Building better contracts: What you need to know about time and materials contracts

Your ultimate guide to the perfect time and materials contract

Accurate estimates on construction, oil & gas, mining, and manufacturing projects are critical to their success. Because of the scope and duration of these projects, delivering accurate contract estimates can be a major challenge, particularly for contractors in the tendering process.

If an estimate is too high, then the project owner might opt for a lower-cost competitor’s bid. Too low, though, and contractors put potential profit at risk, with little flexibility to adapt to changing market conditions. 

That’s where time and materials (T&M) contracts come in. T&M contracts give contractors and owners greater transparency when approaching capital projects while offering more flexibility to manage long timelines. 

In this blog, we’ll explore:

• What time and materials contracts are and how they work
• What to include in a time and materials contract
• Key benefits of time and materials contracts
• Getting started with time and materials contracts

Let’s get into it!

What is a time and materials contract?

A time and materials contract is an agreement wherein the project owner agrees to pay their contractor the costs of materials, labor, and markups for the full extent of the project. In other words, the project owner is footing the entire bill for the entire project. These contracts are common in situations where scoping the full cost of materials, labor, and time are impractical or otherwise not feasible, notably capital projects.

Far from a blank check for contractors to spend spend spend, T&M contracts feature not-to-exceed clauses that establish project maximums and prevent cost overruns. These contracts are most often used in situations where owners have strong relationships with strategic contractors, as they require a great detail of trust and collaboration.

Ambiguity is the bane of effective project delivery. No one wants big question marks floating over any elements of work, especially when significant costs are involved. Time and materials contracts help reduce the guesswork, and are commonly used in these situations:

• Unpredictable scenarios: T&M contracts are particularly useful when dealing with unpredictable scenarios, such as construction bidding on complex or unfamiliar projects where cost and duration estimates are challenging to determine accurately.
• Uncertain project scope: If you're dealing with a project that lacks a clear or accurate estimate of the time and costs involved, this contract type is a wise choice. Fixed-price contracts require a well-defined scope, making them inappropriate for uncertain or evolving projects.
• Variable duration: T&M contracts work well when the project's duration is uncertain or likely to change. With hourly labor rates specified, clients have flexibility in project timelines.
• Limited cost certainty: When you have limited insight into the overall project cost but still require work to commence, T&M contracts offer a way to start while maintaining effective cost controls through hourly rates and oversight.
• Flexibility requirements: If your project may undergo changes in scope, design, or materials, T&M contracts provide the flexibility to accommodate these modifications without extensive contract revisions.

As an example, the price of lumber has been volatile due to shifting trade policies. In a traditional lump sum (also known as a fixed-price) contract, contractors would have to carry any additional material costs based on the fixed-price terms. In a T&M contract, though, contractors are able to recoup material costs more easily.

Lump sum contracts vs. time and materials contracts

Choosing between a lump sum contract and a time and materials contract ultimately boils down to the needs of the project in question. Lump sum contracts provide clear, fixed predictability with a simplified budget—but accommodating changes in project scope can be challenging, and you may face higher initial costs. 

By contrast, T&M contracts are inherently adaptable to changing conditions and requirements and offer greater transparency, but may introduce some elements of budget uncertainty. 

What to include in a time & materials contract

Most time and materials contracts will include the following key components:

• Labor rates: This section specifies the hourly rates for laborers, subcontractors, and any other personnel engaged in the project. It may also encompass administrative expenses if applicable.
• Maximum labor hours: T&M contracts may define a maximum cost or percentage of the estimated project price. This serves as a safeguard to prevent excessive budget overruns.
• Materials costs and materials markups: Clients are typically invoiced for both the actual cost of materials, including expenses like materials procurement, freight, and a markup. This ensures the contractor recovers material expenses.
• Time and materials not-to-exceed clause: This clause extends beyond labor costs and covers the entire project cost, providing clients with a maximum spending limit to enhance budget predictability.
• Breach of contract clause: This provision outlines the consequences if either party breaches the agreement. It may include terms like liquidated damages, choice of law, venue selection, and more.
• Disclaimers: Contractors often include disclaimers, especially regarding warranties and the quality of client-chosen materials. This shields the contractor from liability for the quality of specific products chosen by the client.
• Modifications clause: Recognizing that changes may be necessary during the project, this clause outlines how and when changes can occur and when they become legally binding.
• Payment milestones: The contract specifies payment dates, which can occur at project completion or at specified project milestones. Payment frequency may be periodic, such as weekly or monthly, depending on the project's nature and timeline.

As common as some of these elements may be to most contract types, it’s important to review each component carefully in collaboration with your partners to set clear expectations, ensure transparency, and maintain accountability. 

The benefits of time and materials contracts

T&M contracts have a host of benefits to offer contractors and owners involved in capital projects. The first and most immediate is, obviously, that they remove uncertainty over project expenses on the contractor side of the equation. This makes it easier for contractors to take the lead and put their expertise to work on highly complex projects, particularly those with great deals of uncertainty. 

But that’s not all:

Flexibility and agility

T&M contracts make it far easier for contractors and owners to make changes to project scope without the need for major renegotiations. This is particularly useful in those situations where total project duration isn’t set in stone, as it offers immense agility.

On that note, agility is often the name of the game for these projects, and T&M contracts make it possible for all parties involved to hit the ground running. We’ve mentioned it before, but these contracts are commonly used with trusted or strategic contractors, which allows a certain degree of independence based on mutual trust between all parties. partners. Plus, because these projects are often a moving target with regards to overall scope, there’s less time spent trying to lock down variables. 

Transparency

Billing is determined based on actual time worked and actual material costs, ensuring greater transparency on the client side. Using a platform like PayShepherd also makes it easy for owners and clients to monitor these costs in real-time, with automated notifications about timesheet submissions or if budgets start to approach limits laid out in the contract’s terms.

High-quality outputs

For as much as they rely on mutual trust and a degree of independence, T&M contracts also incentivize greater collaboration. Think of it this way: the project has a clear goal, but how both parties achieve that goal has yet to be determined. Project owners leveraging these contracts are looking for partnerships that can offer insight and expertise. 

Plus, the nature of these contracts means there’s less of a focus on balancing quality with the constraints of a budget. Put simply, there’s no need to settle for “good” in terms of work quality—contractors can continuously strive for the best possible outcome. 

Shared risk

Owners take on the bulk of the financial risk under these contracts, but also have greater input into the project’s outcome. Simultaneously, this means that contractors are held accountable for their decisions and spending. By shifting how risk is shared, these contracts foster greater collaboration.

Considering that limits and expectations are established early on in the contracting process, the only real downside of T&M contracts is the increased need for visibility. That transparency takes work, after all.  

Getting started with T&M contracts

Using a time and materials contract effectively involves careful planning, clear communication, and proactive management. Here are a few best practices for utilizing a T&M contract:

• Negotiate rates and terms: Reach an agreement on hourly labor rates, material markup percentages, and other financial terms. Ensure that these rates are both fair and competitive.
• Establish transparent reporting: Set up a reporting system for regular updates. Contractors should submit comprehensive records of their hours worked, materials used, and expenses incurred. These reports should be reviewed and approved on a regular basis.
• Set milestones: Create project milestones or billing points that align with completed phases of work. This helps maintain a balanced cash flow for both parties involved.
• Track budget: Continuously track direct costs and indirect costs against the budget, paying close attention to labor hours, material expenses, and other project-related costs.
• Communicate: Foster open and transparent communication among all project stakeholders. Address concerns promptly and provide ongoing updates on project progress and expenses.
• Track documentation: Keep thorough records of all project-related documents, including contracts, change orders, invoices, and correspondence. 
• Conduct regular reviews: Schedule periodic project reviews with the contractor to evaluate progress, address challenges, and provide feedback, ensuring the project stays on course.
• Closure and evaluation: After completing the project, hold a closure meeting to assess the contractor's performance. Identify lessons learned and discuss areas for improvement.

If that sounds like a lot, well… it is! These contracts require more visibility and trust than most traditional approaches demand. But T&M contracts can be real assets provided you’re willing to offer some TLC on your part in the form of careful management, transparent execution, and maybe a few protective clauses for good measure. 

The secret is crystal-clear communication, everyone being on the same page, and a proactive approach to project management—and PayShepherd can help.

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Updated April 30, 2025