Fixed price vs Cost plus contracts: Which is better for you?
There are two main types of contracts in business: fixed price and cost plus. Each has its own set of pros and cons, which can make it more or less advantageous for a given company, or home-owner. Let’s take a look at the key differences between these two contract types for every knockdown and rebuild project.
Fixed Price Contracts
What are fixed price contracts?
A fixed-price contract is much simpler than a cost-plus one. Everything related to the construction, from the materials used and labor hours required to even profit margins of the custom-home builder, are all included in an agreed upon set price. This way there'll be no nasty surprises when it comes time for billing. As opposed to a cost-plus contract, the owner and contractor/builder have agreed upon a fixed price that must be abided by throughout the course of the project. This requires contractors to remain within their designated budget in order to complete any materials or labor needed for completion, as no extra costs can be invoiced back to the owner. Within a fixed-price contract, if the custom-home builder exceeds their budget then it's on them to fund the project. There may be particular provisions in the agreement that allow for extra fees to be incurred; take time and read through everything carefully as additional costs such as survey reports are often not included in the original fee estimate.
Pros:
When you have a fixed budget, it becomes easier to allocate funds and plan your expenses accordingly.
No extra costs and in the off-chance that both parties agree to alter the initial fixed cost, it must be done so formally and mentioned explicitly in independent legal documents.
With a fixed-price contract, the owner may not need to provide as much oversight compared to other types of contracts, such as cost-plus.
Cons:
It is the responsibility of the contractor to deliver this project within budget and on time, or else they will be liable for additional expenses.
Modifying the original plan to fit budget needs might not be welcomed with open arms by the owner.
In an effort to stay within the allocated budget, if not well estimated, cheaper, and lower quality products may be used to cut costs
Cost Plus Contracts
What are cost plus contracts?
A cost-plus contract ensures that the owner is provided with an additional benefit beyond just reimbursing construction costs. Not only are building materials and labor expenses factored in, but any supplementary material needed for the project will also be included and charged to the owner along with a profit margin on top to cover contractors' overhead. This sort of agreement is made to guarantee the contractor gets rewarded for both direct and indirect (overhead) expenditures. Moreover, they're allowed to add a little extra into their pocket as profit, which normally comes in the form of a pre-decided percentage - this forms part of what we refer to as “plus” side within such contracts. To ensure all expenses are used for the construction, the contractor must show proof in a documentation form. Cost-plus contracts can be difficult to establish as there is no fixed number on final price. Regular payments are made with this type of contract rather than one lump sum because they come through different jobs within the project. In addition, clauses may also be inserted into the agreement that puts maximum spending restrictions and more in place.
Pros:
This incentive encourages custom-home builders to utilize higher-quality, (but pricier) materials, as they don't have to worry about the cost coming out of their own pocket.
The project owner has the option to cap it if they want.
With flexible invoicing, owners have the ability to remain in control of their project's costs and progress as they are only billed for when materials need to be purchased.
Cons:
For a contractor to be compensated for their materials, it is essential that they keep meticulous records and documentation of costs throughout the entire design and build process. Otherwise, there could be financial issues, and lack of payments down the line.
For contractors, having to pay for the materials up-front before they can invoice them to the owner can be a difficult task if they don't have enough funds.
As expenses get more and more expensive, the "plus" part of any agreement will also become increasingly pricey - consequently, it's in the owner's best interests to maintain their costs as low as they possibly can.
Fixed price vs Cost plus contracts: Which do you pick?
There are three main differences between the two types of contracts;
Budget: A fixed-price contract guarantees that the agreed-upon price at the start of a project is equal to what you will pay at its end. On the other hand, cost-plus contracts anticipate a project’s expenses but won't establish an exact fee until it's finished.
Profit: When it comes to a fixed-price contract, there is no assurance that profit will be made. The prices are set at the start of the job with profits already included but as soon as costs exceed expectations, then the contractor must deal with them on their own dime. On the other hand, cost-plus contracts separate expenses from any profits made by ensuring that profits become a prearranged fee or percentage of what was spent for completion of said project.
Risk: A fixed-price contract places the majority of risk on the contractor, whose duty is to remain within budget so their gain margin isn't compromised. Miscalculations at the beginning can lead to unfortunate outcomes later on in terms of profits. Alternatively, with a cost-plus agreement, it is then up to project owners if expenses surpass expectations and they must confront any implications that may come out of this situation after the design and build process.
Negotiations between a contractor and project owner will determine the best contract for their situation. Fixed-price or cost-plus, both parties must be content with all aspects of the agreement from the start. The larger in scope a project is, it's wise to have an attorney review its terms; this action could save everyone time and money later on. If a project is fairly straightforward, like replacing a roof, then it may make sense to use a fixed-price contract.
These types of contracts are ideal for projects that contractors have completed many times before (which is why you should go to builders experienced in your home style if you choose this type of contract, for example, if you would like a French Provincial home, you should go to a custom-home builder experienced with French Provincial homes, and if you would like a modern home design, you should go to a builder experienced with modern home designs).
However, when the scope and scale of the work is more difficult to define in advance - such as constructing an entire apartment complex - then using a cost-plus contract will likely be your best bet. No matter what, it is essential that contractors keep accurate records of their expenses for not only reimbursement but also to make the most out of their profits. Project accounting and financial management software can help with this too as it automates many tasks, allowing them to devote more time to doing excellent work and gain new clients.
Uncertainty is inevitable in any construction project, and the amount of uncertainty largely dictates which type of contract a contractor and project owner agree to use: either cost-plus or fixed-fee. If the project is relatively small and straightforward, then it's wise to opt for a fixed-price contract—which sets out all costs upfront. Cost-plus contracts are ideal for larger, more complex projects with unclear scope. Although you won't know the final price until completion of the project, all involved should be aware of both advantages and drawbacks to this contract type and take steps to watch expenses closely.
Contact Carmel Homes
If you think a fixed price contract is the right decision for your home, or would like to know more about what it may mean for you, contact Carmel Homes today!
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