What is the difference between "fixed-price" and "cost-plus" contracts?

The distinction between fixed-price and cost-plus contracts lies primarily in the structure of payment and risk allocation. In a fixed-price contract, the contractor agrees to complete the project for a predetermined price. This means that any cost overruns or unforeseen expenses are absorbed by the contractor, putting the financial risk on them. This type of contract is commonly used in situations where the scope and costs are well-defined, allowing for predictable budgeting.

In contrast, a cost-plus contract allows for the reimbursement of actual costs incurred by the contractor in addition to a specified fee that serves as profit. This means that the contractor is guaranteed payment for all legitimate business expenses related to the project, which reduces their financial risk. The fee can be a fixed amount or a percentage of the costs, depending on the agreement terms. This type of contract is beneficial in projects where costs are difficult to estimate, as it provides a degree of flexibility and encourages the contractor to start the work without the pressure of adhering to a strict budget.

Understanding this difference is crucial for stakeholders involved in contracting, as it influences project management, risk management, and financial planning.