Key Details: The government contracting marketplace offers a wide variety of contract types, each with individual benefits and drawbacks. These contract vehicles specify the agreement between your business and the federal government and can cause shifts in the placement of risk. Many contractors kick off with firm-fixed-price (FFP) contracts. However, cost-plus contracts are gaining popularity. There are significant differences between these two contract types. Government contractors are encouraged to understand the various benefits and challenges associated with each type of contract and to analyze how each contract impacts profitability. In part 1 of this two part series, we explore the differences between FFP and cost-plus contracts, the advantages of each, and the questions to ask before accepting a contract. Stay tuned for part 2 where we dive into the key requirements of cost-plus contracts. For further information and expertise, contact Ryan & Wetmore today.
Under FAR (Federal Acquisition Regulation) 16.202-1 FFP contracts prescribe a price that is not subject to any adjustment based on a contractor’s cost while performing the contract. As such, FFP contracts place maximum and full risk and responsibility on the contractor regarding costs and the resulting profit or loss. Therefore, contractors are incentivized to control costs to maintain efficiency and profit margins. Furthermore, performing on an FFP contract places additional inflation risk on the contractor as prices remain constant throughout the lifetime of a contract.
FFP contracts are typically used when the government is purchasing commercial items, supplies, or services that have very detailed and definite specifications and quantities. These items are also offered at a reasonable price and usually include the following situations:
Recently, the federal government has started utilizing fixed-price contracts under many different scenarios for a wide variety of products and services. As such, contractors are encouraged to fully understand the benefits and drawbacks of this type of contract as well as the placement of risk on the contractor.
Contractors are encouraged to consider the following key items prior to accepting FFP contracts due to the large amount of risk placed on the business:
Under FAR 16.3, cost-reimbursement contracts allow contractors to request payment of allowable costs incurred. Through this, an estimate of the total cost is established for obligating funds and establishing a ceiling that contractors may not exceed.
Most cost-plus contracts are broken down into 3 components that we describe in the following sections.
There are varying forms of cost-plus contracts, each with different components. Contractors are encouraged to understand the following cost-plus contract types:
Under FAR 16.306 CPFF contracts are a type of cost-reimbursement contract that provides payment of a negotiated fee (profit) amount that is fixed upon inception of the contract. This negotiated fixed amount does not vary based on the actual cost incurred but can be adjusted due to changes in work performance under the contract. Therefore, accepting a CPFF contract type lowers the risk contractors may face and places more risk on the government as there is a lower incentive to control costs. This may be especially appealing during periods of high inflation.
CPFF contracts also provide both the government and the contractor with the flexibility of entering into either a large or small-scale project. These contracts allow for more complex jobs where instructions or job specifications are not well defined. CPFF contracts typically include three key components:
Contractors are also encouraged to fully understand unallowable costs while performing on cost-plus contracts as these costs must not be billed to the government. Under FAR Part 31, unallowable costs include expenses incurred by the contractor that do not meet the authorization under contract terms and cannot be billed or claimed as part of the contract. Common examples include certain donations, advertisements, entertainment expenses, or fines and penalties. As such, government contractors must have an adequate accounting system and chart of accounts whereby unallowable costs are easily distinguishable and segregated from calculation of indirect rates.
Cost-plus contract types bring about another layer of government surveillance due to the reimbursement of allowable costs. As such, contractors are encouraged to consider the following key items before accepting a cost-plus type contract:
FFP and cost-plus type contract contracts both bring about various benefits and drawbacks. Government contractors are encouraged to review the list below to understand how each contract may impact your business and operations strategy or to contact Ryan & Wetmore today to speak with an expert.
Firm Fixed Price
Cost Plus Contracts
Profits subject to cost incurred
Contractors reap the benefit of higher efficiencies and lower costs
Lower risk borne by contractor
Low administrative management
Possibility for additional reimbursement
The contractor bears full responsibility for the performance costs and net income from the contract
Helpful in the solicitation and bidding process
Lower stress relating to cost control
Higher performance incentives
Allows the contact to be bid when scope of work is not defined
Need to control costs
Accounting system must be adequate
High administrative management requires more software, accounting staff, contracts management etc.
High risk and higher prices
Risk of estimating errors and cost overruns not covered
Supply chain disruptions and inflation could lead to unprofitable contracts
Accounting system compliance
Cost savings are passed on to the government
Low profit margins, only costs plus some fixed cost of fee percentage are allowed
Be aware of ceiling caps on Overhead & G&A rates
Difficult for complex projects
DCAA unallowable costs are not reimbursed
Government contractors performing under FFP or cost-plus type contract contracts should understand the regulations and impacts each contract type brings. Furthermore, risk assessment and profit margin analysis associated with performance on different types of contracts should be conducted. As the contracting marketplace consists of a wide variety of contracts, government contractors are encouraged to review and understand the challenges and benefits of each. For more information, contact Ryan & Wetmore today and stay tuned for part 2 of this series.
Today’s Thought Leaders
About Peter Ryan
Partner, Co-founder, & CPA
Peter T. Ryan co-founded Ryan & Wetmore in 1988 with business partner Michael J. Wetmore. Peter provides clients with the best strategies for success. His expertise extends across various industries. Peter obtained a Master of Business Administration in Finance from the University of Baltimore and a Bachelor of Arts in Accounting from the Catholic University of America.
About Rosie Cheng
Finance Consultant
Rosie Cheng is a Finance Consultant at Ryan & Wetmore. She focuses on government contracting services and produces many of the firm’s government contracting newsletters. Rosie graduated from Georgetown University with a Master of Science in Management and from William and Mary with a Bachelor of Business Administration.
