A time and materials contract (T&M): What is it and when to use it
Are you looking for a contract that offers plenty of flexibility regarding changes in the scope and the budget of your project? A time and materials contract (T&M) may be just what you need!
A time and materials contract is a type of agreement in which the employer agrees to pay the contractor based on the time spent on the project and the materials used in that same project.
So, in this article, you’ll learn more about:
- What a time and materials contract is,
- What a T&M contract should include,
- When you should opt for a time and materials contract, and
- Key advantages and disadvantages of a T&M contract.
Table of Contents
What is a time and materials contract (T&M)?
The official definition of the term is provided by the US Government Accountability Office. According to that definition, T&M contracts are contracts for which “payments to contractors are made based on the number of labor hours billed at hourly rates and, if applicable, other direct costs”.
Just like most other contracts, T&M agreements are typically signed between two parties: contractors and clients.
To make sure you fully understand the meaning of a T&M contract, we contacted an expert in the field, Greg Batista to get more insight into the topic.
Greg is the CEO and Founder of G. Batista Engineering & Construction. He defines a T&M contract and warns about the dangers of improperly managing the costs:
“The client reimburses the contractor for the time spent by their workers and for the materials used in the project, often with invoices providing detailed accounting. This type of contract is often used when the scope of the work is unclear or subject to change, providing flexibility for both parties. However, it may pose a risk to the client if costs aren’t well managed, as it can result in a higher final bill compared to a fixed-price contract.”
T&M contracts are mostly used in construction. However, that doesn’t mean other industries can’t benefit from this kind of agreement. Due to its flexibility, a T&M contract can be used in industries such as:
- Software development,
- Graphic design, and
- Research projects.
What is the difference between fixed-price contracts and T&M contracts?
Fixed-price is the most common type of construction contract. But, in some cases, opting for a T&M contract is a much better option.
We’ll go over the main differences between these two types of contracts to help you determine which type suits your project and your needs better.
As their name states, fixed-price contracts contain the final price of the construction services and the project that is not subject to any changes. The project’s price, deadline, timeline, and scope are set, unlike T&M contracts.
With fixed-price contracts, contractors are aware of their exact profit prior to the project’s start, while clients know how much their project will last as well as its exact cost.
According to the US General Services Administration, a fixed-price contract “provides for a price that is not subject to any adjustment on the basis of the contractor’s cost experience in performing the contract.”
An attorney from Schmidt and Clark LLP, Mike Schmidt, highlights a closer alignment between the client and contractor as a crucial difference between a fixed-price and a T&M contract:
“Unlike fixed-price contracts, where a set amount is agreed upon irrespective of changes in scope or expenses, T&M contracts offer a more flexible approach. They provide a transparent means of accounting for the actual hours worked and the materials used, ensuring a closer alignment between the client’s needs and the provider’s efforts.”
This table shows the main differences between fixed price and T&M contracts:
|Time and materials contracts
|The project price is set.
|The project price is unclear.
|The project deadline is set.
|The project deadline is flexible.
|There’s less room for changes in the project’s timeline and scope.
|The project’s time and scope are easier to change.
|Contractors know their exact profit.
|Contractors are less certain about their profit.
|Clients have a set budget.
|Clients’ budgets are subject to change.
What are the components of a time and materials contract?
Instead of one price for the whole project, a T&M contract means that parties need to reach an agreement on crucial elements of the project, while most other aspects remain flexible.
There are 10 essential components every T&M contract has to include:
- Scope of work,
- Labor rates,
- The materials markup,
- Overhead expenses,
- Payment milestones,
- Maximum labor hours,
- A not-to-exceed clause,
- The change order process,
- Breach of contract clause, and
Component #1: Scope of work
While time and materials contracts allow for flexibility regarding the scope of work, certain aspects need to be defined prior to the start of the project.
Schmidt explains how important it is to get into specifics when defining the scope of work:
“It is crucial to clearly define the scope of work, outlining the specific tasks, responsibilities, and objectives. This helps prevent misunderstandings and disputes down the line.”
The most important aspects to include within the scope of work are:
- Key project outcomes,
- Project phases,
- Estimated timeline and milestones,
- Deliverables (including the key results and reports showcasing labor and materials needed for the deliverables), and
- The process of reporting and documenting deliverables.
Once both parties agree on the scope of work, a T&M contractor can estimate the costs and the duration of the project. Furthermore, parties need to agree on the key deliverables and the process of documenting them to ensure the project stays within the agreed-upon scope.
Component #2: Labor rates
Schmidt notes that labor rates include the rates of all of the personnel involved:
“The contract should establish a detailed breakdown of labor rates, including hourly rates for different categories of personnel involved in the project.”
So, a good T&M contract must include the hourly rates of every worker, including everyone involved in administration and project management. Lastly, the contractor (as the project leader) also has to include their own hourly rate.
Some contractors include their markup for profit within their hourly labor rates. Others treat profit as a separate element. So, depending on the contractor, a T&M contract can include the contractor’s hourly rates with the profit already incorporated within the rate or have the profit item as a separate component.
🎓 Clockify Pro Tip
Labor costs can be pretty difficult to calculate. Learn how to estimate direct and indirect labor expenses here:
Component #3: The materials markup
In a time and materials contract, prices for materials are not known until the very end of the project.
The cost of materials typically includes:
- Material prices,
- Taxes, and
- Contractor markup.
Most of these aspects are hard to specify before the project starts.
The only aspect almost always specified in the contract is the materials markup which comes down to 10% of the material cost and presents the contractor’s rate for acquiring the materials.
Component #4: Overhead expenses
A T&M agreement should also include overhead expenses. Overhead is the cost of running the whole construction operation which includes costs such as:
- Administrative expenses,
- Costs of temporary facilities, and
- Equipment rentals.
While this component may also be subject to change once the project begins, it’s wise to provide at least a rough estimate of the expected overhead costs.
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Component #5: Payment milestones
As the costs of the project remain unknown until the project’s finished, the payment for a T&M contract can go two ways:
- Once the project is over, and
- While the project is ongoing (progressive billing).
If parties opt for progressive billing, they should include payment milestones within the T&M contract. Payment milestones are progress payments made to the contractor as the work progresses.
For example, a client can make their first payment once the project initiation phase (first phase of the project) is completed, the second one when the second construction phase is over, the third after the third phase is completed (for instance, utilities such as electrical and plumbing installation are installed), and so on. In this case, the payment milestones correspond to the completion of specific project stages.
Component #6: Maximum labor hours
In a time and materials contract, maximum labor hours present the limit regarding the number of hours workers can work on the project. This component helps with the unpredictability of the project as it ensures clients don’t pay too much for workers’ hours worked as a result of a prolonged project.
Moreover, if the project is too unpredictable, parties may add an adjustment to the limit clause. This clause allows for changes in the maximum labor hours once both parties agree the change is necessary for the project’s success.
🎓 Clockify Pro Tip
Looking for an easy way to track labor hours for your project and ensure they stay within the maximum labor hours limit? Try Clockify Free Work Hours Tracker:
Component #7: A not-to-exceed clause
A not-to-exceed clause (NTE) presents the cap on the overall cost of the project. It’s usually determined by estimating the costs of the project while in the initial phase and leaving room for unexpected costs during the project’s implementation.
The NTE clause serves to protect the client from the project going way over budget. Moreover, this clause also protects contractors.
With a T&M contract, contractors are fronting the costs and then get reimbursed for the expenses. If both parties agree on the maximum amount a client is willing to pay for the project — the contractor can avoid potential legal disputes which can happen when a client refuses to reimburse the contractor.
Component #8: The change order process
This component is among the most overlooked ones when it comes to time and materials contracts. The change order process consists of a predetermined procedure for dealing with any changes to the original agreement for the project’s scope and budget.
As T&M contracts leave room for project changes, it’s important to determine the exact process a contractor or a client has to go through when making any changes.
The process depends on the project and, in most cases, the change order process includes:
- A request for changes (from the client or contractor),
- A change proposal (includes the description, reasoning, and costs of the change),
- Proposal negotiation (between the client and the contractor), and
- A written approval of the change from both parties.
Component #9: Breach of contract clause
A crucial part of any contract is the breach of contract clause.
Its main purpose is to outline what happens in case any party violates the terms of the agreement or fails to fulfill their obligations.
The breach of contract clause typically includes:
- The definition of the breach of contract,
- The process of giving notice of the breach,
- A cure period for correcting the breach before the agreement is terminated,
- Provisions for damages and penalties in case of a breach, and
- The process of resolving the dispute (in a T&M contract, this usually includes litigation, arbitration, or mediation).
→ Note: This is just an informatory text. For more information on what this clause should include in your case, you should consult a legal expert.
Component #10: Disclaimers
Disclaimers are additional provisions that protect either the client or the contractor and limit their liability in certain events.
The disclaimers vary depending on the parties and the project. But, in most cases, disclaimers involve:
- Limited/no warranty for the contractor for the quality of materials chosen by the client,
- No guaranteed project completion date/budget for projects that are too unpredictable,
- Risk of price fluctuations, especially for materials and their transportation, and
- Parties’ responsibility to maintain communication, provide accurate information, and ensure timely access to the site.
How do I bill a T&M contract?
A time and materials contract gives more flexibility when it comes to billing. The client and the contractor have the freedom to agree on the payment schedule that works for them.
However, regardless of its flexibility, a time and material pricing agreement should always be included in a contract — as that’s the only way to ensure the workers are fully paid for their work.
No matter what kind of payment schedule contract parties agree on, one element of the time and management contract is always the same — the contractor (or an administrator responsible for tracking) has to track every expense regarding materials and labor involved in the project. This ensures that the client has a clear overview of all of the costs that need to be reimbursed. Tracking expenses and hours of work can be a time-consuming task. Luckily, there are tools that will make the process of tracking T&M rates much easier, and one such is Clockify.
With Clockify’s Construction Timesheet, you can:
- Track hours worked,
- Calculate billable hours based on hourly rates,
- Record expenses,
- Use the clock-in and clock-out system, and
- Export reports to clients.
Once all hours are tracked, the contractor can create an invoice with all of the billable time and expenses and present it to the client.
🎓 Clockify Pro Tip
Managing contractor payments can be challenging. Here are some easy steps to follow when paying independent contractors:
When should you opt for a time and materials contract?
Time and materials contracts offer a lot of flexibility in terms of the duration of a project and overall project costs.
Opting for a time and materials contract instead of a fixed-price one allows both contractors and clients more freedom in determining the specifics of a project, as there’s no fixed price or deadline to be followed.
Furthermore, if the size of the project is susceptible to change, a T&M agreement won’t have to be renegotiated as it’s pretty flexible in terms of size and time spent on the construction.
So, the time and materials contract is a great option when it’s difficult to determine some or all of these elements:
- The size of a project,
- The duration of a project,
- The exact project costs, and
- The specifics of a project.
What are examples of time and materials contracts?
Construction in older buildings tends to be unpredictable, as there’s little to no way to determine the state of the building prior to the project’s start. For instance, installations could be outdated and the rot and damage to the walls and floor can be much bigger than it may seem in older buildings.
Thus, contractors usually opt for a T&M contract to leave more room for changes in both the duration and the costs of the construction.
For example, if a client needs to renovate a historical building or wishes to preserve the state of an older one, it’s much wiser to opt for a time and materials contract. Older installations are pretty unpredictable, and you never know what kind of challenges a contractor will face during the renovation period.
Moreover, it’s likely that a historical building will have unique restoration and preservation requirements the contractor didn’t come across before. Thus, the costs and the process would be nearly impossible to predict. So, a fixed-term contract is not the best option.
Another example of a situation where a T&M contract is a great option is the construction of a customized building with lots of interesting and unique features and designs. The intricate features make the costs difficult to estimate and predict.
What’s more, if a client wants to fully customize their home, they may be more likely to request changes during the process. A time and materials contract allows for more client involvement and changes as the project duration and costs are not determined.
Tips for creating a time and material contract
Let’s go over some crucial tips for T&M contracts that will help you avoid common mistakes people make before signing this kind of legal document.
Tip #1: Clearly define expectations
The flexibility of a T&M contract can lead to misunderstandings if expectations and goals are not clear to both the client and the contractor.
That is why it’s wise to incorporate the scope of work and objectives that need to be achieved during the project.
Tip #2: Have detailed records
Keeping detailed records is essential for a time and materials contract.
Schmidt explains that agreeing on how the records will be kept ensures accuracy:
“A mechanism for tracking and reporting time and expenses should be established, ensuring accurate documentation for billing purposes.”
Records of hours worked, materials used, and information about everything else that went into the project ensures the client understands the costs of the project, and that the contractor is properly reimbursed.
Tip #3: Set a realistic timeline and budget
A T&M contract leaves room for changes during the project. But, that doesn’t mean you shouldn’t spend time researching the initial budget and timeline estimations.
This helps avoid legal issues in case a client is unsatisfied with how the project is going, which is something that can happen when the budget and timeline were unrealistic to begin with.
Tip #4: Communicate regularly
Regular communication between the client and the contractor is crucial, especially when the work is prone to changes.
It ensures everyone is aware of how the project is going, as well as any potential issues that may arise during the implementation stage.
Tip #5: Send/ask for regular invoices
Aside from regular communication, regular invoice exchange is another way to provide the client with up-to-date information on project expenses.
Batista recommends weekly or monthly invoices:
“Send invoices regularly (weekly or monthly) to keep your client updated and maintain cash flow; ensure they are sent promptly after the period they cover to facilitate timely payment.”
What’s more, Schmidt agreed on the importance of regular invoicing and noted they should be well-organized and detailed:
“This information should be compiled into well-organized invoices that specify the nature of the work, the hours expended, and the materials utilized. Transparency in billing fosters trust and minimizes potential disputes.”
Tip #6: Wait for approval before any change
If you incorporate the change order process into your contract, you’ll have to go through a detailed process before making any changes to the project.
In case you decide to go without this clause, it’s still important to wait for approval before making any changes.
For contractors, a client’s approval is necessary as they’re the ones that have to make the final decision for their project. On the other hand, clients should also consult with contractors when requesting changes, as they’re the experts with a much better understanding of the construction process.
Tip #7: Consult a legal expert
Consulting a legal expert before signing a contract is wise regardless of the type of contract you sign.
But, it’s an essential step with a time and materials contract as it ensures you are protected from the unpredictability a T&M contract may come with.
What are the advantages of time and materials contracts?
Time and material contracts are a great option for projects that need more flexibility and transparency. Here are its main advantages.
Advantage #1: Flexibility in terms of project changes and duration
The most important advantage of a time and materials contract is its flexibility. The scope of the project as well as its duration and budget in a T&M contract can be changed at any time.
Therefore, any delays or issues are much easier to manage and deal with.
Advantage #2: More project control for clients
Clients that want the ability to influence and change the construction process should opt for a T&M contract. Its nature allows the project to be more customizable to the client’s needs throughout the project.
Still, regardless of the scope of the changes a client wants to make, they should always consult contractors first, as they’re much more familiar with the construction process.
Advantage #3: Work and budget transparency
Quality assurance is much easier with a time and materials agreement. That’s because this kind of contract allows clients to be involved in every step of the process. They can overview the decision-making process and account for both the expenses and the labor involved in the project.
Thus, clients looking for more transparency and accountability will be better off with a time and materials contract.
Advantage #4: Budget flexibility
Progressive billing is typical for a T&M contract since it allows the client to understand the costs at each stage of the project.
The flexibility in the budget can be an upside for contractors as well. They’ll have a chance to propose new construction ideas or alternative features that may be an even better option during the project’s implementation phase.
Advantage #5: Easier negotiation prior to the project’s start
Many important elements of the project such as the deadline and costs are undetermined when the T&M contract is signed.
The negotiation between the client and the contractor is usually much easier as parties don’t have to be too specific regarding the budget, deadline, or even the scope of the project. They can agree on certain aspects of the project and then decide on the next steps while the project is ongoing.
What are the disadvantages of time and materials contracts?
While a T&M contract comes with many upsides, there are some drawbacks of T&M contracts, especially when it comes to certain types of projects.
Disadvantage #1: Difficulty in tracking time and materials
With a time and materials contract, workers are paid based on the time spent on a project and materials used. Therefore, every hour and expense has to be meticulously tracked to ensure everybody is paid fairly.
This can be a pretty tiring process and often involves additional costs for administration and proper tracking.
🎓 Clockify Pro Tip
Proper time tracking is essential for project management with T&M contracts. Here are other benefits of time tracking for project management:
Disadvantage #2: No incentive for worker efficiency
One of the main downsides to T&M contracts is that they often don’t include clear scope of projects as well as a definite timeline. When there’s no deadline or scope limitations, workers have no incentive to finish their work efficiently. Moreover, they may even be incentivized to work longer so they can charge for more hours worked.
Luckily, many time and materials contracts nowadays have not-to-exceed and maximum hours clauses to prevent this from happening.
Disadvantage #3: Cost uncertainty
Flexibility in the budget can allow for more freedom in decision-making. However, it also brings a lot of uncertainty.
That’s why there’s always a risk of the project becoming too expensive for the client.
Disadvantage #4: Profit uncertainty
Without specific clauses regulating this element, time and materials contracts can bring profit uncertainty for contractors. This is a huge risk in case a contract doesn’t contain markup and profit percentages for contractors.
For instance, if labor prices increase during construction, they can consume a large portion of earnings meant for the contractor, reducing the estimated profit.
Disadvantage #5: Dependency on trust
With a T&M contract, a client has to trust the contractor will report the costs and hours worked truthfully.
On the other hand, contractors have to trust the client will reimburse them without having to resort to legal action, which can be a costly option.
Conclusion: Protect yourself from unpredictability to reap the benefits of a time and materials contract
A time and materials contract is great for clients that want more flexibility regarding the budget and the scope of the project. However, it can bring a lot of unpredictability when it comes to costs and the project duration.
By including key components such as maximum hours and not-to-exceed clauses, both clients and contractors can enjoy the benefits of a flexible contract without the fear of exceeding the budget or facing legal issues.
In addition, utilizing amazing expense and time tracking tools helps you get a thorough understanding of the labor and costs involved in a project, which ensures everyone is properly informed and reimbursed for their work.