Retainage has several implications for cash flow management and financial reporting, making it an important consideration in construction bookkeeping and accounting. For example, let’s assume that ‘ACME Plumbing’ is a subcontractor on a project where retainage of 10% will be withheld from their payments. In this scenario, ACME is going to be in the red on this project to the tune of -3% until they finally receive their retainage withheld. Just like with federal projects, retainage can be withheld on state, municipal, and county projects. In fact, there are very few instances when the laws are in agreement in every state, but this is one of those instances.
- While some job sites are bundled together within the same division, others can be separated by entire neighborhoods.
- This type of flow does not work well for many contractors because you are waiting for substantial completion on a job and different trades finish at different times on the same project.
- By knowing that a percentage of payment is reserved, you can better allocate resources and maintain liquidity.
- That means the resources used to support each project, including everything from equipment used to the construction workers tasked with working the sites, are constantly on the move.
- While the full contract amount is an expense, the retainage portion is not immediately deductible since it has not been paid out.
Release processes and procedures
You’re required to track retainage amounts separately from regular invoices. For example, if a project payment is $100,000 with 10% retainage, only $90,000 is initially disbursed. The remaining $10,000 is reserved until specific milestones are achieved or the project finishes. This practical guide for construction companies explains how you can accurately allocate overhead costs to maximize profit, including finding overhead rates.
Plan for the Impact on your Cash Flow
Under the Federal Acquisition Regulation (FAR), a prime contractor may withhold payments from their sub pursuant to the contract between the parties. So, if the contract between them provides for retainage, they are allowed to do so under the terms set forth, even if the government is not withholding retainage from the prime. The practice is also baked right into laws all across the world that regulate the types of contractual provisions that contractors can agree to. Most of these laws were created to regulate and create limitations on the practice, mostly to promote its fair use and to prevent its abuse. By tracking the amounts owed for retention, companies can make plans on how to collect overdue payments based on the amount of risk involved.
Leveraging Technology for Retainage Management
This is a very unique practice specific to the construction industry, but within the industry, it’s extremely popular. Most construction contracts mandate that a certain percentage of the contract price (frequently 5% or 10%) is withheld from the contractor until the entire project is substantially completed. This creates cash flow challenges in an already cash-poor industry, the practice is too frequently abused, and of course, it’s subject to complicated regulations that make it tricky to execute. Effective cash flow management with retainage accounting improves financial planning for construction projects. Retained funds create a financial buffer, helping manage over-budget scenarios or unforeseen expenses. By knowing that a percentage of payment is reserved, you can better allocate resources and maintain liquidity.
Contractors on public projects might need to secure a bond or a reserve in lieu of a standard mechanics lien due to sovereign immunity that protects public entities from liens. In contrast, those in the private sector can generally rely on mechanics liens to claim unpaid retainage. In the construction industry, payment mechanisms, such as retainage, are applied differently across public and private projects. This variance impacts how contractors manage receivables, exercise lien rights, and deal with reserve accounts. Retention payable is recorded by owners and general contractors and is the amount owing to contractors or subcontractors for retention. Since these funds aren’t due until the project is completed, they are recorded in a separate account on the general ledger.
Here are top tips from Buildertrend’s webinar to finish jobs on time and on budget. The Internal Revenue Service requires contractors who exceed $10 million in gross receipts to use a percentage of completion method in their accounting practices. Contractors who what are retained earnings report less in gross receipts may be able to pick other approaches based on what can provide the most benefit per contract. If you’re not sure how retainage affects your taxable income, an experienced small business tax accountant can help you prepare an accurate return. Make sure to protect your retainage and other progress billings by filing the proper mechanic’s lien on the public project you are working on. A mechanic’s lien is the legal right to be paid for the services rendered to physically modify a property.
Best Practices for Managing Retainage
- Lien waivers and lien releases are completely different documents (even though they are often confused by the construction industry).
- Under GAAP, retainage payable is recognized as a current liability on the balance sheet.
- If you have any questions or concerns, it’s critical to address them before signing a new contract.
- 👉 Retainage payable – Funds held by the general contractor or project owner that are owed to contractors, vendors, and subs downstream.
- This may be an account held with the construction lender, an escrow account, or a trust fund.
- The tax implications of retainage payable are an often-overlooked aspect that can have significant consequences for both contractors and project owners.
By delaying full payment to contractors, companies can preserve cash in the short term, which can be used for other operational needs or investments. However, this also means that there will be a future cash outflow when the retainage is eventually paid, which must be planned for to avoid liquidity crunches. The presence of retainage payable on a company’s financial statements can significantly influence the overall financial Accounting for Churches health and perception of the business. On the balance sheet, retainage payable is listed as a current liability, which can affect the company’s liquidity ratios. These ratios, such as the current ratio and quick ratio, are key indicators of a company’s ability to meet its short-term obligations. A higher retainage payable balance can lower these ratios, potentially signaling to investors and creditors that the company has less liquidity available to cover immediate expenses.
Recording Retainage on the Balance Sheet
Has your company been in business for a long time with an equally long track record of success? The challenge with the private project laws is that those who need the money the most won’t have the cash to fight for the penalties. While this does not address the retainage problem head-on, it does minimize the problem significantly since the completion of the project will also trigger the retainage payment. On the one hand, owners and others are allowed to withhold money from a contractor until the very end of the project.
How long is retainage withheld?
The primary advantage of a letter of credit lies in its ability to secure an agreement backed by a bank’s creditworthiness, which often instills greater confidence compared to a standard retention agreement. Mechanics liens are the most powerful tools available to construction companies to secure all of their payments, including withheld retainage. If you retainage in construction want to find out more about how mechanics lien rights can help your company, get in touch with us, or just go forward to file your lien online now. According to 2004 research on retainage by construction educator Dennis Bausman, PhD, at Clemson University, it’s very common for retainage to be held from contractors on a job.