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One of the most important things to understand in the construction industry is how to bill for services. Once you have a better understanding of the billing structure it is much easier to compare bids and construct the contract.
This post is not a complete list of all forms of construction contracts and there may be instances where contracts have portions of each type of contract.
Fixed price / Lump sum contract:
From the name you can understand fairly easily that the lump sum or fixed price contract is a construction contract that stipulates the price of the building project based upon the needs included in the design/per your written contract. However, it is important to note that usually these construction contracts are fixed as it relates to the agreed service level. In the construction industry changes happen constantly. For this reason, construction contractors should get signed change orders as changes occur so they are not left eating the cost of construction changes when the contract is complete.
Cost plus contract:
With the cost plus contract, the construction company says that they will charge the contract out at the cost of materials plus a percentage or fixed price for their own construction time. This model is based upon the thought that construction materials represent the largest portion of the overall construction contract.This model is nice in a scenario with many change orders, because it usually avoids the need for many signed change orders (as long as the change order can be supported in some manner). This is also nice for construction companies because purchasers are more concerned with the reputation of the company they hire, not the cost of the project. These types of contracts are also helpful as they can be bid before the scope of the project is known completely. Certain preparatory work such as site preparation, utility work and other prep stage projects are agreed based upon a cost plus model.
Maximum price contract:
Under a maximum price contract, or a price not to exceed contract, the construction company bids on the job, or part of the job and gives an overall estimate of the fees involved with a cap on the price charged for the project. Under this model, construction companies have an incentive to cap overall costs, while still making sure that the project is done appropriately. Many buyers are more willing to sign a cost plus contract with a price not to exceed, than a cost plus contract. The fact that these contracts are more valuable to consumers is the incentive for this type of contract. Many construction contractors include incentives to share the “cost savings” if the actual cost of the construction project comes in lower than the maximum price. This blending of risk and reward makes the maximum price contract a very attractive option in the construction field.
Unit price contract:
Unite price contracts are usually used in construction for repetitive tasks, which at the start of the contract the actual amount of the service is unknown. Examples of this type of contract include an agreement to deliver a certain amount of rocks, soil or other aggregate for a specified price per yard/ton. These types of contracts are used extensively in the road construction contracts as the tasks are usually repetitive and the costs can be estimated on this basis with relative ease.
Construction accounting can be very complex. If you are in the construction industry and do not use someone who specializes in the industry you are throwing money away. Let us focus on your business so you can run operations.