You quote a bathroom remodel at $24,000 fixed. Two weeks in, the crew opens the wall and finds rotted subfloor and unpermitted wiring from the 1980s. The fix adds $5,800 in labor and materials you never bid. Under the contract you signed, that $5,800 comes straight out of your profit — the client owes you nothing extra. One bad assumption just turned a healthy job into a break-even one.
Now imagine the same job under a different piece of paper: the client pays your documented costs plus an agreed fee, and the $5,800 flows through to their final bill with your markup on top. Same rot, same rewiring, completely different outcome for your bank account.
That piece of paper is the whole game. A CFMA industry report found that 1 out of 3 construction projects comes in over budget — and even among contractors' self-reported best-performing jobs, more than 1 in 5 misses the estimate. When overruns are that common, the contract type you choose matters more than the precision of any single estimate, because it decides in advance who absorbs the difference. This guide explains how fixed-price and cost-plus contracts work, when each one wins, how to calculate a markup that actually covers your costs, and how to account for overruns so they show up in your books before they show up in your cash balance.
What Each Contract Type Actually Promises
A fixed-price contract (also called lump sum) sets one price for a defined scope of work. You bid $24,000 for the remodel; the client pays $24,000 whether your costs land at $17,000 or $27,000. Every dollar you save below your estimate is extra profit. Every dollar above it is your loss. The client gets budget certainty; you keep the efficiency gains and eat the surprises.
A cost-plus contract flips that bargain. The client reimburses your documented job costs — labor, materials, permits, equipment rental — and pays an additional fee for your work. That fee takes three common forms:
- Fixed fee (CPFF). A flat dollar amount, say $6,000 on top of costs. Your profit is known up front regardless of how the costs move, which removes any suspicion that you benefit from spending more.
- Percentage fee. A percentage of costs, say 15%. Simple to compute, but note the built-in tension: the more the job costs, the more you earn. Sophisticated clients know this and many refuse percentage-fee deals for exactly that reason.
- Cost-plus with a guaranteed maximum price (GMP). Costs plus fee, but capped — if the total would exceed, say, $30,000, you absorb the excess. The cap is often paired with a savings split: come in under the GMP and you share the savings with the client, commonly 50/50. The GMP hybrid is popular because it gives the owner a ceiling while preserving your incentive to run an efficient job.
A close cousin worth knowing is time and materials (T&M): the client pays an hourly or daily rate plus materials at cost. Economically it behaves like cost-plus — the client carries the overrun risk — but billing is by the hour rather than by documented cost, so it suits service work and small jobs where formal cost accounting would be overkill.
The One-Line Difference: Who Carries the Risk
Strip away the terminology and the choice is a single question: if this job costs more than expected, whose money covers it?
Under fixed-price, the contractor carries the risk. That is why fixed-price bids include a contingency allowance — typically 5 to 10 percent of estimated costs on familiar work, more on anything with unknowns. You are not padding the bid; you are pricing the risk you agreed to hold. A fixed-price quote without contingency is just a bet that nothing will go wrong, placed with your own money.
Under cost-plus, the client carries the risk. That is why cost-plus clients demand transparency: open books, copied invoices, and the right to audit job costs. You are asking them to fund uncertainty, so you owe them visibility into every dollar. Contractors who treat cost-plus as "bill whatever, no questions asked" lose the client's trust by the second invoice and never get a third job.
Neither allocation is morally better. Risk has to live somewhere, and a fair contract puts it with the party best able to manage it — or prices it explicitly when it cannot be managed away.
When Each One Wins
Choose fixed-price when the scope is knowable. Production-style work with a defined spec — a standard deck build, a website with a locked sitemap, ten identical tenant improvements — rewards fixed pricing. You have done the thing before, you know your unit costs, and the contingency you bake in converts directly to profit when the job runs clean. Fixed-price also wins competitively: clients comparing three bids will almost always pick the firm number over the open-ended one, so if your competitors bid lump sum, you usually must too.
Choose cost-plus when the scope is genuinely uncertain. Remodels behind old walls, ground-up work on untested soil, software integrations with a legacy system nobody documented — any job where a responsible estimator would have to say "it depends." Forcing a fixed price onto unknowable scope does not eliminate the uncertainty; it just hides it inside an inflated bid (which loses you the job) or an underpriced one (which loses you money). Cost-plus lets both sides be honest: the client pays for reality, whatever it turns out to be.
Owner-driven change is the tiebreaker. If the client is likely to revise the plan midstream — and residential and small-commercial clients almost always do — cost-plus absorbs changes gracefully while fixed-price turns every revision into a renegotiation. When you do bid fixed-price for a change-prone client, protect yourself with a tight scope definition and a written change-order process, discussed below.
How to Calculate a Markup That Actually Covers Your Costs
Here is where small contractors quietly go broke under either contract type: the rate math. Most underpricing traces back to marking up the wrong base — raw wages instead of fully burdened labor cost.
Step 1: burden your labor. A carpenter earning $30 an hour does not cost you $30 an hour. Add payroll taxes (roughly 10 to 12 percent), workers' comp and liability insurance allocations, paid time off, vehicle and tool allowances, and supervision time. A realistic burden rate runs 25 to 40 percent above gross wages. At 35 percent, your $30 carpenter costs $40.50 for every hour on site. Every estimate, fixed or cost-plus, must start from the burdened number — bill $38 an hour against a $40.50 true cost and you lose money on every hour while feeling busy.
Step 2: know the difference between markup and margin. They answer different questions and confusing them is a classic leak:
- Markup = profit ÷ cost. A 20 percent markup on $100 of cost gives a $120 price.
- Margin = profit ÷ price. A 20 percent margin on a $120 price means $24 of profit on $96 of cost.
To earn a 20 percent margin you need a 25 percent markup; to earn 30 percent margin you need roughly a 43 percent markup. The conversion is markup = margin ÷ (1 − margin). Decide which number your business targets — most healthy small contractors aim for 10 to 20 percent net margin after overhead — and mark up from burdened cost accordingly.
Step 3: cover overhead explicitly. Rent, office salaries, estimating time, software, insurance that is not job-allocated — none of it appears on a job cost sheet unless you put it there. The standard approach is an overhead recovery rate: divide annual overhead by annual billable hours (or by annual direct labor cost) and add that rate to every hour or every cost dollar. A contractor with $120,000 of annual overhead and 4,000 billable hours needs $30 of overhead recovery on every billed hour. Skip this step and profitable-looking jobs still leave the company poorer at year end.
Step 4: add contingency on fixed-price work. Unknowns you cannot itemize still have a price. Five percent for repeat work in familiar conditions, 10 percent as a default, 15 percent or more when the scope has genuine discovery risk. And on cost-plus work, remember the fee must cover your overhead, your profit, and the administrative cost of the open-books billing the client expects — tracking and documenting every cost is itself billable effort.
For a sense of the stakes, the CFMA 2025 Construction Financial Benchmarker found specialty trade contractors averaging about 22 percent gross profit and under 8 percent net income before taxes. Net margins that thin mean a single unburdened rate or a skipped contingency can erase a whole quarter's profit.
How to Account for Overruns Before They Eat You
Good contracts still overrun — remember, one in three does. The difference between a survivable overrun and a fatal one is how fast your books tell you it is happening.
Run job costing on every job, no exceptions. Each project gets its own cost bucket tracking labor, materials, subcontractors, equipment, and permits against the estimate, updated at least weekly. The moment a cost category crosses its budget line, you should know — while there is still time to staff differently, reorder materials, or have the change-order conversation with the client. Contractors who reconcile jobs only at completion discover overruns the way drivers discover cliffs: all at once, at the end.
Put every scope change in writing before the work happens. The handshake change order is the number-one profit leak in fixed-price contracting: the client asks for "one small thing," the crew does it to be agreeable, and $3,000 of unbilled work accumulates across a dozen small things. Use a one-page change-order form — description, price, schedule impact, signature — and make it a crew-level rule that unsigned changes do not get built. On cost-plus jobs the paperwork matters just as much, because undocumented extras are the first thing a client disputes at final billing.
Keep a work-in-progress (WIP) schedule. For every open job, track contract price, costs incurred to date, estimated cost to complete, billings to date, and the resulting over- or under-billing. The WIP is the instrument panel that tells you whether each job is making or losing money right now, and it is also what your CPA and your bank want to see: under-billing (costs ahead of billings) is an asset, over-billing (billings ahead of costs) is a liability, and a WIP that shows systematic under-billing means you are financing your clients' projects interest-free.
Recognize revenue the way the rules require. On your books, long-term contracts generally recognize revenue over time as work progresses — under ASC 606, typically with a cost-based input method (costs incurred ÷ total estimated costs × contract price). For taxes, small contractors under the inflation-adjusted gross-receipts threshold (around $30 million in average receipts) may generally use the completed-contract method and defer profit until the job finishes. Know which method each set of books uses, because the book-tax difference is real and your estimated tax payments should follow the tax method, not the book profit.
Book expected losses immediately. If a fixed-price job's estimated total cost climbs above its contract price, accounting rules require recognizing the full expected loss at once — not gradually as the red ink arrives. Painful, but honest: a WIP that hides a known loser misleads everyone, including you, and banks treat a discovered-then-hidden loss far worse than a disclosed one.
Mistakes That Turn Good Contracts Bad
- Bidding fixed-price off unburdened wages. The most common Estimating 101 failure. If your bid math starts from take-home pay rates, every job begins underwater.
- Percentage-fee cost-plus with no cap. It hands you a financial interest in higher costs and hands the client a reason to distrust every invoice. Use a fixed fee or a GMP unless the client explicitly prefers otherwise.
- GMP with no savings split. A bare cap gives you all of the downside past the ceiling and none of the upside below it — the worst of both contract types. Always pair the ceiling with shared savings.
- Verbal change orders. Covered above, repeated because it kills more small contractors than any estimating error. No signature, no work.
- Mixing job costs with overhead in one bucket. When materials for three jobs and office supplies share one ledger account, job costing is impossible and overruns become invisible. Separate accounts per job are non-negotiable.
- Ignoring the WIP until tax season. A WIP schedule updated quarterly is a history lesson; updated weekly, it is a control system. The entire point is early warning.
Keep Every Job's Numbers Honest from Day One
Whether you bid fixed-price or bill cost-plus, the contract only sets the rules — your bookkeeping decides whether you actually know the score while the job is still open. Per-job cost tracking, weekly estimate-versus-actual reviews, and a living WIP schedule are what turn a signed contract into a controlled outcome instead of a quarterly surprise. Beancount.io provides plain-text accounting that gives you complete transparency and control over your financial data — per-project accounts and tags make job costing a natural part of the ledger, not a spreadsheet bolted on afterward, with version control and no vendor lock-in. Get started for free and see why developers and finance professionals are switching to plain-text accounting.
