What Is a Fixed-Price Contract?
A Fixed-Price Contract is a contract in which the buyer and seller agree on the total price of a piece of work or product that will be under production for an agreed-upon time. The buyer pays the seller at fixed intervals until the predetermined project is complete and all work has been completed to their satisfaction. A Fixed-Price Contract consists of a Fixed-Price Agreement from the seller to the buyer, Fixed-Price Invoices from the seller to the buyer, and Fixed-Price Payment Terms from the buyer to the seller. Buyers can use Fixed-Price Contracts on simple or complex projects, while sellers usually use this type of agreement for tasks that have been done repeatedly before. Owners often use Fixed-Price Contracts on new buildings or renovation projects.
Advantages of Fixed-Price Contracts
A Fixed-Price Contract is useful when the buyer does not have an accurate idea of the scope of work involved in completing a project.
- Fixed-Price Contracts protect both parties from unknown quantities and help reduce risk, by offering investors and buyers a predetermined price for the work.
- With Fixed-Price Contracts, both parties can plan effectively; sellers can predict revenue, while buyers can predict their final costs.
- With Fixed-Price Contracts, both parties do not have to worry about losing money or canceling the contract if unforeseen events occur during the project.
- Fixed-Price Contracts are easy to draw up, as the agreement is made between two parties who have agreed on a specific price for an item or service.
Disadvantages of Fixed-Price Contracts
Contractors often use Fixed-Price Contracts when they need quick and fast cash flow and do not want to wait for payments over time.
- Contractors can use Fixed-Price Contracts on simple or complex projects, but Fixed-Price Contracts are only beneficial to the contractor if they know how much time and money a project will cost.
- Fixed-Price Contracts can be more expensive for contractors than Hourly Agreements because Fixed-Price Contracts require a higher hourly rate from contractors.
- Contractors can also lose money if the Fixed-Price Contract fails to account for hidden costs. When most Fixed-Price Contracts fail, it is because of unforeseeable problems that occur during the project.
- The owner does not have control over how much time or resources are put into completing a Fixed-Price Contract with their contractor.
Differences Between Fixed-Price Contract and Hourly Contract
Fixed-Price Contracts are used when a buyer pays the seller based on predetermined milestones. It guarantees the cost of each milestone. Fixed-Price Contracts are used when the buyer does not want to pay for services until after they have been completed. Fixed-Price Contracts protect both parties from unknown quantities and help reduce risk, by offering investors and buyers an option that offers them a predetermined price for the work.
Hourly Contracts are used when a buyer pays the seller an hourly rate for time spent on the job. Hourly Contracts are used when the scope of work is unknown and can vary from day to day. Hourly Contracts do not include Fixed-Price Agreement, Fixed-Price Invoice, Fixed-Price Payment Terms, and Fixed-Price Milestones.
Types of Fixed-Price Contracts
There are various types of fixed-price contracts that buyers and contractors can agree into.
Fixed-Price Fixed Bid Contract
In a Fixed-Price Fixed Bid Contract, the contract prices are based on the estimated cost of labor and materials. Fixed-Price Fixed Bid Contracts offer a set price that protects both parties from loss or added expenses due to unforeseen circumstances during the project.
Fixed-Price Fixed Time Schedule Contract
In a Fixed Price Fixed Time Schedule Contract, the price is fixed for a certain amount of time. The prearranged completion date or time is not changed.
Fixed-Price Fixed Scope Contract
Fixed-Price Fixed Scope Contracts are used when there is limited information about the project, but enough to estimate how much work will be involved. These contracts are better for shorter, more straightforward projects.
Fixed-Price Fixed Unit Price Contract
Fixed-Price Fixed Unit Price Contracts are similar to Fixed Bid Contracts in that contractors are paid a prearranged price for each unit of work.
Fixed-Price Fixed Unit Rate Contract
Fixed-Price Fixed Unit Rate Contracts, such as Fixed Price Fixed Bid Contracts, determine the price for each unit of work. With Fixed Price Fixed Unit Rate Contract, contractors use an hourly rate to calculate the cost of labor and materials. These contracts are often used when contractors don’t know exactly how long the job will take.
Tips to Remember When Using Fixed-Price Contracts
- Buyers should not use Fixed-Price Contracts when the scope of work is unknown and can vary from day today.
- Buyers need to know how much time and money a Fixed-Price Contract will cost them before signing any Fixed-Price Agreements with their contractor.
- Conduct thorough research on Fixed-Price Contracts so you know what you’re getting into before signing any Fixed-Price Contracts with your contractor.
Fixed-Price Contracts are used when there is a fixed price agreed for the project. The advantage of this type of contract agreement is that it provides both parties with some protection against unknown quantities and reduces risk as well as offering investors and buyers a predetermined price for the work. Fixed-Price Contracts are not always the best option to use but it provides payment plans and protection for buyers and contractors alike.
About the Author
True Tamplin, BSc, CEPF®
True Tamplin is a published author, public speaker, CEO of UpDigital, and founder of Finance Strategists.
True is a Certified Educator in Personal Finance (CEPF®), author of The Handy Financial Ratios Guide, a member of the Society for Advancing Business Editing and Writing, contributes to his financial education site, Finance Strategists, and has spoken to various financial communities such as the CFA Institute, as well as university students like his Alma mater, Biola University, where he received a bachelor of science in business and data analytics.