a Time and Materials Contract
The goal of any contract is to meet the project requirements, cover the contractor’s costs and overhead, and deliver a profit to the contractor. To that end, these items are usually included in a T&M contract:
- Labor rates: These should include the hourly wages for not only the laborers and subcontractors, but also administrators who manage the project and billing.
- Maximum labor hours: To guard against runaway costs and protect the client, a maximum number of labor hours can be specified. Any excess hours must be absorbed by the contractor.
- Materials markup: The client will be billed for the actual cost of materials (including freight), plus a specified markup, usually between 15% and 35%.
- NTE clause: An NTE quote for the entire project can be included so the client knows the maximum cost of the project before work begins.
- Payment milestones: To protect the contractor’s workflow, in some cases agreed-upon milestones for progress payments can be included.
Additional Items to Consider for a Time and Materials Contract
A T&M contract should stipulate when the contractor will be paid. As an incentive 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 of the project. The customer may also specify the quality or type of materials to be used—for example, the grade of lumber on a construction project.
Advantages and Disadvantages of Time and Materials Contracts
Opting for a T&M contract rather than a fixed-price contract has its advantages and disadvantages:
- Advantages: With assurances that all costs will be covered T&M contracts are simple to implement and a low risk for the contractor. Profit is predictable, and adjustments are easy when specifications or resource needs change.
- Disadvantages: Clients often prefer a fixed-price contract because their risk is lower and budgeting is easier. When bidding against a fixed-price contract, the contractor with a T&M contract may lose the bid. Tracking materials costs and labor hours is also extra work for the contractor. With open-ended labor hours, the contractor’s laborers may not be motivated to work efficiently. Including an NTE clause can help offset this problem.
Advantages and Disadvantages of Time and Materials Contracts
| Pros | Cons |
|---|---|
| Simple | Client could run out of money before the project is complete |
| Minimizes the risk of an unprofitable job | Without a not-to-exceed clause, workers have no incentive to work efficiently |
| Easy to adjust to changes | Rising labor prices could eat into profit |
| Easy to add or remove resources when needs change | Tracking costs is extra work |
Time and Materials Contracts Compared to Other Contracts
Understanding common contract types, including T&M, helps contractors select the right approach for each project to protect both their own profitability and their clients from financial risk. While T&M contracts offer flexibility, other contract structures may better serve projects with well-defined parameters, fixed budgets, or measurable work phases.
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Fixed price vs. time and materials:
Fixed-price contracts, in which the final price is determined before work begins, are more common than T&M contracts, and they’re best suited to projects that are well understood by both the client and the contractor.
With fixed-price contracts, if job specifications change after the work begins, client and contractor must negotiate an amendment to their agreement. But a T&M contract usually specifies only the purpose of the job along with hourly labor rates and materials costs.
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GMP vs. time and materials:
A guaranteed maximum price (GMP) contract establishes a cost ceiling that protects the client from budget overruns. The contractor agrees to cover any expenses beyond this maximum, unless the client formally approves scope or budget changes. Unlike T&M contracts, where costs vary based on actual hours and materials, GMP agreements shift more financial risk to the contractor. GMP contracts work well when clients need budget certainty, but the project still requires some flexibility during planning.
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Cost-plus vs. time and materials:
Cost-plus contracts reimburse contractors for all project expenses plus an additional fee for profit. This fee can be a fixed amount, a percentage of total costs, or an incentive-based payment tied to performance or timeline targets. While both cost-plus and T&M contracts pass costs to clients, cost-plus agreements typically provide broader expense coverage beyond the direct labor and materials included in a T&M contract by including overhead and indirect costs.
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Unit price vs. time and materials:
Unit price contracts set fixed rates for specific, measurable units of work, such as per square foot of flooring, per linear foot of pipe, or per cubic yard of concrete. Final project costs depend on the actual quantities installed, whereas T&M contracts bill for labor hours separate from output. Unit price agreements are common for subcontractor work involving repetitive tasks with clearly quantifiable deliverables.
Government Time and Materials Contracts
T&M contracts can be used for government projects only when the contractor can document that the extent or duration of the job can’t be determined or that costs can’t be estimated accurately. The contractor specifies separate fixed hourly rates for each class of laborer. Materials include the necessary supplies, along with the costs of transporting them to the job site, as well as incidental services, such as cleanup work. Contracts should include a (maximum) ceiling price. The contractor must cover any excess labor costs. To keep contractors working efficiently, the public entity responsible provides oversight on the project.
Billing With Time and Materials Contracts
With a T&M contract, it’s essential for an administrator to track costs and maintain documentation. Receipts for materials should be retained and labor should be documented. Unused materials that are returned should be subtracted from the total. If the contract has an NTE clause, the contractor should notify the client when the limit is nearing.
Free Time and Materials Contract Template
Every construction project is unique and requires a contract carefully drafted to match its requirements. Still, all contracts have certain aspects in common, and there are certain additional elements that every T&M contract should contain.
Time and Materials Contract Template
Example Time and Materials Contract
Forge Ahead, a hypothetical building contractor, is hired to work on a commercial construction project under a T&M contract. The agreement specifies that the contractor bills $75 per hour for carpenters, $95 per hour for licensed electricians, as well as a 20% markup over cost for all materials.
Once demolition begins, the construction manager discovers water-damaged framing and outdated wiring that must be replaced. Addressing these issues requires 25 hours of carpentry work, 40 hours of electrical work, and $3,200 in materials. Under the T&M terms, Forge Ahead adds $5,675 ($75 x 25 carpentry hours + $95 x 40 electrical hours) for labor and $3,840 ($3,200 + 20% markup) for materials to the invoice, for a total of $9,515. This transparent billing shows the client the exact cost of the unexpected work without requiring contract renegotiation or incurring project delays.
Managing Time and Materials Contracts With NetSuite
With NetSuite’s construction accounting software, accounts receivable departments can efficiently and accurately invoice clients that use T&M contracts. It also automates revenue recognition and helps companies comply with appropriate standards and accounting rules such as ASC 606 or IFRS 15. And NetSuite’s SuiteProjects professional services solution provides comprehensive project accounting functionality that makes it easy to track hours spent, materials acquired, and the other accounting details required for T&M contracts.
NetSuite’s Project Management Dashboard
T&M contracts work best when the scope and duration of a project is unpredictable before work begins. The simplicity of a T&M contract helps ensure contractors earn a profit but adds an administrative burden in terms of tracking time and costs. However, good accounting software can automate much, or even all, of that added burden.
Time and Materials FAQs
How do time and materials contracts work?
Time and materials (T&M) contracts specify the scope of a project but are open-ended. They set prices for materials and hourly rates for labor, and the client is billed at those rates for as many hours and as much material as is required to complete the project. To protect project owners, T&M contracts usually include a maximum price in the form of a not-to-exceed clause.
When should a time and materials contract be used?
A time and materials (T&M) contract should be used when the scope or duration of the project can’t be accurately estimated. US Federal Acquisition Rules, in fact, state that’s the only case when T&M 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 quotes hourly labor rates and materials costs. The client pays for this labor and the cost of materials 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 fixed price?
In fixed-price contracts, the contractor quotes a fixed price for the entire project and assumes the risk of overruns. In a time and materials (T&M) contract, the contractor charges the client for the cost of materials, plus a fixed hourly rate for labor. In a T&M contract, the client assumes more risk.
