Looking to streamline the process of sharing and managing contracts?
To achieve this, you’ll need to have a clear understanding of different types of contract — and one of the types of contract that people get most confused about are cost reimbursement contracts.
That’s why this article will explain what cost reimbursable agreements are, what’s included in them, and how to use and manage a cost reimbursement contract.
Use a cost reimbursement contract to remove risk for contractors
Make sure to provide cost estimates and fee information in your cost reimbursement agreement
Choose a fixed price contract instead for smaller projects
Use contract management software to streamline your cost reimbursement contracts
Let’s say you’re about to start a project with another company.
You’ve agreed to build an office for them.
You can either sign a contract in which the other party pays you the money it will cost you to build that office straight away or a contract in which the other party promises to reimburse the costs once they’ve taken place.
This latter contract is a cost reimbursement contract (which, if they include a profit and the costs, are known as cost plus contracts).
It’s a flexible agreement that requires the buying party to cover all the work costs.
This means that the cost is worked out once the work has been fully completed – letting the buyer reimburse the costs incurred by the contractor.
Of course, this means that the buying party has less control over the project’s price.
However, many cost reimbursement contracts are designed with an estimated cost in mind, and restrictions (such as the maximum price point for building materials) can be agreed on in advance.
When creating a cost reimbursement contract, you’ll need to know what is included in them.
Here are the main elements of a cost reimbursement contract.
It should be clear in the agreement that it’s a cost reimbursement contract.
As there are also different types of cost reimbursement contracts – which we’ll cover later in this article – you should specify which type it is.
Of course, a cost reimbursable contract is a legally binding document.
This means that you’ll have to ensure you’ve covered all of the fundamentals to ensure its legal validity.
The key legal details you must include are party names, contact information, effective dates, and signature lines.
All of this is essential if you want your contract to actually count.
If a selling party doesn’t indicate the expected cost of a product, the buyer is taking on enormous amounts of risk – indeed, they almost certainly won’t sign the contract.
That’s why cost estimates are crucial to a cost reimbursement contract.
Sellers need to be able to provide an accurate estimate of their costs, while the contract should also incorporate a clause that explains what will happen if actual costs exceed this estimate.
Just as cost estimates reduce the amount of risk for the buyer, an indication of the total project value will limit the level of risk for the seller.
That’s because this lets the selling party know how much they will be paid in fees once the project is completed.
This clause should also explain how this fee is determined – think about whether you want to produce a fee according to a fixed amount or a formula based on costs or performance levels.
In any contract that deals with costs and payments, it’s crucial that you provide definitions of the different types of recoverable costs.
Be as clear as possible about the costs that buyers will need to cover and those that the sellers will have to carry themselves.
This will reduce the likelihood of any disputes further down the line.
Leverage contract templates and management software to help create your contracts in minutes.
No general rule explains when you should use a cost reimbursement contract.
That’s because it all depends on the amount of risk your organization is willing to take on – and this will vary according to the size of your business and the financial demands of the project.
However, you should generally use a cost reimbursement contract when the amount of uncertainties in a project means that a fixed price contract would be too risky.
If your project is dynamic or dependent on changeable market conditions, a cost reimbursement contract is your best option.
For the seller, a cost reimbursement contract is a great way to ensure that you remain in the driving seat of a project.
The buying party will cover those, and you won’t have to worry about spiraling costs or surprise inefficiencies.
For the buyer, it helps avoid paying upfront for a job that may or may not meet your expectations.
By only paying the costs after the project completion, you can ensure it’s finished up to the requested standard – rather than risking your money being taken and nothing being produced.
If you decide to use a cost reimbursable agreement in your project, it’s essential that you know the different types of cost reimbursement contract. Here are the main ones.
This is when the contract simply covers the costs of the project.
The contractor won’t receive any profit or fee, meaning this is a rare cost reimbursement contract outside of the non-profit sector.
In this type of contract, the contractor and the buyer share the costs according to the previously agreed formula.
Again, no additional fees are involved.
This is one of the more common forms of cost reimbursement contracts.
Once the project is completed, a fee is negotiated ahead of the project, which is received along with reimbursement for the costs.
Many of these contracts will include a provision for this fee to be revised according to performance-related criteria.
in this contract, the fee received by the contractor is adjustable.
Minimum and maximum fees are agreed ahead of the work, while targets are determined to produce the final fee.
This type of contract incentivizes the contractor to keep costs low as this will directly impact the fee they receive – making it a great way to share risk.
This is another way of providing a performance-related incentive.
According to an assessment of performance, an additional fee can be given to the contractor on top of the reimbursement and a pre-agreed fixed fee.
In this type of contract, an additional fee is added as a percentage of the cost.
This is useful for industries with supply chain disruptions or a shortage of skilled workers, as it prevents the seller from coming out at a loss.
One of the most common examples of when to use a cost reimbursement contract is in the construction sector.
The cost of making a building can be very high, so it makes sense for the buying party to protect themselves against the risks that come with this high cost.
In this example, the buyer would determine which type of cost reimbursement contract is most suitable and negotiate a cost estimate and fee structure with the construction company.
Once the building has been completed and the buyer is happy, the costs will be reimbursed and the fee paid.
Another cost reimbursement contract example is outsourced software development.
This is because making new software can also be costly while using a cost reimbursement plus fee contract allows the buying party to have more confidence in the quality of the software.
Cost reimbursable contracts can be complex legal documents.
That’s why it’s crucial that you manage them carefully.
Here are four top tips that can help.
By far, our most important tip is to use contract management software.
This will take most of the hard work out of your hands and into the secure control of a well-designed and intelligent piece of software.
It will also ensure that you and the other party can easily access the contract on a cloud-based platform while allowing you to use an eSignature and collaborative editing tools to make managing the contract as easy as possible.
Without contract management software, you risk losing track of your contract, leading to inefficiencies and failures in your contract management process – especially damaging in the complex world of cost reimbursable contracts.
There’s no doubt managing a cost reimbursement contract can take a lot of time, as you must negotiate cost estimates, fee agreements, and payment structures.
Set specific deadlines for tasks, and keep tabs on them with your contract management software.
A cost reimbursement contract should be easily accessible to both parties.
This will let the contractor repeatedly refer to the document to manage their costs when completing the work while letting the buyer easily prepare for fees.
Contract tracking can clarify this during every part of the contract management process.
When paying costs and fees, this can often be determined by a complex formula agreed on in the contract.
Automating this workflow can save a lot of time and worry.
Before you decide to use a cost reimbursement contract, it’s important that you’re able to recognize the pros and cons of using a cost reimbursable agreement:
The opposite of a cost reimbursement contract are fixed price contracts.
Here are the key differences:
Cost reimbursement contracts are a great way to spread the risk on large projects.
However, they can be challenging to manage.
This is why contract management software, like PandaDoc, is so essential.
By providing contract templates, collaborative editing tools, and eSignature processes, you can ensure that both parties are up-to-date throughout the process.
Use our software to boost productivity with automated contract management.
Cost reimbursement on a project is when the buyer reimburses the contractor for the costs they have incurred completing a project.
Both parties carry some element of risk. The seller has to buy materials and pay for labor out of pocket. However, the buyer carries more risk, as they have to reimburse all costs.
The main limitation of a cost reimbursement contract is that it makes future financial planning more difficult for the buyer. Additionally, monitoring is necessary as there is less incentive for the seller to be cost-efficient.
No. While a cost reimbursement contract can include labor costs, a stand-alone labor hour contract doesn’t include reimbursement for materials.
If your project is large-scale and carries many risks, a cost reimbursement contract is well-suited. However, a fixed price contract is likely to be more suitable for smaller, low-risk projects.
PandaDoc is not a law firm, or a substitute for an attorney or law firm. This page is not intended to and does not provide legal advice. Should you have legal questions on the validity of e-signatures or digital signatures and the enforceability thereof, please consult with an attorney or law firm. Use of PandaDoc services are governed by our Terms of Use and Privacy Policy.
Olga Asheychik Senior Web Analytics Manager at PandaDoc
Olga is a Senior Web Analytics Manager at PandaDoc who has been working in the Digital Marketing field for the past 15 years. Olga had roles driving marketing campaigns in document automation, contracts, invoices, and agreements. In her daily life, she is a big fan of traveling and connecting with new people.
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