Construction Retainage Accounting: Why Your Profits Don't Match Your Bank Account

You finished three projects last quarter. Your invoices went out, most of the payments came in, and your profit and loss statement looks healthy. But when you check your bank balance, something doesn't add up. You're working more than ever, winning bids, keeping crews busy. Yet you're still shuffling money between accounts to make payroll or waiting until the last minute to pay suppliers.

This is one of the most common frustrations among Indianapolis construction contractors, and it usually traces back to a single culprit: retainage that isn't being tracked properly.

The Money That Exists on Paper But Not in Your Pocket

Retainage is a standard practice in construction. On most commercial and public projects, the property owner or general contractor holds back a percentage of each payment, typically between 5% and 10%, until the project reaches substantial completion or final sign-off. The practice protects owners from incomplete work and gives contractors an incentive to finish punch lists and close out properly.

Every contractor knows this. What many don't realize is how that held-back money affects their financial picture when it isn't separated in their books.

Here's what happens. You complete $50,000 worth of work in a month. You invoice for the full amount. Your accounting software records $50,000 in revenue. But the check that arrives is only $45,000 because 10% is being retained. If your bookkeeping doesn't distinguish between the $45,000 you received and the $5,000 being held, your records show you earned more than you actually have access to.

Multiply that across several active projects over the course of a year, and you can easily have $30,000, $50,000, or more sitting in retainage that your books are treating as available cash. It isn't available. You can't spend it, and you won't see it for months. Sometimes you won't see it until the following calendar year. Yet your financial statements suggest it's already yours.

The Tax Problem Nobody Warned You About

This is where the situation gets expensive.

Most construction businesses operate on either a cash basis or an accrual basis for tax purposes. Each method handles retainage differently, and if your bookkeeping doesn't match your tax method, you're creating problems.

Cash basis accounting means you recognize income when you receive it and expenses when you pay them. In theory, this should protect you from paying taxes on retainage you haven't collected. But if your books lump retained amounts together with actual receipts, your records don't accurately show what you received versus what you're owed. When tax time comes, you or your accountant may not have clear data to work with.

Accrual basis accounting recognizes income when you earn it, regardless of when the money arrives. Under this method, you could legitimately owe taxes on retainage the moment you invoice for it. Larger contractors often use accrual because it gives a more accurate picture of performance, but it requires careful cash management to ensure you have money available to pay taxes on income you won't collect for months.

Either way, the contractor who doesn't track retainage separately is flying blind. They're looking at reports that don't reflect reality, making decisions based on numbers that misrepresent their actual cash position, and potentially paying taxes on money that's still sitting in someone else's account.

What Proper Retainage Tracking Actually Looks Like

Good construction accounting treats retainage as what it is: a receivable that you've earned but cannot yet access. This means creating a separate account in your books specifically for retained amounts.

When you invoice a customer for $50,000 with 10% retainage, the transaction gets recorded in two parts. You have $45,000 in standard accounts receivable that you expect to collect soon. You have $5,000 in retainage receivable that won't come until the project closes out.

This separation accomplishes several things at once. Your accounts receivable aging report now reflects what you can actually expect to collect in the near term. Your cash flow projections become realistic because they're not inflated by money you won't see for six months. And your financial statements give you an honest picture of where you stand.

For Indianapolis contractors working on public projects, university jobs, hospital construction, or large commercial developments, these retained amounts add up fast. A mechanical contractor running $2 million in annual revenue with an average 8% retainage has $160,000 cycling through retention at any given time. That's not a rounding error. That's a truck, a quarter's worth of payroll, or the cash cushion that keeps you from borrowing at unfavorable rates.

The Cash Flow Timing Problem

Retainage doesn't just affect your balance sheet. It affects when money becomes available and whether you can meet your obligations in the meantime.

Most retention gets released 30 to 90 days after substantial completion, though some public contracts extend that timeline considerably. If you're a subcontractor, you're also waiting on the general contractor to process the release after they receive it from the owner. Add another few weeks.

During that waiting period, your business keeps running. You have payroll every week. Material invoices keep arriving. Insurance premiums come due. Equipment payments don't care that your cash is locked up in retention on a school renovation that won't close out until the district accepts the work in August.

Contractors who track retainage separately can plan for this. They know exactly how much is being held on each project, when it's likely to be released, and what their true available cash will be over the coming months. This lets them make informed decisions about taking on new work, purchasing equipment, or hiring. They're not surprised when the bank account looks thin despite a strong income statement.

Contractors who don't track retainage are constantly reacting. They don't understand why they feel broke when business is good. They take on debt or delay their own bills because the cash simply isn't there, even though the profit and loss statement insists it should be.

Getting This Right Going Forward

If your books don't currently separate retainage, the fix isn't complicated. It does require some intentional setup and consistent discipline.

Your chart of accounts needs a retainage receivable account. Some contractors also create a retainage payable account if they're generals holding retention from their subs. When invoices go out, the retained portion gets posted to this separate account rather than lumped in with regular receivables.

Each project should have its own retainage balance tracked so you know exactly how much is being held and when to expect release. Your project management and accounting systems should talk to each other, or at minimum, someone needs to reconcile them regularly.

At the end of each month and quarter, you should be able to pull a report showing total retainage outstanding by project, anticipated release dates, and any retention that's become collectible. This is the information you need for cash planning and tax preparation.

For many Indianapolis contractors, this is where working with a bookkeeper who understands construction pays off. Retainage accounting isn't difficult once the system is set up, but it requires someone who knows to ask the right questions and post transactions correctly. A bookkeeper who only handles retail or professional services clients may not think to separate retention because they've never encountered it.

The Bigger Picture

Construction contractors deal with enough uncertainty. Material prices shift. Projects get delayed. Customers dispute invoices. Labor is tight. The last thing you need is financial statements that add to the confusion by misrepresenting your cash position.

Proper retainage accounting won't generate new revenue or win you more bids. What it will do is show you the truth about your business. When you know exactly how much cash you have, how much is tied up in retention, and when those held amounts will become available, you can make better decisions. You can plan ahead instead of scrambling. You can stop wondering why you feel cash-strapped when the numbers say you're profitable.

That clarity is worth the effort of setting up your books correctly. It's worth finding someone who understands how construction money flows. And it's worth fixing now, before you pay taxes on another year's worth of income you haven't actually collected.