What is Retainage in Construction?

Many contractors deal with retainage clauses in their construction contracts, a practice prevalent in the area. However, many contractors and business owners still do not know how to apply retention to construction programs, resulting in difficulties with capital flows or not understanding what steps to take to obtain approval for the final payment. What makes the situation even worse is that different regions use different withholding standards. This blog post will explore the idea of retainage in construction and how it affects all participants involved in a building plan.

Exploring Retainage in Construction

Retainage, also referred to as “retention” or “holdback,” is the portion of a contractor’s payment that the owner or general contractor withholds until the project reaches a specified milestone. The withholding amount varies, but in most cases, it is between 5% and 10% of the milestone payment to which it applies.

Since holdback is capital that the owner or CEO holds until they are gratified with the activity, it acts as leverage. The project initiator and general contractor must ensure the agreement completes the work before the last payment. All its standards are specified in the initial construction agreement if a lien is applied to a project.

How Retainage Works in Construction Projects

The words “retainage” and “retention” are sometimes utilized as synonyms. However, in the building area, they sometimes mean different things. Let’s look at the distinction between retainage vs retention. The main aim of retainage is to stimulate high-quality activity, compliance with graphs, and protection of the project initiators from work that will be performed at a low level or not fulfilled.

Simultaneously, retention in the area can serve goals beyond quality control, such as coating the warranty periods, eliminating troubles that arose after the project’s completion, protecting against non-fulfillment of financial obligations, etc.

Retainage accounting practices

There are various methods of interacting with holdback. Consider some features of retainage accounting.

Retainage is an element of the retail activity price that belongs to the prime contractor. This money is paid when certain terms may vary. Holdback is an asset displayed on your balance sheet. It always happens. The nuances of managing such an asset depend on the organization’s selected financial strategy.

You create a new item in the chart of accounts. It is the category “Current assets”. As a rule, the account is known as “holdback receivables”. The item can be called as you like; the main thing is that its essence is understandable to the whole group of accountants.

Now, when you have an account to record operations, you must form an Invoice Item for Retainage. It will enable you to add a position to the payment document; the sum will be negative.

When the cooperation ends or another retainage condition is activated, you can issue an invoice to the counterparty for a holdback on the project. Forming a payment document is similar to dealing with other Invoices, except the Rate is indicated as a positive number.

Retention billing process

Consider this example: you and the counterparty have agreed to a deal worth $80,000 with a holdback of 10% until the end of the activity. Let’s analyze the main actions to provide retention billing to the counterparty at 50%:

Create an invoice for $40,000. If you prepared an Estimate, you may form an account based on it.

In the next cell of the same payment document, enter the element of retainage in construction. The counterparty invoice indicates a negative value of $4,000, and the net debt is $36,000.

Remember, if you have specific positions on the payment document that are not subject to storage (as a rule, this is the Mobilization Payments), indicate all the positions subject to storage, the intermediate result, and the sum of retainage. Next, you should designate other components that are not subject to storage.

Contractual Considerations

States’ norms regarding retainage fee may vary considerably. In some regions, the directives are clear; in others, they are blurry; and in thirds, the directives are absent. This means contracting organizations and subcontractors must study the staff to form a thriving financial and executive strategy to provide plan implementation. So, owners and main contractors do not have the right to hold more than 5% of the agreement in California. In Arizona, the maximum retainage is 10%.

Besides, it is vital to know the legal limits for state, provincial, and municipal programs since they also change depending on the region. In Alabama, the maximum deduction is 5% for state plans and 10% for private projects.

Contract clauses and the American Institute of Architects (AIA)

The American Institute of Architects (AIA) has created the most widely utilized standard form contract in the construction area. From the launch of a project to its completion, AIA ensures each participant realizes their responsibilities and processes to resolve disputes. Let’s consider other advantages of such contracts:

• Simplified communication. Documents suggest business owners a transparent framework to provide communication and transparency with all participants.
• Quality assurance. AIA agreements require compliance with certain norms and directives. This guarantees all jobs are performed at the highest level.
• Financial clarity. With a clearly defined budget, payment schedule, and process for adjustments to program costs, AIA contracts suggest financial transparency and predictability to all parties.
• Timely completion of the project. The documents indicate the timing of the program. It is essential because any delay can result in loss of capital and increased expenditures.

Series A contracts concentrate on agreements between the owner and contractor. They offer different project implementation methods and construction finance, including retainage. Such documents vary depending on the size of the program, from small commercial construction to a large-scale program.

Each Series A contract is tailored to meet the individual needs of varying project volumes. It provides a personal approach to engaging a contractor.

Claims and Disputes Over Retainage

Retainage in construction is controversial. Many entrepreneurs argue it exacerbates working capital troubles, leading to disputes. Let’s consider how they can be effectively prevented and resolved:

• Study the terms of the agreement. You must carefully study the agreement and find clauses indicating the retainage percentage, schedule, release, and exceptions. It is vital to check the laws and directives in your area. All issues must be discussed before agreeing.
• Document activity and progress. Carefully record the volume of work, schedule, budget, and all difficulties and controversial issues. Constantly contact owners and other interested parties, providing them with accounts, reports, and photographs.
• Request partial or early release if possible. Some contracts specify the possibility of partial release of retainage, considering milestones or completion percentage. All requests must be made in writing, following procedures and deadlines.
• Negotiate or act as a mediator. You should resolve all issues peacefully and professionally, avoiding escalation. We recommend documenting negotiations or mediation activities and retaining all copies of agreements and settlements reached. It will save time and capital and create good relationships.
• File a lawsuit if amicable settlements don’t work. It is necessary to consult with a lawyer and strictly adhere to legal procedures and deadlines. Prepare arguments in favor of a claim for relief from withholding or damages. Filing a lawsuit will help protect your rights, but it is a long and expensive process.

When resolving lien disputes, it is important to consider alternatives if possible. Most counterparties choose bonds, escrow accounts, letters of credit, etc. These options provide greater flexibility for both contractors and owners.

Impact of Retainage on Cash Flow and Project Financing

The most severe problem with holdback is that it limits the contracting organization’s cash flow. If a delay in payment occurs, these specialists may be unable to purchase materials or pay wages to personnel. This effect can affect the full supply chain.

Holdback creates the most significant problems if the plan has a limited profit rate. The deduction sum may exceed the predicted income. As a result, the contracting organization will remain at a loss until it receives all construction payments.

Some firms call retainage outdated practice and choose other options to eliminate it or at least reduce the adverse effects:

• Choose Retention or Surety Bonds. Instead of holdback, the contracting organization pays a Surety or Retention Bond. The customer of the contracting organization is a beneficiary. It partially resembles the opposite of retainage. The distinction is that the contractor receives the total amount during the project’s implementation. The owner retains the opportunity to file a court case against the Retention Bond if there are problems with adopting the project. Ideally, such a bonus should be less than retainage so that it makes sense.
• Work with Substitute Security. The owner may allow the contracting organization to utilize another security format to protect the whole capital, e.g., bank credit and various securities guaranteed by the United States, including certificates and notes.
• Create a construction trust fund. Many regions have decided to launch targeted construction funds. In this case, the capital that the contractor received to pay for the services of a subcontractor is stored in an interest-bearing trust account. The contractor has no right to spend this money until everyone receives the amount due to them. If the contracting organization utilizes inaccessible money, it can be held accountable.

Do not forget about the reputation. If the contractor has a good reputation and has completed many programs, you can agree to reduce the interest rate.

Best Practices for Managing Retainage

You may have previously been able to prevent contract holdback, but in the construction field, it is impossible to deal without them, especially concerning private projects. Let’s analyze some recommendations to improve the retainage handle:

• Consider including holdback in the initial agreement value. This will raise the agreement’s amount, but you will be sure you have enough funds to deal with it. In some cases, this may convince counterparties to abandon the retainer completely.
• Track your financial flow. Construction firms are more susceptible to capital movement troubles when most agreements utilize retainage. As a result, adopting a cash flow control procedure is in your best interest.
• Use software. Many digital construction solutions in the area are specifically designed to control building project data. Payment management apps built for general contractors offer many valuable options, including digital invoicing, lien waiver exchanges, and the ability to pay or bill for retainage quickly. Significant benefits of using software include eliminating inefficient paper-based processes, accurate records, and timely document creation.

Many companies today open a business savings account. It ensures they have extra funds when needed, e.g., if a counterparty is trying to withhold capital after a job is completed.

Closing

Whether you like liens or not, construction firms must deal with these standards, and it’s crucial to prepare appropriately. When all parties contribute, the capital retained will motivate you to do a good job and become a savings project (with interest). It will enhance cash flow in future projects.

Unscrupulous organizations can abuse the holdback scheme, so reading the fine print in documents is critical, and accepting clearly formed programs is crucial. Phrases such as “substantially complete” or “90% complete” can be interpreted differently and may impact when you obtain your payout. Cooperation with BooksTime specialists with bookkeeping experience in the construction area will help you save your income.