Advantages and Disadvantages of Lump Sum Contracts
It is important to consider the advantages and disadvantages of lump sum contract, which is typically used in the construction industry for cost management.3 min read
The advantages and disadvantages of lump sum contracts are important to consider. A lump sum contract is typically used in the construction industry to lessen the costs associated with planning and contract management.
Lump Sum Contracts in Construction
- In a lump sum construction contract, the contractor tenders one set price for all work carried out during the project.
- This approach is often used for big or complex construction projects, and it is considered standard practice.
- It is also one of the most implemented types of contract in construction.&
- The contractor takes responsibility for any risks associated with this agreement and is in charge of predicting project costs from sketches.&
- The contractor must include overhead and his profit to work out the cost of the project.&
- Lump sum construction agreements are regarded as the most efficient way to lower the cost of construction, and they are particularly valuable when everything involved in a project is clearly planned out.&
- Lump sum construction contracts are the most frequently used contracts between owners and contractors because they are typically easy to administer and they ensure the best price positioning.&
Owner Benefits of Lump Sum Construction Contracts
There are some restrictions in relation to an owner's position, along with liability at the time of the construction. This is because the owner has already accepted a set price. As the contractor has also accepted a set price for the construction, the owner is not responsible for any extra spending. This is the most significant advantage.&
It is also much easier to be approved for a construction loan when you have a lump sum contract. This is because it offers a lot of assurance in terms of associated cost. Additionally, it is significantly easier to oversee and administer lump sum contracts. The payments are made at set times, according to the volume of work completed. This is different to the balloon payments that occur under other contracts.&
Contractor Benefits of Lump Sum Construction Contracts
There is a bigger margin for profit attainment for contractors and designers. Overall, these contracts are reliable, so contractors often attempt to improve production standards and execution. They are also motivated to try to finish the job faster. With a lump sum contract, it is relatively easy to evaluate soil conditions, tendering prices, and pre-manufacturing assessment, which all make the selection process less frustrating.&
During deliberations, the contractor and designer state what they think is a reasonable price without explaining or defending hourly costs or the price of materials. Similarly, they do not use the multipliers that are frequently used in cost-plus agreements. These are the type of costs that owners try to reduce in negotiations. Since the associated accounting for lump sum contracts is relatively simple, the overhead costs for the contractor are lower, enabling a steady cash flow.&
Overall Advantages of Lump Sum Construction Contracts
Aside from the advantages listed above, lump sum& construction contracts encourage improved communication and cooperation between the owner, contractor, and planner or designer. The contractors aim for the project to be carried out efficiently in order to increase their profit margin. Additionally, the owner knows about any additional costs incurred as a result of the required change orders.
Disadvantages of a Lump Sum Construction Contract
- A lump sum agreement presents a higher risk to a contractor.
- Measuring the number of changes is difficult.
- Such contracts require paperwork and records of change orders from each phase, and this means further documentation is needed.
- A rejection of change order can be asked for by the employer.
- Building plans and drawings have to be finished in plenty of time before the work begins.
- Overall, the construction could take more time to finish than other contractual options.
- As the contract is founded on a fixed cost, the contractor could potentially use inferior tools, techniques, and methods to work.&
- To avoid this, the owner should state that he or she wants specific building materials used before the work starts.&
- Also, lump sum contracts often result in a higher set cost to include unanticipated situations.&
- Owners are liable for unplanned situations that are out of the control of either party.
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