Cost-Plus Contracts Expose Contractors to Huge Risks

Zack Beveridge
February 28, 2023
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This article assumes that you know what Cost-Plus Contracts are. If you don’t you can read more about them in our article about how Construction Contracts Affect Project Finances.

The Problem With Cost-Plus

There are many benefits to using a cost-plus contract, however, despite the benefits, cost-plus contracts expose contractors to huge risks. One of the biggest risks is untacked cost overruns. This happens when a project’s expenses exceed the original budget, and the contractor is still obligated to complete the work but doesn’t track the changes that occurred. This can lead to a decrease in profits, or even a loss, for the contractor.

Another risk is the potential for miscommunication between the contractor and the property owner. This can result in misunderstandings about the expenses incurred, leading to disagreements about how much the contractor should be paid. The contractor may end up incurring additional costs due to these misunderstandings, leading to even more issues down the line.

Cost-plus contracts also open up the possibility for fraud and abuse. Contractors can inflate expenses or manipulate invoices in order to increase their profits, which can lead to mistrust and dissatisfaction between the contractor and property owner. This can ultimately harm the reputation of the contractor and the construction industry as a whole.

The issue of cost overruns can be particularly dangerous for contractors who are working on a tight budget. They may find themselves unable to complete the project, or they may be forced to take on additional debt in order to complete the work. This can have long-term consequences for the contractor’s financial stability and reputation.

How to Avoid the Pitfalls

So, what can be done to mitigate these risks? One solution is to use a software platform like inBuild. inBuild provides a secure and transparent platform for contractors to track and manage their expenses. This helps to eliminate the risk of cost overruns, miscommunication, and fraud, as all financial transactions are recorded and accessible in real-time.

Financial Oversight

One of the biggest challenges of cost-plus contracts is the lack of clear, accurate, and up-to-date information about project expenses. This information is crucial in determining the profit margin for the contractor and the final cost for the property owner. However, it can be difficult for contractors to track and manage expenses accurately, especially for projects that involve multiple sub-contractors, suppliers, and materials.

Contractors may be tempted to inflate expenses or manipulate invoices to increase their profits, while property owners may be concerned about the accuracy of the expenses reported by the contractor. This can lead to mistrust between the parties and negatively impact their relationship, especially if the property owner is paying for the expenses on a regular basis. Owners might even stop paying.

With inBuild, contractors can accurately and easily track expenses that are constantly flowing into their email. Then they can ensure that the agreed-upon expenses match up to the budget to prevent it from not being exceeded. Additionally, inBuild provides contractors with a clear, detailed breakdown of expenses, which can be easily shared with the property owner. This helps to ensure that both parties are on the same page and eliminates the risk of miscommunication.

Man looking through red-tinted binoculars

Comprehensive Records

The lack of proper documentation and communication can result in disputes between the contractor and subcontractor or supplies, which can impact the project timeline and budget, and damage their relationship. Disputes can arise due to misunderstandings about the work completed, discrepancies in invoices, or changes in the budget and the actual scope of work. This can be especially problematic when it comes to change orders, which are agreements between the contractor and subcontractors when modifying the scope of work, resulting in changes to the budget.

In order to mitigate these risks, it is important for contractors and property owners to have a clear and effective communication and documentation process. This includes regular project updates, transparent tracking of expenses, and detailed invoices/pay applications. Contractors can use software platforms like inBuild to automate this flow of communication and ensure accurate and up-to-date information about expenses and budgets.

In addition to improving communication and documentation, contractors can also take steps to minimize the risk of cost overruns and disputes. For example, they can provide regular cost estimates, obtain quotes from multiple suppliers, and seek the advice of an expert when it comes to complicated or high-value items. Contractors can also establish clear and detailed scope of work agreements with the property owner, including a detailed budget and timeline.

Furthermore, property owners can play a role in mitigating the risks of cost-plus contracts by doing their own due diligence and conducting regular inspections. This includes verifying the expenses reported by the contractor and comparing them to the budget to cross-reference that the contractor is adhering to the agreed scope of work. Property owners can also consider working with an experienced and reputable contractor, who has a proven track record of delivering projects on time and within budget.

Security First

The robust security features built into inBuild help prevent fraud and abuse. All transactions are recorded and stored securely, and all invoices are verified to ensure that they are accurate and legitimate. This helps to create a trusted environment for contractors and property owners to work together, without the risk of financial mismanagement.

Final Thoughts

To wrap up, cost-plus contracts are a useful tool for contractors and property owners, but they also expose both parties to significant risks. However, these risks can be minimized by having clear and effective communication, proper documentation, and effective risk management strategies. Contractors and property owners can work together to ensure that the project is completed on time, within budget, and to their satisfaction. The use of software platforms like inBuild (schedule a demo) is critical in automating and streamlining the financial management process. It provides everyone involved peace of mind that accurate and up-to-date information about expenses and budgets is constantly being tracked.