In many industries, billing is a simple matter of exchanging a fixed amount of money for certain goods or services. Using this structure in the construction industry can quickly become complicated and fail to serve both contractors and property owners. Since construction projects typically take place over an extended period and include unexpected changes, it’s essential to have streamlined billing practices in place that consider the unique factors of the industry. For this reason, construction companies generally use one of these 5 types of construction billing contracts.
Sometimes referred to as fixed billing contracts, lump-sum contracts roll the entire price of a project into one fixed price. At first glance, this option seems to offer a simplified process that will eliminate the pain points associated with construction billing. The bidding process only requires an experienced contractor to provide one price for materials and labor to complete a specific project. As a bonus, the construction company enjoys wide profit margins for jobs that are under budget or completed early.
Unfortunately, it’s not usually that simple. Every construction project has variables. A large job that takes months or years to complete requires multiple tiers of contractors and subs working on different aspects of the project. Estimating the cost of such a project can be difficult, and the competitive nature of bidding can force contractors to aim low. As unexpected issues crop up, change orders integrate into the project as well. With a lump sum contract, any deviation from a perfect workflow cuts directly into profit margins. For this reason, lump-sum contracts work best for smaller projects.
A cost-plus contract provides more flexibility for contractors than the lump sum, but it can be risky for the owner. Cost-plus billing requires the owner to pay the contractor for the cost of the project plus a fee for profit. These costs include direct costs like labor, materials, and equipment. They can also include indirect costs like insurance, travel mileage, and communication expenses.
This structure takes care of unexpected changes and rising material costs without cutting into profit margins. However, it generally requires a lot of documentation to justify the costs. Owners can also be resistant to indirect costs like travel and administrative tasks. The cost-plus structure can be helpful in a project with a largely undefined scope. The project needs professional creativity. While the risks of a cost-plus contract are generally higher for the owner, you may be on the hook for overhead costs you expected to be paid. The language in a cost-plus contract should be specific to protect both parties.
Time and Materials
Similar to a cost-plus contract, time and materials billing provides flexibility for a project with a less defined scope. As it sounds, a time and materials contract is based on the cost of materials for a project and a defined hourly or daily rate. The contract allows you to set rules for what materials will be covered and provides flexibility to include change orders. A set pay rate also adds the advantage of full payment for hours worked if the project takes longer than expected.
While a time and materials contract may seem to have the most benefits, it’s a document-heavy process. As with all construction jobs, you only get paid for what’s been documented. Additionally, this structure doesn’t reward efficiency. Simply put, there’s no reason for the contractor to get the job done quickly. For this reason, the early completion of a project includes a bonus.
A unit price contract breaks the project into segments instead of pricing a complete job. The number of segments or units of work is usually undefined at the beginning of the project when using this structure. Unit price billing provides room for additional work or materials to a project. However, the structure is only effective when the job divides into clear blocks. Repetitive projects or certain portions of a project use unit price contracts. Paying for gravel by the load, for instance.
While a unit price contract can simplify invoicing and help contractors maintain profit margins, it can cause disputes. Predicting the final value of a contract can be challenging when the number of units is undefined. Defining the scope of labor throughout the project leaves room for potential errors and can lead to delayed payments when remeasurement takes place.
The construction companies considered AIA billing as the only option to perform progress billing for an ongoing project in the past. Technically, AIA billing is more of a description of any progress billing type that utilizes official forms from the American Institute of Architects than a specific billing type. Large construction projects utilize some form of progress billing since businesses recognize revenue, as an IRS requirement, within the earning period. It bills the owner for the completed portions of a project. Contractors can use costs, units, or labor hours to calculate the percentage of the project that is complete. The project uses the same method all throughout.
Contractors use and recognize AIA, however, they provide a variety of complications. The forms include the considerable potential for errors. Contractors must use some form of the percentage of completion formula for progress billing. They can customize the documents, however, certain changes can lead to legal compliance risks. Unfortunately, using these forms can also be expensive. This is another cost that eats away at profit margins.
It’s easy to see that each construction billing type has its own set of advantages and disadvantages. Unfortunately, any billing process in construction can include complications that slow down payments. Proper documentation is the key to getting paid. This is whether you stick to one method or use different payment types based on the project. Ensure you’re keeping up with your construction billing documentation, no matter what method you use, when you use Flashtract’s pay app software.