Fixed Price or Time and Material? How to compare the profitability of the two billing models?

Why you cannot compare Fixed Price and Time and Material by invoice value alone

Sales value shows how much the company has invoiced the client. It does not answer the question of how much delivery cost and what share of revenue stayed in the company.

Two projects worth 100,000 PLN can have completely different results.

The first may be delivered in line with the estimate by a properly chosen team and end with a 30% margin. The second may involve seniors, require additional meetings and exceed the budget by several hundred hours.

The revenue will be the same. The profitability completely different.

Fixed Price shifts the estimation risk onto the contractor

In a fixed-fee project the client pays an agreed amount for a defined result. If delivery takes more time, the company does not automatically receive additional pay.

The margin is lowered by, among other things:

• an underestimated scope,
• an overly optimistic schedule,
• free revisions,
• additional requirements,
• the need to involve more expensive specialists,
• technical problems not included in the estimate,
• a prolonged approval process,
• mistakes that require work to be redone.

The Fixed Price model can be very profitable if the scope is well described, the project is repeatable and the company can forecast cost accurately. It can also quickly become a source of loss.

Time and Material does not eliminate the risk of unprofitability

In the hourly model, additional time can be billed to the client. That does not mean, however, that every T&M project is automatically profitable.

The problem may result from:

• a selling rate that is too low,
• an incorrectly calculated cost of an hour,
• a large number of non-billable hours,
• low utilisation of the team’s available time,
• gaps between tasks,
• involving more expensive people than planned,
• incomplete time reporting,
• work done without the client’s approval,
• delays in approving timesheets.

A company can bill all of its hours and still achieve a low margin if the difference between the selling rate and the specialist’s real cost is too small.

Cash flow can look different from the project result

A project can be profitable and yet, for a long time, need to be financed from the company’s own funds.

In Fixed Price, team costs are incurred regularly, while the invoice may be issued only after a stage is completed. In Time and Material, billing may take place monthly, but the client pays only several dozen days later.

That is why you need to compare not only margin, but also:

• the invoicing schedule,
• the actual dates of inflows,
• the dates of salaries and payments to contractors,
• the value of work done but not yet invoiced,
• the project’s cash gap.

A project with a higher margin can be harder on liquidity than a project that earns less but is billed regularly and paid on time.

Fixed Price or Time and Material – how to compare profitability

To compare the two models reliably, all projects have to be analysed using the same indicators.

1. Calculate the real cost of working time

The number of hours alone is not enough. Each hour should be converted at the cost rate of the specific person.

The basic formula:

Specialist labour cost = number of hours worked × individual cost rate

It is worth including in the cost rate:

• salary or the B2B invoice,
• employer costs,
• holidays and absences,
• non-commercial time,
• equipment and software,
• management,
• workstation costs.

If a project uses 500 hours but a significant share of them is delivered by seniors, its cost will be higher than for the same number of hours worked by a cheaper team.

2. Include all external costs

To the team’s time you should add:

• subcontractor invoices,
• licences,
• hosting and cloud services,
• paid components,
• design tools,
• travel,
• additional infrastructure,
• materials or production.

If a cost relates to several projects, it can be allocated proportionally.

Only the full cost lets you calculate the margin:

Margin in PLN = project revenue – full cost of delivery

Margin in % = margin in PLN ÷ revenue × 100%

3. Separate billable and non-billable hours

In Time and Material it is especially important to check what share of the time has been approved and invoiced.

It is worth separating:

• hours billed to the client,
• hours worked but not yet invoiced,
• hours not approved,
• bug fixes,
• internal work,
• waiting time,
• meetings and administrative activities.

In Fixed Price all hours weigh on the project, even if they do not increase revenue. In Time and Material some of the time can in theory be billed, but in practice it is not always accepted by the client.

4. Compare the forecast final result

You should not assess a project solely on the basis of the current difference between the contract value and the cost incurred.

You also need to estimate:

• the number of hours needed to finish,
• the team composition at later stages,
• future external costs,
• likely revisions,
• post-implementation work,
• the revenue that is still to be invoiced.

An example of a Fixed Price project:

• contract value: 180,000 PLN,
• cost incurred: 90,000 PLN,
• forecast cost of the remaining work: 65,000 PLN,
• forecast final margin: 25,000 PLN.

An example of a T&M project:

• revenue invoiced: 150,000 PLN,
• cost incurred: 110,000 PLN,
• hours worked but not invoiced: 15,000 PLN of revenue,
• forecast margin after billing: 55,000 PLN.

Only this kind of picture allows a reliable comparison.