Time and Materials Contract: Clauses, Rates and Billing

A time and materials contract either runs smoothly or ends in an invoicing dispute, and the difference is almost never the people. It is whether the contract was built properly before anyone wrote a line of code.

8

Components a functional T&M agreement needs

75%

Of the cap where notification should be contractual

1.485

Illustrative wrap multiplier on base labour

0

Verbal approvals that should ever be billable

If you want the case for choosing this model at all, our piece on the advantages of T&M pricing covers that ground. This article is about the paperwork instead: how a rate is assembled, which clauses protect each side, and who is allowed to authorise a change.

What a time and materials contract actually commits you to

The buyer pays for actual labour hours at specified fixed hourly rates, plus the actual cost of materials with a negotiated markup. In US federal procurement, the framework governing these contracts generally requires that the hourly rate already include wages, overhead, general and administrative expenses and profit, rather than a wage with something added on top.

Those rules often inform commercial practice too, although the specifics of any citation are worth confirming directly rather than relying on a summary. For reference, see the Federal Acquisition Regulation on contract types.

These contracts are inherently open-ended, and that is the design rather than a defect. They exist for projects where the problem is understood but the full solution is not, so the structure lets teams discover and reprioritise without a formal renegotiation every time requirements move.

The eight components of a functional agreement

None of these are optional extras. Rather, they are what separates an agreement that works from one that produces disputes by month three.

• Statement of work, detailed enough to define goals, deliverables and explicit exclusions.
• Rate structure, ideally tiered by labour category rather than a single blended figure.
• Materials markup, stated as a percentage rather than as "cost plus handling".
• Billing schedule, tied to approved time logs rather than to milestones.
• Change order provisions, written, signed, and before the work.
• Not-to-exceed clause, a hard ceiling with an early notification threshold.
• Schedule and milestones, even though billing is not tied to them.
• Termination terms, exit on written notice, paying only for work already done.

How the hourly rate in a time and materials contract is built

The rate on your invoice is not a salary divided by annual hours. Instead it is a fully burdened rate, often called a wrap rate, which layers fringe benefits, overhead and general and administrative costs onto base labour before profit is added.

Swipe the table sideways to see all columns.

Treat that as a worked illustration rather than a formula, because burden levels vary considerably by company, region and accounting practice. As a directional anchor, though, US-based developer base wages commonly run around $35 to $50 an hour, and the fully loaded rate that reaches the invoice commonly lands somewhere between $80 and $120 depending on seniority and specialism.

One caveat, therefore: check whether the contract genuinely defines the rates as fixed and contains no escalation clause. A rate described as fixed in a proposal and indexed in the agreement are two different commitments.

Materials and invoicing in a time and materials contract

Materials are typically billed at actual cost, meaning purchase price plus freight and taxes, and then a markup covering handling, storage, logistics and vendor profit on those materials. Commonly cited ranges sit somewhere around 15 to 35 percent, although the number matters far less than whether it is written down.

In fact, "actual cost plus handling" with no defined percentage is one of the most reliable sources of billing dispute in this model. Insist on a figure. Invoicing itself normally runs monthly and ties to approved time logs and materials receipts rather than to project milestones, which is precisely why the time logs need signing off as they happen.

The clauses that decide whether a time and materials contract holds

The not-to-exceed cap is the client's main budget protection in an open-ended structure. It should be a specific figure rather than a percentage of an estimate, negotiated from projected hours multiplied by fixed rates, plus estimated materials and a reasonable cushion.

Crucially, the vendor should be contractually obliged to notify you at a threshold, commonly around 75 percent of the cap, and not once the ceiling has already been passed. That window is what lets you choose between authorising more budget and cutting scope.

On change orders, written and signed before work begins is the only workable rule. Verbal approvals cause disputes routinely, so the contract should require written orders and you should check enforceability requirements in the relevant jurisdiction with counsel. Similarly, the statement of work should list exclusions explicitly, since anything unlisted ought to require a change order rather than appearing as an invoice line.

Termination, IP and licensing

Termination should let either side exit on written notice, with the client paying for hours worked and materials bought up to that date and nothing beyond.

Finally, address IP and licensing directly rather than by assumption. Many clients negotiate ownership or a broad licence over code and deliverables, although the outcome depends on the drafted terms, any work-for-hire arrangement and the licensing of third-party components. General guidance rather than legal advice, so put the wording in front of counsel before signature.

Against fixed-price and cost-plus

All three allocate risk differently, and that allocation is the whole decision.

Fixed-price gives certainty, but you often pay a premium for uncertainty that never arrives. Conversely, T&M carries no hidden premium and no ceiling either, until you write one in. Cost-plus resembles T&M structurally while guaranteeing vendor margin regardless of efficiency, which is why it appears mostly in government and construction contracting where the client wants the vendor unpenalised for working carefully rather than fast.

Research comparing public-sector software projects has found meaningfully higher success rates for T&M than for fixed-price arrangements in similar contexts. That pattern is consistent with what happens when contract structure gets mismatched to project complexity. So the test is simple: if you can write a complete specification today and it will not change, fixed-price is right. If you cannot, T&M protects both sides better.

Controlling scope creep in a time and materials contract

Scope creep here is rarely dramatic. Instead it accumulates through small verbal approvals, undocumented feature additions and extra revision rounds that never reach a change order. The controls that prevent it are about cadence and documentation rather than contractual complexity.

1. 01
   Daily time logs with client sign-off

   Not end-of-month summaries. Signing daily means a disagreement surfaces while the work is still remembered accurately by both sides.
2. 02
   One centralised change-order log

   Date, description, cost impact and signature for every modification. Scattered email approvals are not a log, and they will not settle anything later.
3. 03
   The notification threshold as an obligation

   Around 75 percent of the cap, written into the contract rather than offered as a courtesy. A courtesy arrives after the ceiling.
4. 04
   Regular scope check-ins on complex work

   Deviations get caught while they are small, instead of compounding into a budget conversation at invoice time.

Above all, the approval process is where disputes originate or get prevented. Treat pre-work authorisation as mandatory, and for anything affecting budget, schedule or compliance, require the cost and schedule impact in writing before the approver decides. On the broader question of keeping spend down without losing quality, see our piece on optimising costs in IT projects.

Frequently Asked Questions

Build the contract first, then pick the model

Three things decide whether a time and materials contract succeeds or produces disputes: a rate schedule both sides genuinely understand, a working not-to-exceed clause with an early notification threshold, and a mandatory written change order process covering every modification before the work happens.

Beyond that, choosing between T&M, fixed-price and cost-plus should follow the nature of the project rather than habit. Complex evolving work benefits from flexibility, whereas repeatable defined work benefits from certainty, and the wrong match in either direction creates problems no clause fully repairs. More on how we structure both in project development and implementation.