Published on: Feb 18, 2025 by Vanessa Conlin, CPA
Updated on: February 18, 2025
In the construction industry, managing cash flow and accurately tracking revenue are critical to staying profitable and competitive. One unique financial element that construction companies must navigate is retainage—a contractual practice that can significantly impact both liquidity and financial reporting.
While retainage helps ensure project completion and quality for clients, it can also create cash flow challenges for contractors.
Retainage is a portion of a construction contract's payment that is withheld by the project owner or general contractor until the project is substantially complete. Retainage amounts typically range between 5% and 10% of the total contract value.
It acts as a safeguard to ensure that the contractor fulfills all obligations, including completing the project to the agreed-upon specifications and addressing any punch-list items or defects.
While retainage protects project owners, it presents unique accounting and cash flow challenges for construction companies, particularly those working on multiple projects simultaneously.
Retainage represents earned revenue that remains unpaid until the project reaches specific milestones, often the end of the project or after warranty periods. This delay ties up cash that could otherwise be reinvested in operations, such as purchasing materials or funding new projects.
For construction companies, the delay in receiving retainage payments can result in a mismatch between expenses incurred and revenues collected. This can create a cash flow gap, making it difficult to cover operational costs or meet payroll obligations.
Retainage can have a cascading effect, particularly for businesses with multiple large projects. The cumulative delay in cash inflows can strain overall liquidity, necessitating reliance on lines of credit or other financing to bridge gaps.
Properly accounting for retainage is critical to ensure financial statements are accurate and comply with Generally Accepted Accounting Principles (GAAP). Here's how retainage should be handled:
|
On the Balance Sheet |
Retainage receivables on completed jobs are included in Contract Receivables. Retainage receivables on jobs still in progress at the end of a reporting period are included in Contract Assets. |
|
On the Income Statement |
Retainage does not directly affect the income statement since it is part of the revenue earned from contracts. However, it impacts the timing of cash inflows, which should be reflected in the cash flow statement. |
|
Cash Flow Statement |
Retainage receivables impact the operating activities section of the cash flow statement. Even though revenue is recognized, the delay in cash collection reduces cash flow from operations. This should be closely monitored to avoid liquidity issues. |
Before signing a contract, take the opportunity to negotiate more favorable retainage terms with clients. For example, you might request a lower percentage of retainage—such as 5% instead of 10%—or propose releasing retainage in installments at various project milestones instead of withholding the entire amount until project completion.
Clear communication with clients about your company’s proven track record of successful project delivery can strengthen your case for leniency on retainage terms.
Keeping track of outstanding retainage receivables is critical to ensuring timely collection. Use accounting or project management software to maintain a detailed schedule of retainage amounts, expected release dates, and collection status.
Follow up with clients proactively to confirm their satisfaction with completed work and ensure they’re prepared to release payments as agreed. Addressing any client concerns or potential disputes early can help avoid payment delays.
Incorporate retainage into your broader cash flow management strategy by preparing realistic forecasts that account for delayed payments. Use these projections to identify potential shortfalls and explore solutions like credit lines or invoice factoring to bridge gaps.
Additionally, communicate regularly with stakeholders—including subcontractors and suppliers—to align payment expectations and maintain smooth operations during periods of reduced liquidity.
Establish a reserve fund specifically for offsetting the impact of delayed retainage payments. Set aside a portion of revenues from each project into this reserve so you have a buffer to cover operational expenses during lean periods.
A disciplined approach to maintaining this reserve can reduce your dependence on external financing and improve your overall financial stability, particularly for businesses managing multiple retainage-heavy contracts.
Managing retainage doesn’t have to be a constant headache. While it’s a common practice in construction, a proactive approach can help you stay in control of your cash flow and financial reporting.
Negotiating better terms, keeping a close eye on receivables, planning for cash flow gaps, and setting up a reserve can help you minimize the stress retainage brings to your business.
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Vanessa is a Principal at SVA Certified Public Accountants and is responsible for audits, reviews, and compilations of financial statements for clients in a wide variety of industries. She also assists with other agreed-upon procedure assurance engagements to address specific client issues. Vanessa is in charge of a large number of employee benefit plan audits at SVA. She prepares and oversees the preparation of audit fieldwork and required financial statements and supplemental schedules and assists clients with various other compliance-related issues with the plans.
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