The Differences between Time and Material Billing and Fixed Cost Billing

Time and Material Billing

Time and material billing refers to the billing process wherein actual number of hours worked and the resources deployed are billed on an as is basis with the margin added to it.

In other words, time and material billing refers to the billing that is done as per the actual number of hours/days/months worked by the resources (how many ever) and multiplying the two to arrive at the consolidated figure.

Time and material billing is very popular in the software industry as schedules are often difficult to manage and hence, project managers bill the clients for actual work rather than estimated work.

Further, time and material billing has the advantage of taking into account project overruns, which means that even when the project shoots past the estimated deadline, the vendor is covered because of the actual billing that takes place. On the other hand, the clients in recent times have been reluctant to go in for a time and material actual costs billing because of the risks involved in terms of budget overhangs and delays.

In other words, time and material billing can lead to cost overruns and associated problems.

Fixed Cost Billing

On the other hand, fixed cost billing introduces an element of discipline both for the vendor and for the client as the billing is done based on estimation of costs and a margin that is added by the vendor.

In recent years, the software industry has moved into the fixed cost mode because of the fact that project overruns and delays have become common and the clients do not want to suffer for the vendor’s mistakes.

Of course, the delays can be from the client side as well and this is the reason why many contracts explicitly specify the penalty clauses and other fine print details so that both the vendor and the client are protected.

Fixed cost billing ensures that the vendor has a cushion against cost overruns as well as ensuring that the vendor has an incentive to deliver on time. Further, fixed cost billing also ensures that the clients cannot get away with delays because the vendor can invoke the penalty clause. It is for these reasons that fixed cost billing has become very popular in recent years.

Which is Preferable and When

This is not to say that time and material billing is redundant or not being used. On the other hand, time and material billing is very important when multinationals have their subsidiaries in overseas locations as cost centers. These cost centers are setup with the express purpose of providing services to the multinationals and are not expected to be profit oriented.

In other words, they are known as cost centers because they need to show that they have accounted for their costs and have returned some profit to the headquarters.

The fixed cost billing is preferable when both the client and the vendor are entering into a relationship for the first time and where each has to apprise and evaluate each other for genuineness and adherence to the terms of the contract.

Further, defense contractors in the United States are now operating under fixed cost billing because of complaints and public outcry over cost plus billing which is a variant of time and material billing. In cost plus billing, the vendor recovers the entire actual cost along with a profit and this method has come in for severe criticism in recent years. This is the reason why across the world, fixed cost billing is emerging as the favorite method of billing.

Concluding Remarks

Whichever method of billing one prefers, the key aspect is that the terms of the contract must be adhered to and therefore, there must be an occasion where either side invokes the penalty clause or sues the other side for breach of contract. This is the bottom line requirement that should govern the execution of any contract.