Cost-Plus Contracts 101: Key Terms, Benefits, and Best Practices
- Cost Construction Accounting
- 2 days ago
- 6 min read
In the construction sector, choosing the correct contract form is critical for risk management, financial stability, and building confidence between contractors and customers. Cost-plus contracts are a flexible and transparent choice for building projects with changeable scopes or unclear costs.
This thorough reference gives an in-depth description of cost-plus contracts, covering important terms, benefits, drawbacks, and recommended implementation strategies. It is written from the perspective of an experienced construction bookkeeper to assist contractors, builders, and construction business owners in making sound judgments and effectively managing cost-plus contracts.
What Is a Cost-Plus Contract?
The contractor is paid back for all real, allowable costs incurred during a project, plus a fee that represents the contractor's profit. This is called a cost-plus contract. This fee might be a set amount or a share of the whole project's cost.
In fixed-price contracts, the total cost is known ahead of time. Cost-plus contracts, on the other hand, give you more freedom to deal with unexpected costs. This makes them very useful for projects where the whole set of tasks isn't clear at the start or is likely to change over time.
Key Terminology in Cost-Plus Contracts
It is important to understand the terms that are often used in cost-plus contracts in order to follow the law and make good financial decisions. These are some of the most important words:
Direct costs are things that are directly related to building, like wages for workers, buying materials, paying subcontractors, and renting tools.
Indirect Costs: These are costs that aren't directly related to building but are still needed to run the project. Office management, insurance, and energy are some examples.
Repatriable Expenses: These are all the costs that the client agrees to pay back, as written in the contract. Most of the time, both direct and indirect costs fall into this group.
Contractor's Fee: This is the amount that is paid to the contractor to oversee and carry out the job. It's normally set up as a flat fee or a share of the total costs that can be reimbursed.
Maximum Price (GMP) or Not-to-Be-SoldExceed Limit: This rule lets the owner choose how much they are willing to pay for the whole thing. The contractor has to pay for any costs that go over this amount.
Benefits of Using Cost-Plus Contracts
Cost-plus contracts are good for both freelancers and clients in a number of ways, especially when the scope of a project is unclear or when the client's needs change. Some important perks are:
The ability to adapt:
Cost-plus contracts let you change the scope of a job without having to renegotiate the terms all the time. This adaptability lets changes be made to work, materials, and style without stopping the flow of work.
Much more openness:
Contractors have to give clients specific cost records, which lets clients see how project funds are being spent. This builds trust and makes disagreements less likely.
Recovery of all costs:
Contractors are paid back for all valid costs, which lowers the chance of losing money because of wrong cost estimates or changes that were not expected.
Encouragement of Good Work:
Cutting cuts to stay under budget isn't always a contractor's only way to make money, so quality, safety, and on-time delivery are often given more weight than cutting costs.
Read more: Best Practices for Tracking Expenses in Cost-Plus Construction Contracts
Cost-Plus Contracts & Fixed-Price Contracts
To better understand where cost-plus contracts excel, it is helpful to compare them with fixed-price contracts:
Criteria | Cost-Plus Contract | Fixed-Price Contract |
Cost Certainty | Lower – costs vary with actual expenses | Higher – total cost is predetermined |
Flexibility for Changes | High – scope changes easily incorporated | Low – changes require formal change orders |
Contractor Risk | Low – reimbursed for actual costs | High – assumes risk for cost overruns |
Client Risk | High – final price may exceed initial estimates | Low – price is locked in from the beginning |
Reporting Requirements | Detailed cost reporting is essential | Minimal reporting beyond scope of work |
Cost-plus contracts are particularly well-suited for complex or custom construction projects where the scope is likely to evolve.
Types of Cost-Plus Contracts
Depending on how the contractor's fee is set up, cost-plus contracts come in different forms:
Cost-Plus Fixed Fee (CPFF): The contractor gets a set amount of money, no matter how much the job actually costs. This makes it easier to predict how much a worker will make.
CPPC stands for "cost-plus percentage of cost: This means that the contractor's fee is based on a percentage of the total project costs. This makes sure that contractors get paid based on the size of the job, but it may make them less motivated to keep costs down.
Cost-plus with a Max Guaranteed Price (GMP): The total cost is limited, which protects the client from going over budget while still letting them be flexible.
Risks of Cost-Plus Contracts
While cost-plus contracts offer flexibility and transparency, they also come with certain risks that contractors and clients should be aware of:
Cost Overruns: Since the client pays for actual costs, the total project price could increase if the contractor doesn't carefully monitor expenses.
Complex Accounting: Tracking expenses accurately can be time-consuming, as all receipts and costs must be documented for reimbursement.
Lack of Incentive for Efficiency: If contractors are paid based on total costs plus a markup, there may be less incentive for them to keep expenses low. However, effective project management can help minimize this risk.
Best Practices for Managing Cost-Plus Contracts
Managing cost-plus contracts well is important for making sure that people are held accountable, keeping clients' trust, and avoiding financial disagreements. The following best practices can help workers do a good job with these contracts:
Keep track of detailed records
Every cost should be carefully recorded, such as with purchase orders, vendor receipts, labor timecards, and invoices from subcontractors. This is very important for keeping things clear and supporting requests for reimbursement.
Set up accounting systems that are designed for construction
It is strongly suggested that you use building accounting software. Programs like Sage 100 Contractor or QuickBooks for Contractors let you keep track of project-based costs, keep time, and make invoices.
Set up a standard system for cost codes.
Using a predefined cost code structure to group bills into groups makes them easier to find, report, and keep track of. Some common groups are materials, labor, subcontractors, permits, and tools.
Talk to your clients quite often
Set up a regular time to send interim cost reports, like once a week or every two weeks. Compare actuals to budgets to show that you have control over your finances and keep people from getting too excited.
Keep an eye on markup and profits.
Regularly look over the contractor's fee to make sure it covers profit and costs. When there are a lot of change orders or costs that are going up and down, recalculating profit margins can keep you from losing money.
When to Consider Outsourcing Bookkeeping
If keeping detailed financial records starts to take up too much time and makes it hard to handle projects or talk to clients, it might be best to outsource bookkeeping.
We at Construction Cost Accounting are experts at keeping the books for workers and builders in the construction industry. Many freelancers are able to keep their own records, but they often find that outsourcing has a number of benefits, such as:
More time to focus on project execution and business development.
Improved accuracy in expense tracking and reporting.
Reduced risk of missed reimbursements or audit issues.
Cleaner documentation for client presentations and invoicing.
Our team makes sure that all costs that can be reimbursed are properly tracked, that contracting fees are applied correctly, and that reports are clear, professional, and easy for your clients to understand. We work with a range of cost-plus contracts and offer help that fits the way you run your construction company.
Conclusion
Cost-plus contracts let contractors get back the actual costs of a job while still making money because the fee is clearly defined. But these deals only work if costs are carefully tracked, communication is clear, and both parties fully understand how the contract is set up.
Cost-plus contracts can give contractors more freedom and financial clarity than fixed-price contracts, but only if they are ready to put money into good record-keeping systems or work with a professional bookkeeping service.
If you want to make your project reporting better and your accounting more efficient, you might want to talk to a building bookkeeping expert about how cost-plus contract management can work best for your business.
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