June 27, 2026
Construction activity is strong, but the market is facing ongoing challenges. Rising material costs and global uncertainty are making it more difficult to predict project timing and margins. While contractors can’t control market conditions, they can decide how much risk to accept before work begins. One of the earliest business decisions on any project is the construction contract. More than a legal agreement, the contract determines how financial risk and uncertainty will be shared between the owner and contractor. Understanding the different contract types can help construction leaders choose an approach that best fits each project and protects profitability. To help clients, prospects, and others, Wilson Lewis has summarized the key details below.
The biggest difference between construction contract types is how the project is priced. That structure also determines how financial risk is distributed. Each approach has advantages depending on the project and the level of uncertainty involved. The most common contract types include:
Fixed-Price Contracts — Fixed-price contracts, also called lump-sum contracts, are a common choice for construction projects, especially commercial and industrial building projects. They are typically used when there is a clearly defined scope of work and little uncertainty about costs.
This type of contract has benefits for both parties. Owners know the project cost before construction begins, and contractors have an opportunity to improve profit margins by completing the work for less than the contract price. For example, a contractor that bids a project at $2 million and completes it for $1.8 million retains the additional $200,000 as profit.
The challenge is that the contractor also absorbs most unexpected costs. A 1% increase in material costs may be manageable, but larger swings can have a much bigger impact. Recent market data showed construction input prices up nearly 10% year over year, with iron and steel up 7% and copper wire and cable up more than 24% over the same period. When those increases happen after the contract is signed, they come out of the contractor’s margin. For that reason, fixed-price contracts are generally best suited for projects with clearly defined scopes and relatively predictable costs.
Cost-Plus Contracts — Cost-plus contracts are used for larger or more complex projects where the final cost is hard to predict. This is more common for multi-year projects where the design may change during construction.
In this case, the owner reimburses the contractor for project costs on top of a flat fee or a percentage of the project. The benefit here is that contractors are protected from volatile input costs. In other words, labor, materials, and other expenses are billed based on actual costs instead of potentially eating into the contractor’s margin.
The tradeoff is that owners usually don’t know the final project cost until the project is completed. Because of that, there needs to be a great deal of trust and transparency between parties. Contractors using this type of contract should be prepared to provide receipts and other documentation that shows the costs associated with the project. Some cost-plus contracts include a Guaranteed Maximum Price (GMP), which gives the owner a price ceiling and helps prevent disputes later on.
Unit Price Contracts — Unit price contracts may be used when a contractor knows what each unit of work costs but can’t know exactly how many units the project will need. Instead of bidding one total price, the contractor prices individual units. Expense units can be individual materials, like lumber, cement, or cubic yards of excavation, or they can be labor hours, overhead costs, etc. Then they get paid out based on actual quantities. If the project ends up needing more than expected, those additional units get billed accordingly, and the contractor does not need to absorb the costs.
This contract structure is more common on public infrastructure, utility, roadway, and site development projects, where nailing down quantities before construction starts requires a lot of guesswork. (Refer to FAR16.301 for guidelines on public projects.)
Time and Materials Contracts — T&M contracts are generally used for smaller projects like maintenance work, emergency repairs, and renovations. Instead of agreeing to a fixed project price, the contractor bills for actual labor and materials. This is helpful when the scope is largely unknown or might quickly expand. Like a cost-plus contract, the final cost isn’t known upfront, and documentation is important. Many T&M contracts also include a not-to-exceed amount that establishes a maximum price point.
Choosing the right contract structure for the job begins with understanding the project itself. Before submitting a bid or signing an agreement, contractors should consider several important questions:
Many contractors evaluate each opportunity individually rather than relying on the same contract type for every project. This can help protect profitability, even during periods of uncertainty. Consulting with advisors is also recommended.
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Every project is different, and there’s no single contract type for every situation. Understanding how construction contracts allocate risk can help contractors make better business decisions before work begins. If you have questions about the information outlined above or need assistance with another tax or accounting issue, Wilson Lewis can help. For additional information call 770-476-1004 or click here to contact us. We look forward to speaking with you soon.