Introduction
Managing construction accounting retention is a critical aspect of financial management in the construction industry. Retention, often referred to as retainage, is the portion of payment withheld until a project or specific milestones are completed to the satisfaction of the client. In QuickBooks Online (QBO), effectively managing retention can help ensure that your books are accurate and your cash flow is managed properly. This article will guide you through the process of managing both accounts receivable (AR) and accounts payable (AP) retention in QuickBooks Online.
Understanding Retention in Construction Accounting
Retention, or retainage, is typically a percentage (commonly 5-10%) of each payment made by the client, which is held back to ensure the contractor completes the work to the required standard. Once the work is completed and approved, the retention is released to the contractor. This practice provides a financial incentive for contractors to deliver quality work and ensures clients have recourse if work isn't completed satisfactorily.
Properly tracking retention is essential to maintaining accurate financial records and ensuring that you’re paid the full amount owed once the work is complete. In QuickBooks Online, managing retention involves setting up specific accounts and workflows to track these amounts separately from your regular accounts receivable (AR) and accounts payable (AP).
Scenario: Northwest Electrical’s Retention Challenge
Northwest Electrical, owned by Mike Sanders, is a subcontractor on a large commercial project managed by Scogg Construction, a general contractor (GC). Scogg Construction requires a 10% retention policy, meaning they withhold 10% of all payments to Northwest Electrical until the project is fully completed and approved.
To complete the project, Northwest Electrical subcontracts some specialized work to Southside Wiring Solutions, which handles the data center wiring.
Retention Situation:
- Retention by Scogg Construction (AR Retainage): Scogg Construction withholds 10% of Northwest Electrical's payments as AR retention. For every invoice Northwest Electrical submits, Scogg Construction deducts 10% and holds it until the project is satisfactorily completed.
- Retention for Southside Wiring Solutions (AP Retainage): To maintain cash flow, Northwest Electrical mirrors the retention policy down to Southside Wiring Solutions. They withhold 10% of Southside Wiring Solutions' payments as AP retention.
This scenario highlights the importance of managing both AR and AP retention effectively to maintain financial stability and ensure that all parties are paid appropriately once the project is completed.
Managing Accounts Receivable Retention in QuickBooks Online
Now that we’ve set the stage with Northwest Electrical’s situation, let’s walk through the steps to manage AR retention in QuickBooks Online.
AR Retention (AR Retainage) with Scogg Construction
When invoicing the general contractor, Scogg Construction, Northwest Electrical applies retention directly on the invoice by including a negative line item. This shows the portion of the payment withheld as retention.
- Invoicing Example:
- Total Work Completed: $100,000
- Retention (10%): -$10,000 (negative line item)
- Net Invoice Amount: $90,000 (amount to be received immediately)
- Recording in QuickBooks:
- Line 1: $100,000 for the total work completed, recorded under Accounts Receivable.
- Line 2: -$10,000 for retention, recorded as a negative amount in Retention Receivable.
- Cash Receipt:
- Amount Received: $90,000
- Action in QuickBooks: When Scogg Construction pays $90,000, record this cash receipt against the invoice, leaving the $10,000 in Retention Receivable until it’s released.
Managing Accounts Payable Retention in QuickBooks Online
In addition to managing AR retention, it’s important to manage AP retention if you’re working with subcontractors or vendors who require retention on their invoices. This process ensures that you accurately record the amounts you owe but haven’t yet paid due to retention.
AP Retention (AP Retainage) with Southside Wiring Solutions
Northwest Electrical also applies retention to the payment owed to its subcontractor, Southside Wiring Solutions, by including a negative line item on the bill.
- Billing Example:
- Total Work Completed: $40,000
- Retention (10%): -$4,000 (negative line item)
- Net Bill Amount: $36,000 (amount to be paid immediately)
- Recording in QuickBooks:
- Line 1: $40,000 for the total work completed, recorded under Accounts Payable.
- Line 2: -$4,000 for retention, recorded as a negative amount in Retention Payable.
- Cash Payment:
- Amount Paid: $36,000
- Action in QuickBooks: When Northwest Electrical pays $36,000 to Southside Wiring Solutions, record this payment against the bill, leaving the $4,000 in Retention Payable until it’s released.
Tracking Retention
To maintain an accurate picture of outstanding retentions, regularly review the balance sheet for both AR and AP retention amounts.
- Balance Sheet Review:
- Retention Receivable (AR Retainage) from Scogg Construction: $10,000
- Retention Payable (AP Retainage) to Southside Wiring Solutions: $4,000
Releasing Retention
Once the project is completed and approved, Scogg Construction releases the retained funds. Northwest Electrical must then offset this by releasing the retention withheld from Southside Wiring Solutions.
- Invoicing:
- Retention Amount Released by Scogg Construction: $10,000
- Create a New Invoice in QuickBooks:
- Use the Retention Receivable item as a positive amount to offset the original negative retention.
- The new invoice for $10,000 will clear the Retention Receivable balance once paid.
- Cash Receipt:
- Amount Received: $10,000
- Action in QuickBooks: Apply the $10,000 cash receipt to the new invoice, clearing the Retention Receivable account and recognizing the amount as income.
- Billing:
- Retention Amount Released to Southside Wiring Solutions: $4,000
- Enter a New Bill in QuickBooks:
- Use the Retention Payable item as a positive amount to offset the original negative retention.
- The new bill for $4,000 will clear the Retention Payable balance once paid.
- Cash Payment:
- Amount Paid: $4,000
- Action in QuickBooks: Apply the $4,000 payment to the new bill, clearing the Retention Payable account and settling the payable.
Final Cash Flow Impact
After the retention has been received from Scogg Construction and paid to Southside Wiring Solutions, the final cash flow impact is reconciled.
- Net Cash Inflow from Scogg Construction:
- Initial Cash Receipt: $90,000
- Retention Cash Receipt: $10,000
- Total Received: $100,000
- Net Cash Outflow to Southside Wiring Solutions:
- Initial Payment: $36,000
- Retention Payment: $4,000
- Total Paid: $40,000
Best Practices for Managing Retention in QuickBooks Online
Managing both accounts receivable and payable retention effectively requires careful attention to detail and regular monitoring. Here are some best practices to consider:
- Set Up and Review Retention Accounts Regularly: Use Retention Receivable and Payable accounts consistently in QuickBooks Online. Regularly run and review reports to track the amounts held or owed as retention. Check out our blog Best Practices for Configuring a Chart of Accounts in QuickBooks Online for Construction Companies
- Maintain Clear Communication with Clients and Subcontractors: Ensure all parties are aware of retention amounts and release conditions to prevent disputes or delays in payments.
- Mirror Retention Policies for Cash Flow Stability: Retentions can impact cash flow, so mirror the GC's retention policy with your own subcontractors to maintain stability.
- Avoid Skewing Aging Reports with Full Invoice Amounts: Invoice for the net amount after retention to keep aging reports accurate and avoid confusion.
What RedHammer Can Do for You
At RedHammer, we understand the unique challenges contractors face when managing retention in QuickBooks Online. Our team specializes in helping construction companies streamline their financial processes to improve accuracy and cash flow management. Here’s how we can help you:
- Customized Retention Tracking Setup: We’ll assist you in setting up Retention Receivable and Payable accounts in QuickBooks Online, ensuring proper workflows are in place for tracking retention.
- Training and Support: Our experts provide hands-on training to your team, ensuring they know how to manage retention accurately and efficiently in QuickBooks.
- Retention Report Customization: We can create customized reports that provide you with clear visibility into your AR and AP retention, making it easier to track outstanding amounts and plan for cash flow.
- Cash Flow Optimization: By ensuring retention is managed correctly, we help you maintain cash flow stability, reducing financial strain and keeping projects on track.
- Ongoing Consulting: Our team will continue to provide expert consulting on best practices for managing retention and other critical construction accounting processes as your business grows.
Let RedHammer streamline your accounting processes so you can focus on what matters most—delivering successful construction projects.
Conclusion
Managing construction accounting retention in QuickBooks Online is essential for maintaining accurate financial records and ensuring timely payments and collections. By setting up dedicated Retention Receivable and Payable accounts, creating retention items, and carefully tracking these amounts, you can ensure your books remain accurate and your cash flow is managed effectively. Regularly review your retention accounts, invoice or pay for retention promptly once the work is complete, and maintain clear communication with all parties involved.
The step-by-step approach provided in this article, combined with best practices, will help you manage both receivable and payable retention efficiently in your construction business. By effectively managing retention, you can improve cash flow stability, reduce financial risk, and ensure that your projects run smoothly from start to finish.
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