Cost Plus vs Fixed Price Contracts Explained

The Two Main Contract Pricing Models

Understanding cost plus vs fixed price contracts is one of the first things new government contractors need to learn. How a contract’s price is structured determines who carries the financial risk: you or the government.

The Federal Acquisition Regulation (FAR) Part 16 defines the contract types agencies can use. They fall into two main categories. Fixed-price contracts lock in a set price up front. Cost-reimbursement contracts (often called “cost-plus”) pay your actual costs plus a fee.

There’s also a third category, Time and Materials (T&M), that works differently from both. We’ll cover all three so you can recognize them on solicitations and understand what you’re signing up for.

Fixed-Price Contracts: You Set the Price, You Own the Risk

On a fixed-price contract, you and the government agree on a price before work begins. If your costs come in lower than expected, you keep the savings as profit. If your costs run over, you absorb the loss. The government pays the agreed price either way.

This is the government’s preferred contract type. FAR 16.103 directs contracting officers to use firm-fixed-price contracts whenever requirements are clear enough to set a fair price. Most small business contracts start here.

Firm Fixed Price (FFP)

Firm Fixed Price is the simplest and most common contract type. You bid a price. The government accepts it. You do the work. You get paid that price. Period.

FAR 16.202 governs FFP contracts. They work best when:

• The scope of work is clearly defined
• You know your costs well enough to price accurately
• The work is similar to projects you’ve completed before
• The government is buying commercial products or services

The risk: Every dollar of cost overrun comes out of your pocket. If you bid $100,000 and the work costs $120,000, you lose $20,000. There’s no mechanism to go back and ask for more money unless the government formally changes the scope.

Other Fixed-Price Variations

The FAR defines several other fixed-price structures beyond FFP:

Most small businesses will encounter FFP contracts first. The variations above appear on larger or more complex procurements, including IDIQ contract vehicles.

Cost-Plus Contracts: The Government Pays Your Costs

Cost-reimbursement contracts flip the risk. The government reimburses your allowable costs and pays an additional fee (your profit). If the work costs more than expected, the government covers it, not you.

FAR Subpart 16.3 governs these contracts. Agencies use them when they can’t define the work precisely enough to set a fair fixed price, typically for research, development, or complex services where the scope may shift.

Cost Plus Fixed Fee (CPFF)

Cost Plus Fixed Fee is the most common cost-reimbursement type. The government reimburses all your allowable costs and pays a fixed fee negotiated at the start. Your fee stays the same whether the project costs more or less than estimated.

FAR 16.306 defines two forms of CPFF:

• Completion form: You must deliver a specific end product. The fee is paid when you deliver it.
• Term form: You provide a level of effort over a set time period. The fee is paid at the end of the period.

The catch: “Allowable costs” doesn’t mean everything you spend. FAR Part 31 defines which costs the government will reimburse. Entertainment, lobbying, and certain travel expenses are not allowable. If you charge unallowable costs, you’ll have to pay them back.

Other Cost-Plus Variations

Time and Materials: Paying by the Hour

Time and Materials (T&M) contracts are the third major category. The government pays you a fixed hourly rate for labor (which includes wages, overhead, and profit) plus the actual cost of materials you use.

FAR 16.601 governs T&M contracts. Agencies use them when they can’t estimate the scope well enough for a fixed price, but cost-reimbursement isn’t appropriate either. Think emergency repairs, IT support, or short-term consulting where the hours are unpredictable. Many subcontracting opportunities also use T&M structures.

Every T&M contract must include a ceiling price (per FAR 16.601). You can’t exceed it without the contracting officer’s written approval. This protects the government from unlimited spending.

Labor-Hour contracts (FAR 16.602) are a variation of T&M where you provide only labor, no materials. The government provides the materials or a third party does.

Side-by-Side Comparison

Here’s how the three main contract types compare across the factors that matter most to contractors.

The Accounting System Reality Check

This is where many small businesses get tripped up. Fixed-price contracts don’t require a special accounting system. You bid a price, do the work, and invoice for that price. Standard bookkeeping works.

Cost-plus contracts are different. Before the government awards you a cost-reimbursement contract, your accounting system must pass a pre-award audit. The Defense Contract Audit Agency (DCAA) evaluates whether your system can:

• Separate direct costs from indirect costs
• Track costs by individual contract
• Properly allocate overhead to each project
• Maintain accurate timekeeping records
• Identify and exclude unallowable costs

The Department of Defense (DoD) uses Standard Form 1408 (SF-1408) to assess your system. There are 18 criteria your system must meet (per DFARS 252.242-7006, Defense Federal Acquisition Regulation Supplement).

Building a DCAA-adequate accounting system isn’t free. You’ll likely need government contracting-specific accounting software, a chart of accounts designed for indirect rate tracking, and potentially a consultant to set it up. For a five-person firm, expect to invest several thousand dollars and weeks of setup time before you’re ready for cost-type work.

If you’re just starting out, focus on FFP contracts first. Build revenue, build past performance, and invest in your accounting infrastructure when you’re ready to pursue cost-plus opportunities. Our guide on how to bid on government contracts covers finding and responding to FFP solicitations.

Which Contract Type Should You Pursue?

The right answer depends on where your business is today. As you grow, you’ll likely work across multiple contract types. Our guide on scaling your government contracting business covers how to build that progression. Here’s a practical framework.

Start with FFP if:

• You’re new to government contracting
• You know your costs well (labor rates, materials, overhead)
• The work is similar to what you’ve done commercially
• You don’t have a DCAA-adequate accounting system yet

Consider cost-plus if:

• You have a compliant accounting system in place
• The solicitation is for research, development, or exploratory work
• The scope is genuinely uncertain and a fixed price would force you to pad your bid
• You’re comfortable with government oversight of your costs

Look at T&M if:

• You provide IT support, consulting, or maintenance services
• The agency needs flexible staffing with uncertain hours
• You can track time accurately by project and task
• You’re comfortable with a ceiling price limiting total revenue

Common Pricing Mistakes That Cost Contractors Money

New contractors make predictable errors with each contract type. Knowing these patterns helps you avoid them.

FFP Mistakes

• Underbidding to win. Pricing below your actual costs to beat competitors. You win the contract and lose money on every deliverable. A contract that loses money is worse than no contract at all.
• No contingency buffer. Materials prices change. Employees get sick. Equipment breaks. Build a reasonable contingency into your price. For work you’ve done before, 5-10% is common. For new types of work, 15-20% may be appropriate.
• Scope creep without change orders. The government asks for “just one more thing” and you do it without a formal contract modification. Those extras come out of your fixed price. Get every scope change in writing.

Cost-Plus Mistakes

• Charging unallowable costs. FAR Part 31 defines what the government will and won’t reimburse. Alcohol, entertainment, lobbying, and fines are never allowable. Charging them triggers audit findings and repayment demands.
• Sloppy timekeeping. Employees must record their hours daily, by contract. Estimates, batch entries, and “I’ll fill it in Friday” don’t meet DCAA standards. A timekeeping failure can put your entire billing at risk.
• Mixing contract costs. Charging labor or materials from Contract A to Contract B, even accidentally, is a serious compliance violation. Your accounting system must prevent this.

T&M Mistakes

• Ignoring the ceiling. T&M contracts have a maximum price. If you approach the ceiling and there’s still work to do, stop and notify the contracting officer. Exceeding the ceiling without approval means you won’t get paid for the overage.
• Underpricing hourly rates. Your T&M rate must cover wages, fringe benefits, overhead, general and administrative (G&A) costs, and profit. New contractors sometimes price at their commercial rate without accounting for the full cost structure.

Key Thresholds to Know (2026)

Several dollar thresholds affect which contract types you’ll encounter and what compliance rules apply.

The TINA threshold increase from $2.5 million to $10 million is significant. After June 30, 2026, mid-size contractors won’t need to submit certified cost or pricing data on contracts under $10 million. This reduces the compliance burden for many small and mid-tier firms pursuing negotiated contracts.

FAR References for Contract Types

Here are the key regulatory sections if you want to read the rules yourself:

• FAR 16.103: Negotiating contract type, including government preference for fixed-price
• FAR Subpart 16.2: All fixed-price contract types
• FAR Subpart 16.3: All cost-reimbursement contract types
• FAR Subpart 16.6: Time and Materials and Labor Hour contracts
• FAR Part 31: Cost principles (what’s allowable and what’s not)
• DFARS 252.242-7006: Accounting system administration requirements

All FAR text is free at acquisition.gov.

Frequently Asked Questions

Which contract type is most common for small businesses?

Firm Fixed Price (FFP). It’s the simplest structure and doesn’t require a special accounting system. Most small businesses start with FFP and move to cost-plus or T&M as they build compliance infrastructure.

Do I need a DCAA-adequate accounting system for fixed-price contracts?

No. Standard business accounting works for FFP contracts. You only need a DCAA-adequate system for cost-reimbursement contracts, where the government reimburses your actual costs and needs to audit them.

What happens if I lose money on a firm fixed price contract?

You absorb the loss. The government pays the agreed price regardless of your actual costs. This is why accurate cost estimating is critical before you bid. If the government changes the scope, you can request a contract modification for additional funding.

Can I negotiate the contract type?

The solicitation specifies the contract type. You can’t change an FFP solicitation to cost-plus. However, during negotiations on larger procurements, the contracting officer may discuss contract type if there’s a reasonable basis for a different approach.

What does “allowable cost” mean on a cost-plus contract?

An allowable cost is one the government will reimburse. FAR Part 31 defines the rules. Costs must be reasonable, allocable to the contract, and consistent with your accounting practices. Certain categories like alcohol, entertainment, and lobbying are always unallowable.

Next Steps

Now that you understand how contract pricing works, here’s what to do:

1. Know your costs. Before bidding on any contract, calculate your fully loaded labor rates, overhead, G&A, and profit margin. You can’t price accurately without these numbers.
2. Start with FFP. If you’re new to government contracting, pursue firm fixed price opportunities first. They’re the most common and require the least compliance infrastructure.
3. Learn the FAR cost principles. Even on FFP contracts, understanding FAR Part 31 helps you price more accurately. Read our guide on FAR compliance for small businesses.
4. Build your accounting system over time. When you’re ready for cost-plus work, invest in a DCAA-adequate accounting system. Your local APEX Accelerator (formerly called PTACs, or Procurement Technical Assistance Centers) can recommend affordable options for small firms.
5. Search for opportunities. Go to SAM.gov and filter contract opportunities by your NAICS (North American Industry Classification System) code. Pay attention to the contract type listed in each solicitation.