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Time And Materials Contract

Updated on February 23, 2024
Article byGayatri Ailani
Edited byAlfina
Reviewed byDheeraj Vaidya, CFA, FRM

What Is A Time And Materials Contract?

A Time and Materials (T&M) Contract is an agreement in project management and procurement where the client agrees to pay the contractor based on the actual hours worked and the cost of the materials used for the project. The main benefit of a T&M contract is that it provides flexibility in project management and resource allocation.

Time And Materials (T&M) Contract

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It allows the client and contractor to make changes in the scope of work, timeline, and materials used throughout the project. However, the risk of cost overruns and delays may be higher since the client is responsible for paying for all the additional hours and materials required. As a result, people generally use T&M contracts when other types of contracts, such as fixed-price contracts, are not suitable.

Key Takeaways

  • A T&M contract is a process under which a contractor is paid for their time and for the materials they use to complete a project
  • T&M contracts are often used when the scope of work is uncertain or when changes to the project are likely.
  • It allows the contractor to be flexible in their approach to the work and provides a way for the client to ensure that they are only paying for the actual time and materials used.
  • T&M contracts can be more complex than other types of contracts, and they require careful oversight to ensure that costs are reasonable and that the work is being performed efficiently.

How Does Time And Materials Contract Work?

Time and Materials (T&M) contract is a binding agreement between a client and a contractor that outlines how the contractor will be paid for their services and the materials used in a project. It usually finds application in construction project management but is also used in other industries, such as product development, software development, and consulting services.

T&M contracts typically provide both parties flexibility and can help mitigate risks associated with uncertain project scopes and changing requirements. Additionally, T&M contracts require detailed record-keeping, which provides transparency and accountability in the billing process.

Time and Materials (T&M) contracts provide a framework for billing clients based on the time and materials used to complete a project. Here is how T&M contracts typically work:

  1. Initial Estimate: The contractor provides the client with an initial estimate of the time and materials required to execute the project based on the scope of work.
  2. Hourly Rate and Material Costs: The contractor and client agree on an hourly rate for the contractor’s services and the cost of materials the project might need.
  3. Record Keeping: The contractor keeps detailed records of all time spent on the project, including hours worked, expenses, and materials used.
  4. Invoicing: The contractor regularly invoices the client regarding the time and materials required to finish the project based on the hourly rate and material costs agreed upon in the contract.
  5. Approval and Payment: The client reviews and approves the invoice for payment. The contractor then receives payment for the work completed.
  6. Ongoing Management: Throughout the project, the client and contractor work together to manage the scope of work, timeline, and costs to ensure the successful completion of project.

Components

Time and Materials (T&M) contract is most suitable when it is difficult to determine the scope of work or the project duration beforehand, such as in construction projects. In scenarios such as renovating an old building, unexpected damage or complications may arise during the project, making it difficult to determine the full scope of work upfront. Similarly, suppose the cost of materials will likely change over the project duration. In that case, a T&M contract can help adjust the billing structure based on the actual materials costs incurred.

Time and Materials (T&M) contract typically includes several key items to ensure that project requirements are met, the contractor’s costs and overhead are covered, and the client’s interests are protected. Here are some common items present in a T&M contract:

  1. Labor rates: The contract specifies the hourly wages for all laborers, subcontractors, and administrators who manage the project and billing.
  2. Maximum labor hours: To prevent costs from spiraling out of control, a maximum number of labor hours can be specified. The contractor must absorb any additional hours required.
  3. Materials markup: The client will receive billing for the actual cost of materials, including freight. They will also receive a specified markup, usually ranging from 15% to 35%.
  4. Time and materials not-to-exceed clause (T&M NTE): A not-to-exceed quote for the entire project makes sure that the client knows the maximum cost of the project beforehand.
  5. Payment milestones: Certain milestones ensure that the workflow doesn’t face major setbacks during the course of the project.

Examples

Let us look at the time & materials contract examples to understand the concept better: 

Example #1

Suppose ABC Corporation has hired a software development contractor, XYZ, to create a customized software solution. The project scope is unclear and may require changes as it progresses. Therefore, the parties have agreed to use a T&M contract. The T&M contract includes the following items:

  • Labor rates: XYZ will charge a rate of $150 per hour for each software developer working on the project. The rate for project managers is $200 per hour.
  • Maximum labor hours: A maximum of 2,000 labor hours has been specified for the project. XYZ must absorb any additional hours required.
  • Materials markup: The bill would cover the actual cost of materials. This includes software licenses and third-party services, plus a 20% markup.
  • Time and materials not-to-exceed clause (T&M NTE): A not-to-exceed quote of $300,000 has been agreed upon for the entire project. If the project exceeds this amount, XYZ will absorb the additional costs.
  • Payment milestones: Payments will depend on the following milestones: 30% upon initial design and prototyping, 50% upon core features, and 20% upon completion of testing and implementation.

T&M contract provides flexibility for both parties in case any changes or unforeseen issues arise during the software development process. The T&M NTE clause protects the client, while the maximum labor hours and agreed-upon payment milestones protect the contractor.

Example #2

In a recent ASBCA case, the U.S. government tried to reduce fixed-rate labor charges under a time-and-materials (T&M) contract due to alleged issues with indirect cost rates. The contractor, Granite State Manufacturing, successfully argued that the government lacked authority for this reduction.

The ASBCA stressed the importance of understanding the Federal Acquisition Regulation (FAR). The government claimed authority under FAR 52.216-7(g) to audit and adjust invoices. However, the ASBCA clarified that this pertains only to material costs in T&M contracts, not direct labor charges.

The case highlighted the government’s power to audit direct labor hour charges under FAR 52.232-7 before final payment on a T&M contract. However, the government cannot unilaterally reduce fixed hourly labor rates based on supposed issues with indirect cost rate support.

This case underscores that the government’s audit and adjustment powers face limitations through FAR language. It emphasizes the need for contractors to evaluate this authority and respond carefully to audit requests in T&M contracts.

Pros And Cons

The pros and cons of the T&M Contracts are as follows:

Pros

  1. Flexibility: T&M contracts provide the flexibility needed in an agreement, as clients only pay a set amount till the implementation of the project. It makes it easier to adjust the project scope and budget throughout the project.
  2. Simple negotiation: Negotiating the terms and conditions of a T&M contract is generally easier than with other types of contracts. One can establish these terms quickly, as long as both parties can reach a mutual agreement and neither party tries to negotiate terms that would only benefit themselves.
  3. Maximum hours cap: T&M contracts enable clients to limit the project’s maximum hours. This can prevent situations where contractors might prolong the project to increase profits, resulting in improved transparency and cost management.

Cons

  1. Lack of cost certainty: In a T&M contract, the absence of an established budget allows for the possibility of total costs exceeding initial expectations. This can pose challenges in cost management, especially for smaller businesses with limited resources.
  2. Extensive tracking: Active tracking of billable hours and materials used is necessary for T&M contracts. This can be demanding and time-consuming, particularly for small businesses. The level of involvement required in a T&M contract surpasses that needed for a fixed-price contract.
  3. Complex negotiation: Negotiating the terms and conditions for a T&M contract can be complex. This is because both parties need to agree on the hourly rates, materials markups, and other factors that will affect the final cost. It can lead to lengthy and difficult negotiations, particularly if the parties have different goals or interests.

Time And Materials Contract vs Fixed Price Contract vs Cost Plus Contract

The differences between a Time And Materials Contract, Fixed Price Contract and Cost Plus Contract are as follows:

BasisTime And Materials ContractFixed Price ContractCost Plus Contract
MeaningIn a T&M contract, the client pays the contractor based on the time and materials used to complete the projectIn a fixed-price contract, the client pays a set price for the entire project, regardless of the actual costs incurred by the contractor.In a cost-plus contract, the client pays the actual cost of the project plus a percentage fee to the contractor.
ScopeT&M contracts are typically used for projects where the scope of work is not well-defined, and changes are expected to occur during the project.The scope of work, deliverables, and timelines are all defined in the contract. FP contracts are typically used for projects with a well-defined scope of work and a low risk of changes.Cost-plus contracts are typically used for projects with a high degree of uncertainty and complexity.
BenefitThe main advantage of a T&M contract is that it provides flexibility to the client, but the disadvantage is that it can lead to unexpected costs.The main advantage of an FP contract is that it provides cost certainty for the client, but the disadvantage is that it can lead to disputes if there are changes to the scope of work.The main advantage of a cost-plus contract is that it provides transparency and accountability for the costs incurred, but the disadvantage is that it can lead to a lack of incentive for the contractor to control costs.

Frequently Asked Questions (FAQs)

1. What type of contract is T&M?

Time and Materials (T&M) is a type of contract that is based on the actual cost of materials and the time spent by the contractor to complete the work. It is a flexible contract that allows for changes to be made to the scope of work and materials as the project progresses. T&M contracts are commonly used in construction, engineering, and other industries where the project scope and timeline may change during the course of the project.

2. Are T&M contracts cost-reimbursable?

Yes, Time and Materials (T&M) contracts are typically cost-reimbursable contracts. In a T&M contract, the contractor is paid for the time and materials spent on a project. He also gets an additional fee for profit and overhead. The cost of the materials and the hourly rate of the labor are typically specified in the contract. The client reimburses the contractor for these costs as they are incurred.

3. Is T&M a cost-type contract

Yes, Time and Materials (T&M) contracts are considered a type of cost-reimbursement contract. This means that the contractor is reimbursed for their allowable costs incurred during the performance of the contract, plus a fee or profit. In a T&M contract, the contractor bills the client for the actual hours worked by their personnel at an agreed-upon hourly rate and for the cost of any materials or equipment used during the project. The hourly rate is typically based on the labor category and qualifications of the personnel providing the service.

This has been a guide to what is Time And Materials Contract. We explain its examples, pros, cons, & differences with fixed price & cost plus contracts. You can learn more about financing from the following articles –

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