What Is A Cost-Plus Contract? What Is Included, Pros and Cons, and When To Use One
Imagine actually getting paid for the expenses you incur during a construction project… and then some.
In a nutshell, that’s a cost-plus contract.
A cost-plus contract definitely has its perks, but they aren’t a good fit for every contractor, or every project.
In this guide, we’ll...
- Define cost-plus contracts
- Outline cost-plus contract pros and cons; and
- Provide a cost-plus construction template.
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If you already use cost-plus construction contracts, Flexbase can easily manage those for you, too, with our automated payment platform.
Wondering if a cost-plus contract is the right move for you? Read on.
What Is a Cost-Plus Contract?
There are several types of cost-plus contracts. Generally, you’ll see them defined this way:
A cost-plus contract (also known as a cost-reimbursement contract) describes a contract where the contractor gets compensated for all expenses related to the project in addition to an agreed-upon sum at the end of the project.
The ‘agreed-upon sum’ for profit is the ‘plus’ in a cost-plus contract.
What Is Included in a Cost-Plus Contract?
A cost-plus contract includes payment for all expenses incurred during a construction project plus a pre-specified amount that the contractor is paid at the end of the project.
The costs in a cost-plus contract include:
- Direct costs
- Indirect costs (or overhead costs)
- Profit
Direct costs include any expenses incurred for the specific task at hand. You may
see these called “cost of goods sold” or COGS. Materials used and direct labor is included in direct costs.
Indirect costs or ‘overhead costs’ refer to the expenses related to getting the task done. For example, mileage used to get to a job site can be recorded and reported as an indirect cost.
Profit is the cost or fee that the contractor charges for the work. Typically, this amount is a percentage of the overall cost of the project or of direct costs.
In a cost-plus contract, it’s the responsibility of the contractor to keep a record of all costs incurred on a project so that he or she is accurately compensated for the work they do.
Cost-Plus Contract Types
There are multiple types of cost-plus contracts.
A cost-plus-fee contract is a cost-plus contract that includes some type of added fee.
The primary types of cost-plus construction contracts are listed and described below:
- Cost-plus-incentive-fee contracts allow the initial agreed-upon fee to be adjusted. This usually happens if the contractor meets or exceeds expectations on a given project.
- Cost-plus-award-fee contracts include a fixed base fee and an award amount.
Typically, this happens in a situation where a contractor is being awarded for good performance.
- Cost-plus-fixed-fee contracts included a fixed fee in addition to coverage of indirect and direct costs associated with the project. These are sometimes used in riskier contract work.
- Cost-plus-percent-of-cost contracts simply allow reimbursement to fluctuate with the costs incurred on a project.
Cost-Plus Contract Pros and Cons
There are several reasons why it might be beneficial to use a cost-plus contract for your next job.
After all, they are one of the most widely used agreements in construction — largely because they benefit both the contractor and the owner in most situations.
That said, a cost-plus contract may not be right for all projects or contractors.
Read on as we discuss cost plus construction contract advantages and disadvantages in more detail.
What Are the Advantages of a Cost-Plus Contract?
Contractors and owners alike can benefit from a cost-plus contract.
For the contractor, some of the top advantages of a cost-plus contract stem from the fact that they:
- Are lower risk
- Are quality-focused
- Are practical
- Offer flexibility
- Keep things moving
A cost-plus contract basically shifts most of the risk associated with a given project to the owner. If there are unexpected changes in costs or efficiency, it’s covered under this contract.
In other words, a contractor doesn’t need to worry about the costs coming out of their profit margin which can be a huge relief for many contractors.
Sometimes, however, there is a cap on expenses worked into the contract so that not every cost would be reimbursed. This typically applies to situations where the contractor makes an error or is found to be negligent.
Cost-plus contracts usually allow contractors the ability to prioritize choosing high-quality materials over budget constraints. This shift to a focus on quality can be a benefit for both parties.
A cost-plus contract is something that can be used if a project is especially time-sensitive. In other words, a cost-plus contract provides flexibility so that projects can begin more quickly.
For example:
If a property owner is anxious to get a project going as soon as possible, he or she may opt for a cost-plus contract so that their contractor can get started right away instead of waiting for an estimate to be finalized or approved.
In this type of agreement, of course, an owner would expect a contractor to make good on his or her promises.
What Are the Disadvantages of Cost-Plus Pricing Contracts?
While there are many advantages to a cost-plus construction contract, there are disadvantages that you will want to be mindful of as well.
Cost-plus contracts typically pose more risks for the owner. However, issues can arise for contractors too.
Some of the top disadvantages of a cost-plus contract include:
- Ambiguous deadlines and unknowns
- Difficulties fronting costs
- Additional effort required to track costs & expenses
Since terms are not decided from the get-go as in a fixed contract, navigating the unknowns can get tricky.
Unexpected shortages or delays can cause issues in the overall cost or delivery of the project which may affect profit.
In the same vein, complications with cash flow can make it difficult for contractors to front the cash needed to start a project — and we all know that cash flow isn’t always something to rely on in the construction business.
This is an issue because most cost-plus contracts involve the contractor getting reimbursed for the costs he or she incurred on a project.
That said…
The most important factor in getting reimbursed is to properly keep track of expenses throughout a project.
If you’re someone who tends to misplace receipts or is generally unorganized, this could cause some problems.
Fortunately, there is a quick and easy way to keep track of your projects and invoices thanks to Flexbase.
In fact, Flexbase has an automated invoice template ready for you to use — and it’s free.
Cost-Plus Contract Alternatives
When it comes to contracts where profit is added to the cost of the project, a cost-plus contract is the way to go.
As we mentioned in a previous section, there are a few options you can choose from.
To reiterate, the main types of cost-plus agreements are:
- Cost-plus-incentive-fee
- Cost-plus-award-fee
- Cost-plus-fixed-fee
- Cost-plus-percent-of-cost
Fixed-price contracts would be the other most commonly used type of contract in construction.
Common Cost-Plus Contract FAQs
Cost-plus contracts can be complicated and hard to understand at times.
That’s why we’ve compiled a list of questions contractors usually have about them.
Read on to learn the answers to a few common cost-plus contract FAQs.
When Should a Cost-Plus Contract Be Used?
A cost-plus contract is generally used if:
- There are budgetary restrictions
- Costs cannot be easily estimated
For example, a cost-plus contract would likely be used if it is probable that costs for a given project will be less than anticipated.
Likewise, in a situation where the costs of a project cannot be adequately estimated at the beginning of a project, a cost-plus contract can provide the flexibility and security needed.
What Is Cost-Plus Pricing Example?
As an example...
Let’s say Smith’s Construction Corp. is contracted to build a $10 million retail building.
The owner and Smith’s Construction Corp. have set up a 12% profit agreement while limiting expenses to $11 million.
If Smith’s Construction Corp. finishes the project ahead of schedule, they’ll be eligible for an incentive fee on top of their 12% profit of $1.2 million.
Assuming Smith’s Construction Corp. keeps a proper record of expenses and completes the project on the agreed-upon deadline, they will be reimbursed the $10 million they had to front, in addition to a 12% profit.
Both parties are pleased and have successfully fulfilled a cost-plus contract.
Where Can I Find a Cost-Plus Contract Template?
If you’re looking for a cost-plus construction contract template, there are many available to download.
You can find examples of an AIA cost-plus contract or other types of contract templates online.
But keep in mind…
Any standard, downloadable cost-plus contract will not take into account the necessary legal language and specifics of the client or your project which can leave a lot of room for human error — something very important to watch out for.
Besides, some cost-plus contract language can be hard to understand and can become especially tricky when particular forms or specific language are needed in certain states or even counties.
If just one word is off in a contract, the other party can use that to void the contract and refuse to pay.
That’s where Flexbase can help.
Customize Your Free Cost-Plus Construction Contract Template With Flexbase
We know that the language in a contract is extremely important.
But…
We also know that legal help can be very expensive and time-consuming.
Flexbase can automatically provide you with the forms you need that are compliant with your state’s laws and regulations — automatically removing human error at the same time.
Flexbase knows that every project is unique.
That’s why we’ve created an option for users to customize free cost-plus construction templates for their projects.
Let Flexbase help you complete your cost-plus contract and streamline the billing process as a whole.
