What is Retainage in Construction?

Retainage in construction is a practice where a part of the payment due to a contractor or subcontractor is held back by the developer, project owner, or general contractor. Though grounded in practices that make sense for the construction industry, it is a problematic practice that can add unnecessary complexity to construction businesses.

But it doesn’t have to.

While it can be misused as an abusive practice, you can also safeguard your business by knowing the rules, rights, and available methods to secure timely payments. While the task may seem complicated, it is a core part of the construction business you must deeply understand to avoid financial hardship that can lead to cash flow problems and delays.

Retainage in Construction, Defined.

Retainage refers to the practice of withholding a percentage of a construction contract’s total amount from a contractor or subcontractor. In other words, the developer keeps a small amount from each installment payment to ensure the project’s successful completion rather than paying in full.

How Does Retainage Work in Construction?

The contract between the owner and contractor, and between the contractor and subcontractors, must clearly state the details of the retainage agreement. To ensure retainage works for you, it is vital to negotiate the terms and ensure that the contract is transparent and leaves no room for interpretation, especially when it comes to the definition of the project’s completion.

While the precise retainage percentage varies, the money withheld per installment ranges between 5% and 10% of the overall contract value. That means that if you agree on a 10% retainage fee, your progress payments will be deducted that amount. It is only after the successful completion of the construction project occurs that the withheld balance is paid to contractors and subcontractors.

State laws on retainage can be quite different. In some states, the regulations are clear, in some they are vague, and in others the rules are non-existent. That means that contractors and subcontractors must know the particular regulations in the states they choose to work in to build a successful financial and executive plan to successfully deliver all projects. On top of that, it is important to understand the differences in retainage when it comes to private, public, provincial, and municipal projects, as they may change per state.

The project phases or stages and the construction benchmarks may also determine retainage conditions, such as assigning milestones to release withheld funds upon project delivery. In other cases, the full retainage amount may be kept until the project is successfully delivered.

As you can see, retainage is a tricky subject. This means that contractors and subcontractors must fully understand how it works for every project and create a financial plan that accommodates such conditions.

Benefits and Challenges of Retainage in Construction.

The historical significance of retainage was essential to ensure successful project completion in the 19th century. Today, contractors and subcontractors work entirely differently, but the practice still remains, given its benefits for the industry:

  • Quality Assurance: Contractors and subcontractors must maintain specific quality standards for each project. Retainage is the mechanism that protects developers from malpractice and contractors and subcontractors from predatory withholding practices. It serves both parties and ensures the proper development of the projects.
  • Defect Correction and Disputes: Developers may use retainage as leverage whenever disagreements occur in any given project.
  • Project Completion: Withholding a percentage from each installment acts as a motivation for contractors and subcontractors to successfully and timely finish projects.
  • Risk Avoidance: Retainage is one of the ways for developers to ensure contractors and subcontractors successfully deliver projects on time, mitigating risks.

On the other hand, retainage may also represent a significant challenge in the construction industry:

  • Cash Flow Issues: Contractors and subcontractors tend to run their operations on narrow profit margins. Retainage, however small, may significantly strain financial management and consequentially hurt the project’s development.
  • Financial and Admin Management Burdens: Bookkeeping is challenging for any construction business with multiple stakeholders and teams. All additional financial withholdings make accounting an even more complex task. This is why planning your project with retainage conditions in mind is vital.
  • Abusive Payment Practices and Delays: Delayed payments may occur if a clear contract with mutually beneficial agreements and timelines for the completion and the release of retainage is not present. Always make sure your contract is crystal clear.

How to Handle Retainage in Accounting.

Given that retention is taken from each payment and paid later (until the project’s completion), contractors and subcontractors must record these withheld funds in an orderly fashion.

Before we dive into how to record retainage, it’s important to highlight two essential components of retainage that help contractors and subcontractors successfully run their finances with retainage in the picture:

  1. Include retainage into the contract price: Running out of cash in a construction project can be detrimental to the entire project. Including the retainage costs in the contract is a common practice to avoid financial strains or potential issues and delays.
  2. Watch out for cash flow leaks: Track and manage the money you receive for each project diligently. Knowing exactly where every dollar is spent and how it impacts project completion makes a difference between a successful project, or a difficult one.

When it comes to best accounting practices, contractors and subcontractors should understand and differentiate the receivable from the payable retainage upon project completion.

  • Retainage Receivable refers to the money the project developer withholds and owes to contractors and subcontractors. Since they will pay these funds at a later time, keeping them separate from the primary bookkeeping records is vital to avoid errors and cash flow management problems based on budgets that do not match financials.
  • Retainage Payable is the amount project owners and contractors record to keep track of what they must pay whenever the project is completed.

As a rule of thumb, what matters is ensuring that the retainage percentage of any given project gets recorded separately to avoid financial issues. The more clarity you have, the better you can keep track of your margins.

Retention vs Retainage: What’s the Difference?

Nuance is crucial in every industry, especially in construction, where the terms ‘retainage’ and ‘retention’ often mean the same thing. However, it’s important to note the distinction: ‘retainage’ refers to the agreed-upon amounts withheld until a project’s completion. This previous agreement aims to incentivize quality work and maintain project schedules while also acting as financial protection for project owners or developers.

On the other hand, ‘retention’ refers to any case where the project owner withholds money for purposes beyond quality assurance. Some examples of these scenarios may be warranty periods and disputes.

Difference of Construction State Laws for Retainage.

According to the U.S. Department of Labor, contractors, subcontractors, and project owners must abide by their state’s retainage laws. While this seems straightforward, multiple specific laws and requirements must be considered, given the nature of each project.

Varying Caps and Rates: States differ in maximum retainage rates. For instance, California caps it at 5% for public works, while Texas sometimes allows up to 10%. Knowing these limits is something to consider to ensure every project is successful.

Public vs. Private Projects: Some states have strict retainage guidelines for public projects, given their publicly regulated nature, while private projects may be more flexible. All contractors and subcontractors must know their projects’ legal nature and conditions, given that a successful bidding strategy may differ and determine your success in closing the project.

Release Timelines: Retainage release also changes drastically between states. In New York, for example, it’s within 30 days of substantial completion. Other states, such as Illinois, limit retainage to at most 5% after executing 50% of the contract.

Each state and type of project (public vs. private) is unique. Contractors and subcontractors who understand how these retainage processes work often meet all project deadlines and keep a healthy cash flow.

Protection for Contractors and Subcontractors: Some states, like California, have specific conditions to protect contractors and subcontractors, from malpractice, mandating retainage payment upon satisfactory job completion. Contractors must receive payment within 30 days, while subcontractors must receive it within ten days.

How eSUB Cloud Helps Subcontractors Elevate their Business.

Most commercial construction subcontractors face numerous challenges when managing complex projects including:

  • Unclear labor costs.
  • Change Orders that are poorly managed and cause delays and cost overruns.
  • Material costs that are inaccurate and increase costs.
  • Error-Prone pen and paper processes by multiple people on your team.
  • Inefficient communication leads to missed deadlines, rework, and delays.
  • Lack of visibility and data in silos that makes accounting and management a trial.
  • Retainage issues that arise from poor communication and data management.

We have helped hundreds of trade contractors increase productivity up to 30% while reducing rework by 50% by:

  1. Improving Efficiency: Automating manual processes and streamlining workflows saves time and resources, leading to cost savings.
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  3. Reducing Rework and Delays: Software solutions ensure accurate information is available, minimizing mistakes and speeding up project completion, resulting in higher profit margins.

The Best of All, We Are Built for Subcontractors and Integrate Well with Others

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Are you ready to take your subcontractor business to the next level?