Cost-plus: Overview, definition and example
What is cost-plus?
A cost-plus agreement is a type of contract where the buyer agrees to pay the seller for the actual cost of goods or services provided, plus an additional fee or markup for profit. This markup is usually a percentage of the cost or a fixed fee. Cost-plus contracts are often used in construction, manufacturing, or service industries, where the total cost is uncertain at the start of the agreement.
Why is cost-plus important?
Cost-plus is important because it helps ensure that the seller is compensated for their actual expenses, including materials, labor, and overhead, plus a reasonable profit margin. It provides flexibility when the exact costs aren’t known upfront, making it a useful option for projects that may experience unexpected changes or costs. For the buyer, this agreement offers transparency into the costs involved, though they may bear the risk of cost overruns.
Understanding cost-plus through an example
Imagine a construction company is hired to build a custom office building. The contract is cost-plus, meaning the company will be paid for all the materials and labor costs incurred, plus an additional 10% markup to cover overhead and profit. If the cost of materials goes up or if unexpected labor costs arise, the buyer will pay for those additional expenses, plus the agreed-upon markup.
In another case, a business may hire a consultant on a cost-plus basis. The consultant is paid for the time spent and expenses incurred, plus a fixed fee of $500 per month for their expertise and overhead costs.
Example of a cost-plus clause
Here’s how a cost-plus clause might look in a contract:
“The Buyer agrees to pay the Seller for the cost of materials and labor used in the project, plus an additional 15% markup to cover overhead and profit. The total amount shall be invoiced monthly, and payment will be due within 30 days of receipt of the invoice.”
Conclusion
Cost-plus agreements are useful for projects with uncertain costs, providing a flexible and transparent way to manage expenses. While they ensure that the seller is fairly compensated, they also place the risk of cost overruns on the buyer. By understanding how cost-plus works, businesses can decide whether this type of agreement is the right fit for their needs and budget.
This article contains general legal information and does not contain legal advice. Cobrief is not a law firm or a substitute for an attorney or law firm. The law is complex and changes often. For legal advice, please ask a lawyer.