7 Main Types of Construction Contracts and How to Bill for Each
There are seven main types of construction contracts that every general construction subcontractor should be familiar with:
- Fixed-Price/Lump Sum
- Time and Materials (T&M)
- Cost-Plus
- Unit Price
- Incentive Contracts
- Guaranteed Maximum Price (GMP)
- Design-Build Contracts
In the highly competitive construction industry, general construction subcontractors often find themselves bound by contract terms dictated by general contractors (GCs) or project owners. This lack of control over contract structure and payment schedules can make it challenging for subcontractors to maintain profitability. Knowing the different types of construction contracts—and how to bill for each—is crucial for general construction subcontractors looking to stay ahead in a competitive market.
At JJ&S Environmental Abatement and Services, we've worked on various types of contracts, helping our clients, GCs, and subcontractors navigate the complexities of asbestos removal, mold remediation, and lead abatement. This knowledge allows us to contribute effectively to a wide range of projects, ensuring that everyone from the owner to the general construction subcontractor understands how billing works under different contract structures.
Each of these contract types comes with unique billing requirements, advantages, and drawbacks. Let’s dive into how they work, what general construction subcontractors should expect, and how to optimize billing under each contract
Fixed-Price (Lump Sum) Contracts
A fixed-price contract, also known as a lump sum contract, is the most common type of construction agreement. In this contract, the general construction subcontractor agrees to complete the project for a predetermined sum, which covers all labor, materials, and overhead.
At JJ&S Environmental Abatement, we regularly work under fixed-price contracts for our asbestos removal services. This ensures our clients know upfront how much they’ll be paying, offering them financial certainty.
Pros of Fixed-Price Contracts:
- Budget Certainty: Clients appreciate knowing the total project cost in advance, which helps them manage their budgets.
- Potential for Profit: Efficient general construction subcontractors can complete projects below the estimated cost, increasing their profit margins.
Cons of Fixed-Price Contracts:
- Increased Risk: If project costs rise unexpectedly, the subcontractor bears the financial risk.
- Time-Intensive Bidding: Fixed-price contracts require detailed planning and accurate estimates, which can be time-consuming.
For general construction subcontractors, fixed-price contracts offer predictability but require careful cost control to avoid losses.
Time and Materials (T&M) Contracts
A time and materials (T&M) contract allows general construction subcontractors to bill based on the actual time spent on the project and the materials used. This type of contract is common when the project scope is unclear or when there are frequent changes.
At JJ&S, T&M contracts are often used in emergency abatement situations where the full scope of work is difficult to define upfront.
Pros of T&M Contracts:
- Flexibility: The subcontractor can adjust billing as the project progresses, making it easier to handle unforeseen circumstances.
- Reduced Financial Risk: Since the subcontractor bills for actual costs, there’s less risk of financial loss if the project scope expands.
Cons of T&M Contracts:
- Administrative Burden: Every hour worked and material used must be documented, increasing administrative work.
- Uncertain Final Cost: Clients may hesitate due to the unknown total cost of the project.
For general construction subcontractors, T&M contracts work well in unpredictable environments but require diligent tracking to avoid disputes over billing.
Cost-Plus Contracts
A cost-plus contract allows general construction subcontractors to bill for the actual costs of the project—such as labor, materials, and overhead—plus an additional fee for profit. These contracts are ideal for projects where the scope is uncertain or likely to change over time.
At JJ&S, we use cost-plus contracts for large-scale environmental projects where unexpected expenses are likely, allowing us to cover all costs and still maintain a profit margin.
Pros of Cost-Plus Contracts:
- Guaranteed Profit: Subcontractors are assured that their costs are covered, along with a guaranteed profit margin.
- Less Stress Over Estimates: Since costs are reimbursed, there’s less pressure to create an extremely accurate estimate upfront.
Cons of Cost-Plus Contracts:
- No Incentive for Cost Efficiency: Without incentives to reduce costs, subcontractors may not be as motivated to work efficiently.
- Detailed Documentation Required: Subcontractors must track all project costs and provide supporting documentation, which can become a time-consuming process.
For general construction subcontractors, cost-plus contracts provide financial security but require precise cost tracking and clear communication with the client.
Unit Price Contracts
In a unit price contract, the general construction subcontractor bills the client based on a set price for each unit of work completed. These contracts are commonly used in projects that involve repetitive tasks, such as road construction or multi-unit residential buildings.
At JJ&S, we occasionally use unit price contracts for projects that involve repetitive work, such as removing asbestos from multiple units in a large building.
Pros of Unit Price Contracts:
- Simplified Billing: Contractors bill for each completed unit, making the billing process straightforward.
- Flexibility for Variable Project Size: These contracts are ideal for projects where the total number of units may fluctuate.
Cons of Unit Price Contracts:
- Risk of Underpricing: If subcontractors fail to accurately estimate costs, they may lose money on each unit.
- Unclear Total Cost: The client may be uncertain about the total cost if the number of required units is unclear at the start.
For general construction subcontractors, unit price contracts offer clarity in pricing for each segment of work but require careful unit cost estimation.
Incentive Contracts
Incentive contracts offer bonuses for completing work ahead of schedule or under budget. These contracts are often used for larger projects where efficiency and timeliness are crucial. In many cases, general construction subcontractors can earn extra money for meeting specific performance criteria.
At JJ&S, incentive contracts are used for time-sensitive abatement projects, where completing the job early can result in bonuses for the team.
Pros of Incentive Contracts:
- Motivation for Efficiency: Subcontractors are encouraged to complete work quickly and efficiently to maximize bonuses.
- Cost Control for Clients: Clients benefit from projects completed ahead of time or under budget.
Cons of Incentive Contracts:
- Potential for Cutting Corners: The pressure to finish early may lead to rushed work, impacting quality.
- Difficulty in Meeting Targets: Incentive contracts can create stress if the performance targets are unrealistic or hard to achieve.
For general construction subcontractors, incentive contracts offer potential financial rewards but require careful balance between speed and quality.
Guaranteed Maximum Price (GMP) Contracts
A Guaranteed Maximum Price (GMP) contract sets a ceiling on how much the client will pay for the project. If the project goes over budget, the subcontractor absorbs the excess costs. If it comes in under budget, the savings may be shared between the client and subcontractor.
At JJ&S, we occasionally work with GMP contracts, particularly when the project scope is fairly defined, and the client wants assurance on cost control.
Pros of GMP Contracts:
- Cost Protection for Clients: Clients are assured that costs won’t exceed a certain amount.
- Opportunity for Shared Savings: If the project is completed under budget, both the client and subcontractor can benefit.
Cons of GMP Contracts:
- Risk for Subcontractors: If the project exceeds the GMP, the subcontractor may suffer significant financial loss.
- Detailed Project Planning Needed: GMP contracts require thorough planning to avoid going over budget.
For general construction subcontractors, GMP contracts offer the chance to demonstrate cost control but come with the risk of absorbing overruns.
Design-Build Contracts
In a design-build contract, the subcontractor or a team handles both the design and construction phases of the project. This contract type is becoming more popular for its ability to streamline processes and reduce costs for clients. General construction subcontractors often work alongside designers in these projects.
At JJ&S, we frequently collaborate with GCs on design-build projects, particularly in commercial and industrial sectors where environmental abatement is part of a larger construction effort.
Pros of Design-Build Contracts:
- Efficiency: Combining design and construction phases can lead to faster project completion.
- Collaboration: The design and build teams work together, reducing miscommunication and streamlining the process.
Cons of Design-Build Contracts:
- Limited Input from Clients: Clients may feel they have less control over the design and construction process.
- Higher Responsibility for Subcontractors: Subcontractors take on additional responsibility for both design and execution, which can increase complexity.
For general construction subcontractors, design-build contracts offer the chance to be involved in the project from start to finish but require close collaboration with designers and GCs.
6 Tips to Improve Your Construction Billing Processes
With some strategic steps, you can streamline this process and ensure you get paid on time. Here are six tips to help improve your construction billing practices and minimize delays.
1. Establish Clear Payment Terms
The foundation of a smooth billing process is establishing clear and detailed payment terms. These terms should be laid out in the contract before any work begins. This is your opportunity to set expectations regarding when and how payments will be made, and whether specific conditions, such as “pay-when-paid” clauses, apply.
Taking the time to review these terms carefully helps you avoid cash flow surprises down the line. Ensuring clarity from the start can prevent disputes and delays in getting paid.
2. Submit Payment Applications on Time
Submitting payment applications (pay apps) on time is essential for keeping your cash flow steady. Missing a deadline can delay your payment by an entire billing cycle, which no one wants to deal with.
To avoid this, create a reliable system to track deadlines for pay app submissions. Gather all necessary documentation in advance to prevent any last-minute scrambling. The more organized you are, the smoother the payment process will be.
3. Follow Up on Invoices and Pay Apps
Once your invoice or pay app is submitted, don’t just sit back and wait. Proactively following up with the general contractor (GC) or project owner ensures that your payment is in process. A simple check-in to confirm receipt and approval can make all the difference in getting paid on time.
Maintaining open communication with GCs can also help build trust and keep everything running smoothly, ensuring there are no miscommunications when it comes to payments.
4. Reward Early Payments and Penalize Late Ones
Offering a small discount for early payments is a great way to encourage GCs or project owners to settle invoices promptly. On the flip side, including a late payment penalty in your contract terms can deter delayed payments. Both approaches add incentives for clients to keep the billing process on track.
When setting up your invoicing terms, make sure these rewards and penalties are clearly outlined. They can act as subtle motivators, helping you secure timely payments and maintain steady cash flow.
5. Use Construction Billing Software
Using billing software designed specifically for construction projects can save you time and reduce the risk of errors. Software like Siteline can help you generate pay apps that meet each GC’s specifications, eliminating delays caused by incorrect submissions. It also helps streamline administrative work, allowing you to focus on other aspects of the project.
Billing software also tracks deadlines and payment schedules, making the entire process easier to manage.
6. Track Retainage and Be Prepared
Retainage, where a portion of the payment is held back until the project is fully completed, is common in construction but can create financial strain if not tracked carefully. Make sure to monitor the retainage amount throughout the project and follow up as soon as the final payment is due.
Staying ahead of retainage will ensure you’re paid for all the work you’ve completed and keep your projects profitable. In the long run, this attention to detail helps build a solid financial foundation for your business.
By following these tips, general construction subcontractors can better manage their billing processes, reduce payment delays, and focus more on delivering quality work. Through consistent organization and proactive communication, even complex projects can be kept on track. This approach has worked for many companies in the industry, including those specializing in environmental services, where smooth project execution and timely payments are essential for success.
FAQ
1. How can I negotiate better payment terms in a construction contract?
When reviewing a contract, ensure that the payment terms align with your cash flow needs. Don’t hesitate to negotiate for more favorable terms, such as shorter payment cycles or removing "pay-when-paid" clauses. Always clarify the expectations before signing, as this can prevent payment delays later.
2. What should I do if I miss a payment application deadline?
If you miss a deadline, reach out to the general contractor or project owner immediately. Provide your invoice as soon as possible, and explain any reasons for the delay. Be prepared to follow up frequently to expedite the process and avoid missing the next billing cycle.
3. How can billing software help my construction business?
Construction billing software, such as Siteline, helps you create and manage pay apps according to each project’s unique specifications. It tracks deadlines, organizes paperwork, and reduces administrative errors, which can help you get paid faster and avoid costly delays.
