Retainage is a common practice in the construction industry, but if not managed properly, it can cripple your cash flow and leave you struggling to cover expenses. While it’s meant to ensure project completion and quality work, retainage often turns into a cash flow nightmare for contractors and subcontractors.
This article will explain what retainage is, how it impacts construction businesses, and strategies to manage it effectively.
What is Retainage in Construction?
Retainage, also known as retention, is a portion of the contract payment that is withheld by the project owner until substantial or final completion of a project. The standard retainage percentage typically ranges from five to ten percent of the total contract value.
Example:A contractor completes $100,000 worth of work but only receives $90,000, with the remaining $10,000 withheld as retainage. The contractor will not receive the remaining payment until the project reaches substantial completion or another defined milestone.
Why Retainage is Withheld
From a project owner’s perspective, retainage serves as a financial safeguard to ensure:
The project is completed as agreed
Any remaining punch list items are addressed
There are no outstanding liens or disputes
While this protects the project owner, it can create significant financial strain for contractors who must cover payroll, materials, and other project costs while waiting for retainage payments.
The Impact of Retainage on Cash Flow
Delayed Payments Create Financial Strain
Retainage means that a portion of earnings is held back, often for months, even though all work has been completed. Meanwhile, contractors must continue to pay labor costs, material suppliers, and overhead expenses.
Uncertainty in Financial Planning
If retainage payments are not released according to a clear schedule, contractors may struggle to plan their budgets effectively, leading to potential financial shortfalls.
Greater Risk for Subcontractors
Subcontractors often bear the most significant financial burden of retainage. They typically receive payments only after the general contractor has been paid, which can lead to even longer delays.
Strategies to Manage Retainage Without Cash Flow Issues
1. Negotiate Better Retainage Terms
Before signing a contract, contractors should attempt to negotiate more favorable retainage terms, including:
Lowering the retainage percentage from ten percent to five percent
Releasing portions of retainage at project milestones rather than holding the full amount until completion
Establishing a clear and reasonable timeline for retainage release
Larger contractors may have more leverage in negotiations, but subcontractors should also advocate for more favorable terms before signing agreements.
2. Track Retainage Separately in Accounting Records
Retainage should be recorded separately in accounting systems to avoid unexpected cash shortages. Many contractors fail to track retained amounts, leading to financial mismanagement.
Best practices for tracking retainage include:
Setting up a separate retained receivables account in accounting software
Reviewing outstanding retainage amounts monthly
Planning cash flow based on expected retainage release dates
Using accounting tools such as QuickBooks, Buildertrend, or Procore can help contractors maintain accurate records of withheld payments.
3. Plan Cash Flow to Account for Retainage Delays
Since retainage payments are often delayed, contractors should build these delays into their financial planning.
Effective strategies include:
Creating cash flow projections that consider retainage timelines
Maintaining a reserve fund to cover payroll and other operational expenses
Using credit lines strategically for short-term cash flow needs
Contractors should avoid relying on retainage as part of their regular operating cash flow. Instead, it should be treated as a delayed payment that provides financial stability once released.
4. Invoice Promptly and Follow Up on Retainage Payments
Retainage is often released based on specific project milestones or completion dates. Delayed invoicing can result in even longer wait times for payment.
To minimize delays:
Submit retainage invoices as soon as contractual requirements are met
Maintain documentation of all completed work and approvals
Follow up regularly with project owners or general contractors to confirm payment timelines
In some cases, retainage payments are overlooked or delayed unnecessarily. Persistent follow-up can help ensure timely release.
5. Explore Financing Options for Retainage Gaps
If retainage is creating cash flow difficulties, contractors may consider financing options to bridge the gap. These can include:
Short-term business credit lines
Construction-specific financing programs
Invoice factoring to receive payment advances on outstanding invoices
While financing should not be the first solution, it can be useful in cases where large retainage amounts create significant cash shortages. However, contractors should carefully review interest rates and terms before using financing options.
Conclusion
Retainage is a standard practice in the construction industry, but it does not have to create financial hardship. By negotiating better terms, tracking withheld amounts separately, planning cash flow effectively, and ensuring timely invoicing, contractors can reduce the negative impact of retainage on their business.
Key Takeaways:
Negotiate retainage terms before signing contracts to reduce financial strain
Track retained amounts separately to avoid unexpected shortfalls
Plan cash flow with retainage delays in mind and maintain a cash reserve
Submit retainage invoices promptly and follow up consistently
Consider financing options only as a last resort to cover cash flow gaps
Managing retainage proactively can help construction businesses maintain financial stability and continue growing without cash flow disruptions.
Need Help Managing Cash Flow for Your Construction Business?
At The RedHead Solutions, we specialize in construction accounting and cash flow management to help contractors stay on top of finances, avoid cash shortages, and maximize profitability.
Job costing and financial reporting
Retainage tracking and invoicing strategies
Cash flow forecasting and budgeting support
Construction tax compliance and financial planning
Delayed payments and retainage should not put your business at risk. Schedule a consultation today to take control of your construction finances.
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