The Unwilling Banker: The Hidden Cost of Retainage

Retainage. If you deal with it, is that job holding your company back? Are you being the bank for your job owner? Does it stunt your cashflow and growth? What can you do about it? Find out on this week’s episode.

Topics we cover in this episode include:

  • What is retainage?
  • Retainage can sunt your company’s growth if you don’t bid jobs properly
  • A retainage case study
  • Retainage can cause problems when you’re in growth mode
  • Many contractors do not account for retanage properly
  • How to mitigate or reduce retainage
  • Negotiating retainage with owners or general contractors


Join the conversation on our LinkedIn page:

Wade Carpenter, CPA, CGMA |
Stephen Brown, Bonding Expert |


[00:00:00] Wade Carpenter: Retainage. If you deal with it, is that job holding your company back? Are you being the bank for your job owner? Does it stunt your cashflow and growth? Is there anything we can do about it?

Come on in, let’s talk about it. This is the Contractor Success Forum. I’m Wade Carpenter with Carpenter Company CPAs. With me as always, Stephen Brown with McDaniel Whitley Bonding and Insurance. Stephen, kick us off.

[00:00:28] Stephen Brown: This topic comes up so often, retainage. How do you deal with it from an accounting standpoint? Are you financing the job? Yeah, you are, to whatever extent the retainage is. Also, how is the owner or the general contractor that’s holding that retainage, how’s it funding the retainage?

A lot of lot of times you’ll see them take 10 percent out of each pay draw in the early stages to fund that 5 percent retainage that’s due you at the end.

What is retainage?

[00:00:56] Stephen Brown: What is retainage, Wade?

[00:00:58] Wade Carpenter: Well, without getting too technical, basically, it is a portion that we’re holding back until the contract is done or substantially complete to ensure completion. That was the original intent. And, the history actually goes all the way back to England, back in the 1840s.

And it was brought to the U. S. in the late 19th century. But again, the idea was to ensure that the projects get done. We understand that from the owner’s standpoint, but the fact that the contractor has to basically be the bank is part of the topic today that I think we want to talk about.

[00:01:31] Stephen Brown: Sure.

Retainage can sunt your company’s growth if you don’t bid jobs properly

[00:01:32] Wade Carpenter: We all know that retainage, taking 10 percent out, can cost us money. You know We don’t realize how much that money is actually costing. Stephen, you and I have talked about it. We have contractors that say that’s my gravy at the end, when it comes in.

And if you can float it, that’s great. But if you’re in a growth mode, that’s awful hard to do. A lot of contractors do not bid their jobs properly. They don’t understand their overhead. And a lot of times that retainage is eating up their ability to grow.

So any thoughts on that? I did do a case study I want to talk about in just a second, but–

[00:02:07] Stephen Brown: We were talking about your case study, and I think that’s an important point, Wade, is that, If you haven’t put the appropriate gross profit margins on the job that includes your overhead expenses and your financing retainage, that you’re not going to be paid until the job is completely punched out and you have all lien waivers, everything is to the owner’s perfect satisfaction.

Then you get your retainage. It feels like that money’s being held hostage. And it is to some degree. It’s money that you can’t use for other operating purposes. And maybe in certain situations, if you hadn’t bid it properly, it causes you having to borrow money to make ends meet, and then you’re really depending on that retainage.

So I think it’d be a great time to tell us a little bit about your case study. And I’d also like to talk a little bit later on about how to properly account for it.

[00:03:00] Wade Carpenter: Yeah. Okay. That is obviously something I see all the time where people are not accounting for it properly.

A retainage case study

[00:03:06] Wade Carpenter: You know, What I did here was I just took a hypothetical contractor. Assume that we had a $100,000 contract with a 20 percent gross profit margin. It’s going to take us six months to do, 10 percent retainage.

And what I assumed was say, that contractor getting started, that’s the time you’re trying to really get moving and this contractor needed $8,000 up front to cover payroll or whatever to really get going, he was in growth mode.

And so he took one of these payday loans or pay by the week loans, whatever you want to call it.

And that’s another thing where people have no idea how expensive those payday loans are. Long story short, I did the analysis if we didn’t have the retainage at all, versus having to take just an $8,000 loan and paying it back over, say, a six month time, and what happened to the job in both cases.

And believe it or not, the gross profit difference was like $44,000 and change, over that six months time. And people don’t realize how much money is really tied up in that 10%. That was amazing to me.

And one of the other topics we had talked about is, a lot of times people are getting bonds and having retention held on them as well, and that’s if you had to also figure in a bond, versus not having that versus also having the retainage.

 I would like to go back and maybe recalculate that whole scenario, but it was amazing to me because I wanted to have something I could show to people that like this really is costing you a lot of money. And so part of the idea is what can we do about it today?

[00:04:45] Stephen Brown: Sure. A lot of times I’ll see the retainage change in the final contract with the private owner.

Then the financing institution requires a bond, and they want your price for a bond. Or they want your exact invoice for the bond. They don’t want you to be able to mark up your bond premium like every other item in your operating budget.

So things can get tight. And you have to borrow money and, you’re partially financing the job, and interest rates are so high right now. Even if it wasn’t a payday type of loan situation, interest rates are something you always have to figure, in a project, especially if you’re expected to finance any part of it.

And when I say finance, I mean do any of the work with your own labor and materials that you pay for that you haven’t been paid for yet. And retainage is a chunk of that.

That’s a fascinating case study. So explain those results one more time to me, would you, on this scenario?

[00:05:43] Wade Carpenter: The fact that you’re holding your money. And so many people get in these binds with these pay by the week loans that the interest rates literally are three or four hundred percent. And you don’t realize it because you just pay it back.

Or maybe you even do realize it but you don’t realize that cycle you basically get in where it’s just sucking your cash down and it’s hard to get out of.

[00:06:04] Stephen Brown: Yeah, it’s an extreme example, but it literally sucks all the life out of you when your interest rates are that high. And I think that’s a great point to use that.

[00:06:16] Wade Carpenter: It’s also taking into account the fact that if you did have The 10 percent as you went through the job, it would have allowed you to do other things. I believe it was a realistic way I approached it, but so few people realize what that really is doing.

Retainage can cause problems when you’re in growth mode

[00:06:31] Wade Carpenter: And I actually just spoke with a young man last week that is underground utility grading. He was going from $300,000 to $1.9 million in six months time. He got a big job and they were going to hold the retainage and I’m like, I think you’re going to run into some cashflow problems and we need to help you figure out how to get through this.

Because when you’re growing and you’re relying on that cash and you’re a young company, It’s hard to get financing. You know, bank’s not going to give you a lot of credit. You may have great credit but once you start growing like that, you can easily grow yourself right out of business.

[00:07:09] Stephen Brown: It makes perfect sense. if you put up a bond on a project, look at your contract. You should be able to apply a draw immediately before you even start work for mobilization and utilization costs and your bond premium.

[00:07:23] Wade Carpenter: Those are things we definitely need to talk about. Ways to mitigate or possibly reduce the retainage .

But the whole concept is contractors are being the bank, they’re financing the project costs for their owners. And I know that sounds awful harsh, but it is somewhat true that you’re putting your money in, and your own labor, where you’re paying those guys that they don’t wait to, maybe paying some subs, maybe paying for all these materials.

And some of that you can get up front. But, a lot of times you are waiting 30, 60 days to get paid on those things. And you put retainage on top of that, it compounds the problems.

Anyway, why don’t we talk about some of the problems that I see about accounting for retainage. And then I’d like to maybe come back to the cashflow situations and some ideas on how to deal with it. Is that okay?

[00:08:15] Stephen Brown: Yeah.

Many contractors do not account for retanage properly

[00:08:16] Wade Carpenter: So one of the things that I see all the time when I got a new contractor, that they do not account for retainage properly. And I don’t know if you see that in somebody coming to get bonds from you.

[00:08:27] Stephen Brown: Sure. I see a category of it showing up as a current asset, but then again, the bonding companies will discount that until it’s been paid for underwriting purposes.

[00:08:38] Wade Carpenter: So say you had a $100,000 contract and you only had the right to collect 90%. Most people do an invoice for $90,000. So you’re missing that 10%.

And the way it’s supposed to be accounted for is you’re going to put that retainage receivable in a separate category from your regular accounts receivable and pick up the income on the accrual basis.

A lot of people will pick up just the amount of the pay application that they’re allowed to collect right now. And it does have some impacts on the ability to get banking and bonding. I do realize underwriting may put some restrictions on that, but they also take it into account for working capital. Unless you’ve got retainage that’s going to be on a long term contract and you’re not going to get that for another year or two, then you’re definitely going to throw something like that out.

When I take over a new contractor and they do have retainage, that’s one of the first things that is never set up properly.

And then closing it out, if they Google some way to do it online to put it in their QuickBooks, then they go to do the final billing, they end up double billing that kind of stuff and double counting the revenue.

If you got a payout for $100,000 and you only have the right to collect $90,000, you should be showing 100,000 of accrual basis revenue. But , again, need to put it in a separate receivable account because that’s going to sit there and look like money is sitting in an over 90 day column, and that’s going to get thrown out as well.

[00:10:11] Stephen Brown: Yeah, you usually see that on a 30, 60, 90 day receivables chart and then a column at the far right that’s retainage payable.

[00:10:21] Wade Carpenter: Some of the construction accounting systems treat it that way, but something like a QuickBooks doesn’t do that, and it should be in a separate account. So that people know that this is not something you’re going to get.

[00:10:33] Stephen Brown: Sure.

[00:10:34] Wade Carpenter: It definitely affects your working capital ratio, your equity ratio, and it also may indicate that maybe you’re not as profitable.

Maybe a banker’s looking at it, does a quick glance at it. It’s looking like you’re not very profitable because You haven’t collected all that revenue and supposedly on their accrual, not collected it, but you haven’t recorded all that revenue, I should say.

[00:10:58] Stephen Brown: That makes sense.

I think it’s important too when we’re talking about bankers when you’re explained to a banker you’re in need for funding or financing something, you have to quite literally show them what you’ve already earned in retainage, and what you may need to borrow.

The last thing we want our listeners to do to have to get a payday loan because they’re financing a job where they didn’t realize that they were financing the job to the extent that they are. And how do you get cash flowing to that project quickly to keep you from financing the job?

Anytime that you’re bearing a cost that you’re not being reimbursed for, you got two issues. You may not have accounted for it properly when you bid the job. So you’re losing money to begin with. And then they’re holding money out to make sure that there are absolutely no liens on the project and everything’s punched out to perfection.

That can really hurt you.

[00:11:51] Wade Carpenter: Absolutely. And again, the case study with the payday loan is not so extreme example because I see it all the time. But even if you’re not having to take those payday loans, not having that money in your pocket can definitely affect your profitability on a job. It’s not just about interest rates. It’s about what are you able to do and it really does affect your profitability.

How to mitigate or reduce retainage

[00:12:13] Wade Carpenter: But, I wanted to move into where you’re going with this. What can we do about it? What are some ways we can either mitigate it or reduce retainage? You got any thoughts on that?

[00:12:23] Stephen Brown: You can always negotiate it at the time you sign the contract. You can negotiate retainage down. If it’s a bonded project, you can really renegotiate it down or get rid of it completely. Retainage has, for a large part, been abolished by municipalities and government contracts where a performance of payment bond is required.

And you could say retainage plus a bond is overkill, but it’s most certainly a way to get a project finished and to make sure that the contractor who’s doing the work. It certainly gets your attention, when there’s retainage and it’s a bonded project.

But from a construction point of view, I think that’s– from our listeners point of view, doing the work. I think you’re right. It’s important to realize what is this costing me to do this? If I can’t negotiate down the retainage, and I can’t go back in and negotiate more profit in the job, what do I do? There’s not a whole lot you can do except not sign the contract, or back out of it if you want to.

Talk about retainage before the contract is signed

[00:13:25] Wade Carpenter: That’s where I wanted to talk about some ways that we could potentially manage that or discuss some of that, because the time to talk about it is before you sign that contract.

I now remember one in particular where I had a concrete contractor, it was a pretty big job and he was supposed to do the concrete and the labor and all that stuff.

And with the retainage on it, he was smart enough to realize that it was going to kill his cash flow. And so he actually gave up the concrete. Usually he made some money off the concrete side of it, but he realized how much it was costing him to float that concrete bills for a couple of months before he got paid on it. And he actually allowed the general contractor to pay for that directly, save some of the margin, but he still came out in the end.

By him doing that, they agreed to reduce the retainage amount to 5 percent and then 2. 5 percent later in the job. Thoughts on that?

[00:14:26] Stephen Brown: I think that’s wonderful.

What kind of controls do the owner or the general contractor have to see that a project’s completed? And then what job are you doing for them?

You may have a certain job where there, like you said, there’s a lot of materials involved. It’s a big chunk of it. It may be where it’s predominantly, in this situation with the concrete removed, it’d be a mostly a labor contract.

So labor costs are incurred. And all of your costs to administer that labor and oversee the project, you can get reimbursed for by negotiating the retainage down. And then basically you’re just stuck with getting a percentage of your profit at the end of the project. And I’ve seen a lot of contractors just scratch out retainage and just scratch that whole section out.

And so it’s an ongoing negotiating process and you have to be willing to walk away if the terms aren’t fair enough for you, or you don’t have enough profit in it to justify financing the retainage.

Margin points vs. cash flow

[00:15:28] Wade Carpenter: One of the other things this guy did was said, if we’re going to do this, you’re going to reduce my retainage and you’re going to pay me every week. Because everything is going to be labor, and I’ve got to pay these guys every two weeks.

And he still made really good margin on it, but he gave up some margin points to have the cash flow. And, I think it allowed him to grow. It was a very nice contract and it was a win for both sides. Sometimes maybe talking through that with your general contractor, or even the contract owner, depending on who you are.

Other thoughts on that?

[00:16:02] Stephen Brown: I think that’s a good analogy. You know, the case study that you laid out shows how much things can go upside down, completely and totally out of your control. And then the second scenario is how you could negotiate that retainage down and how it affects your cash flow.

Because as a contractor, you’re thinking non stop. It’s, I have cash in the bank. I have to spend that cash to pay for a project until I get paid. I’m, in effect, financing the project. That’s fine. That might be what you do all day long. That’s the name of the game.

 As long as you’re aware of it and how to calculate the cost of that. I’m sure your contractor figured out not taking the basis points markup on the materials, versus the effect of the cash flow and his need for that cash to not have to finance the job, was just an accounting decision that made perfect sense to him and was explained to the owner or the GC who said, yeah, I get it. Okay, yeah, we can handle that.

Retainage and funds control

[00:17:03] Wade Carpenter: Some other thoughts real quick.

Some of them may seem like extreme measures, but third party escrow service, or somewhat known as funds control.

That’s a dirty word for a lot of contractors, but you know, if the owner knows that the subs are getting paid, the materials are getting paid, would they reduce the retainage?

Another thought is, you know, I said do you need both? But maybe they should say, let’s, hey, you do a performance bond, can we take out this retainage? That’s another way to spin it, and you get them to pay for the performance bond. Then maybe they don’t need to hold the retainage or as much.

[00:17:38] Stephen Brown: Yeah. Now that makes a lot of sense.

And when you’re providing a labor only service, you’re due the markup for managing that labor and paying those payroll expenses. And all the overhead that goes with administering that payroll. You’re due that immediately. That’s something you shouldn’t have to finance.

And anything else the owner or the GC can pay directly, material wise and so forth, that cuts into your profit margin if you mark it up like everything else in your project. That makes a lot of sense. And funds control is something that some contractors like, believe it or not. They’re like, yeah, I have no problem with it.

Funds control is basically set up by a third party and the funds from the owner or the general contractor go into the funds control and then dispersed according to the invoices that are due.

So the funds control doesn’t manage how much profit you make on the job. But it administers the expenses that you have, and the owner knows as long as funds control is issuing this out properly, I literally have no exposure. So I can get rid of the retainage.

[00:18:47] Wade Carpenter: Just a thought, but I’ve seen funds control done wrong in the wrong escrow company, but if you’re on top of your costs and you’re reporting it properly, a good one will pay the bills very quickly and get you money really quickly.

But just continuing the thoughts on this, as you progress through that, can we reduce the amount of retainage and release that?

[00:19:07] Stephen Brown: Yeah, and remember, funds control costs money too. It’s a percent.

[00:19:11] Wade Carpenter: It is, but we’re talking what, one to two percent maybe? And especially if they would do that versus the ten percent retainage and what that really costs you.

[00:19:21] Stephen Brown: Yeah. It’s a–

[00:19:22] Wade Carpenter: If you get the owner–

[00:19:23] Stephen Brown: You could say it’s a deal. Yeah.

[00:19:25] Wade Carpenter: Just a thought.

[00:19:26] Stephen Brown: Yeah.

[00:19:27] Wade Carpenter: Just thinking about, like, how do you secure the payment? Can we reduce the funds? As we go along are you the ones that are in there early? Like the grading guys, the utility guys, the, concrete guys? And do you really need to wait till the end of the job since you’ve already done your stuff? You’re part of the job. You shouldn’t have to.

Again, tiered contract rates that are based on early release, based on your performance. If you get things done on time. We’ve had a couple of episodes where we talked about the time aspect of contracts and the profitability of contracts.

These are just a couple of thoughts that just came to my head when we were talking about this. The faster you can speed that up, the more profitable it usually is.

Negotiating retainage with owners or general contractors

[00:20:11] Wade Carpenter: So what can we do to maybe negotiate with our owners or general contractors, whoever we’re working with?

[00:20:18] Stephen Brown: Sure. Every bit of that increases your cash or your ability to not have to finance. And we talk about this all the time. It’s what our podcast is all about. Cash is king in the construction industry. Your ability to retain cash gets you bonds. It allows you to negotiate interest rates that are so much lower if you do want to finance something. And it allows you to expand and grow, and it takes all the stress of your ability to operate a business. It takes the stress away.

So everything we do, Wade, in our podcast are designed to help you try to increase your cash and understand that whatever situation you’re in right now as one of our listeners, you can work your way out of it and just work smarter, not harder, right?

[00:21:07] Wade Carpenter: For our listeners, if retainage is affecting you, give us some feedback in the comments. Any ways you may have dealt with retainage, especially if you had some innovative ways of dealing with it, we’d love to hear some feedback or other episode topics you’d like us to address.

And we wanna thank you for listening to the Contractor Success Forum. Check out the show notes at or on the Carpet CPA’s YouTube channel for more information.

We would appreciate it if you consider subscribing, follow us every week as we post a new episode, and we will look forward to seeing you on the next show.