Advantages and Disadvantages of a Lump Sum Contract in the Construction Industry
Lump sum contracts are one of the three most common contracts used in the construction industry.
They’re simple, straightforward, and offer benefits to both the contractor and owner.
But they’re not without their disadvantages.
Read on to learn more about:
- When to use a lump sum contract.
- The difference between a fixed price and lump sum contract.
- How to weigh the pros and cons of a lump sum contract.
Flexbase: Easily Manage Lump Sum Contracts With Our Cash Flow Management Solution
Even though contracts are a necessary part of construction work, managing them can feel like a huge chore.
Purchases and payments that need to be meticulously tracked, from material costs to subcontractor invoices, can pile up quickly and leave even the most organized contractor feeling overwhelmed.
What if there was a way to work off of a professional lump sum contract template that would minimize time spent inputting contract terms and payment information and keep clients and other working parties on the same page?
Enter Flexbase.
By using our platform, you can:
- Access a number of different construction contract templates
- Simplify paperwork
- Speed up payments
- And more
Plus, if our lump sum contract templates don’t align with your project seamlessly, you can create your own custom contract template.
Flexbase automatically pulls all the forms you’ll need depending on the county/state of the project, ensuring that your contract is fully compliant with local laws.
Make manual contracts a thing of the past and let Flexbase provide you with everything you need for your next lump sum contract, in the simplest way possible.
In just two minutes, our platform can generate payment apps with:
- AIA forms
- A schedule of values
- Lien waivers
- Notarizations
- Prevailing wage
- Insurance documents
What Is a Lump Sum Construction Contract?
A lump sum contract is a type of construction contract where a predetermined, set price is quoted by the contractor for an entire project based on plans and specifications.
With a lump sum contract, also called a stipulated-sum, the owner knows exactly how much it will cost to complete the project in advance.
The total project price will include:
- All indirect costs
- The profit the contractor will make
- Progress payments to be made each month
Lump sum construction contracts provide limited flexibility, and any changes to design elements or deviation from the original plans require a change order paid by the owner.
What Is the Difference Between Fixed Price and Lump Sum Contracts?
A lump sum contract and a fixed-price contract are different terms for the same type of construction contract.
There is no difference between the two.
When Would You Use a Lump Sum Contract?
Lump sum contracts, along with other types of construction contracts, are best used in certain situations.
It’s may be best to use a lump sum contract on projects that:
- Have a well-defined scope of work (SOW)
- Are fairly straightforward
What Are the Advantages and Disadvantages of a Lump Sum Contract?
Lump sum contract advantages include:
- No unforeseen costs for the owners
- Simple cash flow management
- Opportunity for a larger profit margin for contractors
- Easy access to financing
Disadvantages include:
- Costly miscalculations
- Increased risk for contractors
- Inflexible, compared to other contracts
- Potential for increased cost for owners
4 Advantages of a Lump Sum Contract
There are multiple advantages to lump sum contracts for both the builder and owner.
To start, a lump-sum contract reduces owner risk and gives the contractor greater control over profit expectations, which helps him manage cash flow.
Additional advantages of lump sum contracts include:
- “Fixed” construction cost
- Minimized change orders
- Incentives for completing the project early
- Simplified bidding analysis and selection process
- Realistic expectations for builders and contractors
#1: Simple Cash Flow Management
Because lump sum contracts don’t require expense or purchase tracking in order to invoice, contractors don’t need to spend valuable time creating and double checking that their invoices or payment applications are accurate.
Payments often go out on a progress schedule with a lump sum contract, so owners don’t need to worry about additional material costs or other unexpected costs.
Because of this predetermined payment schedule, contractors are able to more accurately budget for the future and manage their cash flow.
The progress payment schedule allows accounts receivables and cash flow to be much easier to balance.
Whether you’re using a lump sum contract or not, Flexbase can help you rewrite the way you handle cash flow management.
On top of automating the entire payment process, our platform also enables you to get paid sooner with tools like:
- Project tracking
- Lien waivers
- Payment applications
- Legal reminders
- And much more
Staying on top of your invoicing and billing will set you up for positive cash flow.
#2: Larger Profit Margin for Contractors
As part of the bid price, contractors will include an additional profit or insurance percentage.
This enables them to not dip into their profits or reserves if any unexpected costs or delays come up during the project.
But, if the contractor is able to accurately control overhead costs, that additional insurance percentage becomes an additional profit.
And, because profit is already built into overall price, this additional insurance is an added bonus.
#3: Straightforward Contracts
Lump sum contracts are the simplest and most straightforward construction contract available.
The documents included clearly outline the work needed to complete the project as well as how much money the contractor expects upon completion.
Lump sum contracts provide transparency to the owner, so they don’t have to guess about what the final project cost will be.
And contractors appreciate the freedom that lump sum contracts give them to get the job done.
#4: Easier Access to Financing
With other open-ended contracts, lenders become concerned due to fluid-pricing and how much it will actually take to finish the project.
Lump sum contracts, however, provide owners with a total project cost, which lenders appreciate. Because of this, it can be easier to secure financing with a lump sum contract.
So let’s say you choose to (or need to) apply for working capital in order to fund your next project.
Flexbase is here to make accessing working capital quick and easy.
We’re able to integrate with all of your company’s financial data, which makes getting working capital exponentially quicker.
So, how does it work?
Because we already have access to the information that would normally take the banks weeks to review and approve, we are able to share that information with our preferred lenders, allowing you to be automatically pre-approved.
Your Flexbase subscription allows our software to integrate with…
- Invoicing tools
- Project management tools
- Personal bank accounts; and
- Business bank accounts
…that lenders look at to evaluate your funding application.
With the Flexbase pre-approval system, you can see your approval status in just 24 hours, so you can get to work without having to dip into your reserves.
4 Disadvantages of a Lump Sum Contract
As with any type of construction contract, there are downsides to using a lump sum contract.
A few disadvantages to keep in mind include the fact that:
- Changes can be difficult to quantify.
- The owner might reject change order requests.
- The project needs to be designed completely before work begins.
- Budget restrictions can inhibit final outcomes.
- There is little room for error, and miscalculations can be costly.
#1: Increased Risk for Contractors
If unexpected setbacks occur, builders and contractors may end up making less money or even losing money because owners are not required to pay for costs above the agreed-upon price.
Plus, even though contractors are able to build an insurance sum into the contract, any amount that exceeds that will have to be covered by the contractor.
They assume the entire cost of completing the project, whether that ends up being less or more than the predetermined contract price.
If…
- Material prices inflate
- Additional material or labor is needed; or
- The project runs into delays
… the contractor alone shoulders the additional costs.
Because of this, lump sum contracts may be preferred for smaller projects or those with a clear scope and an established timeline.
#2: Projects Cannot Be Flexible
A clear schedule of values is important and essential in any construction contract but especially with lump sum contracts.
They enable a contractor to accurately present a bid and to complete the project to the agreed-upon specs.
However, this clarity also negates any flexibility in the contract.
Any changes that are deemed necessary must be approved by the owner and can be both time-consuming and paperwork-heavy.
Change orders, however, are the only way to keep the contractor’s bottom line from getting off track.
Cost-plus contracts, time and materials contracts, or others are able to adapt to any necessary changes a lot smoother.
#3: Can Be More Expensive for Owners
It’s known by all parties that contractors pad the final project cost in a lump sum contract.
And for good reason — owners are aware of the risk assumed by the contractor if the project exceeds the agreed upon sum.
This additional insurance can make lump sum contracts more expensive compared to other contract formats.
Moreover, if a contractor can find the necessary materials for a lower price than estimated in the contract price, they are able to pocket even more, while the owner does not reap the same benefit.
#4: Contractors Can Conceal Profits
Because the necessary paperwork involved in a lump sum contract is considerably less than other contract formats, contractors aren’t held to the same detail or required to provide itemized lists as they may be with other contracts.
Providing quotes for subcontractors, suppliers, or materials to the owner isn’t required, so contractors are able to save or spend more on various categories and pocket whatever profit they’re able to make from that.
This is where unbalanced bids come into play.
A contractor may increase the price of items or labor in order to compensate for additional profit.
This could include:
- Raising unit prices on items that are to be used at the start of the project.
- Lowering unit prices on items needed in later stages.
Due to the lack of detail and transparency in a lump sum contract, coupled with the fact that contractors don’t have to produce an itemized invoice to prove actual costs, contractors are able to hide their actual profit margin from the owner.
Utilize Lump Sum Contracts and Get Paid Faster With Flexbase
Bidding and securing a lump sum contract is just the beginning.
There are still legal documents, progress payments, and purchases that need to be considered.
Flexbase helps to streamline the whole contract and payment process from start to finish. With automated paperwork and compliance, there is nothing to worry about.
In addition to a compilation of all the necessary forms and documents needed for your lump sum contract, Flexbase can:
- Manage your cash flow.
- Send invoices and paperwork in minutes.
- Get you paid faster.
