Target Profit: The profit amount assuming performance at target cost
Ceiling Price: Maximum amount the government will pay, typically 120-130% of target cost plus target profit
Share Ratio: The formula determining how cost under-runs or over-runs are shared between government and contractor, such as 70/30 or 60/40 splits
Final Price: Calculated based on actual allowable costs and the incentive formula, subject to the ceiling price limit
Cost-Reimbursement Contracts: Government Bears Cost Risk
Cost Plus Fixed Fee Contracts
Cost Plus Incentive Fee Contracts
Cost Plus Award Fee Contracts
Time and Materials and Labor Hour Contracts
1
Understand rate structure
Negotiated labor rates include direct labor costs, indirect costs, and profit. Unlike cost-reimbursement contracts, the government does not audit actual costs against these rates. Rates must be competitive for award but should cover anticipated costs and provide adequate margin.
2
Monitor ceiling price
Time and materials contracts include ceiling prices limiting government obligation. Work approaching the ceiling without anticipated completion creates significant risk—additional work may not be authorized and costs exceeding the ceiling become contractor responsibility.
3
Track hours meticulously
Payment depends on documented labor hours. Maintain accurate timekeeping systems and ensure billing reflects actual hours worked. Errors or inconsistencies can trigger audits and payment disputes.
4
Manage scope creep
Open-ended work statements can expand indefinitely under time and materials arrangements. While this provides continued revenue, ensure scope remains within contracted work and seek modifications when requirements evolve beyond original intent.
Assess estimating accuracy: Track actual costs against estimates to understand systematic biases and estimation reliability for different work types
Evaluate risk tolerance: Organizations with financial reserves can absorb fixed-price risk for potentially higher returns, while smaller contractors may prefer cost-reimbursement arrangements
Consider accounting capabilities: Cost-reimbursement and larger fixed-price contracts require compliant accounting systems and may trigger Cost Accounting Standards requirements
Analyze competitive dynamics: Contract type affects competitive positioning—companies with efficient operations may prefer fixed-price competition while those with unique capabilities may favor cost-reimbursement evaluation
Understand fee potential: Different contract types offer different profit potential and risk profiles that should align with organizational strategy
