Why NetSuite for Construction?
NetSuite is a comprehensive cloud-based enterprise resource planning (ERP) software that offers numerous benefits to the construction industry. The construction business has unique needs, such as job costing, project management, and document management, which can be seamlessly managed using NetSuite. With NetSuite, construction companies can manage their financials, track project costs, allocate resources, streamline procurement, manage inventory, and automate billing and invoicing. NetSuite provides real-time visibility into all aspects of a construction project, enabling companies to make informed decisions, reduce costs, and improve profitability. Its flexibility and scalability also make it an ideal solution for companies of all sizes, from small startups to large enterprises. NetSuite is perfect for construction businesses looking to streamline their operations, improve efficiency, and drive growth.
With NetSuite construction, businesses can easily set up contract retainage schedules and track the retainage amount being withheld from each payment. The software can also automate the release of retainage based on the contract terms, which can help ensure that contractors and subcontractors receive timely payments.
Manage Project’s Subcontractors
If a subcontractor fails to complete the job or delivers unsatisfactory work, following proper procedures for withholding a percentage of the invoice amount is essential.
In the construction industry, informal agreements often establish partnerships with subcontractors and specialists. However, managing the financial relationship with subcontractors as a general contractor can take time and effort. It is crucial to strike a balance between protecting your cash flow and the project's overall health while completing the job on time and within budget.
Negotiating clear payment terms in the contract to avoid payment disputes and delays is essential. You can protect the project and the business from financial and reputational damage from incomplete or unsatisfactory work. One way to achieve this is by implementing retainage, which involves withholding a percentage of the contract payment until the job is completed to the specified standard.
What is Retainage?
Job costing is critical for tracking costs and revenue. Alongside this, paying subcontractors must be managed effectively, often called "holdback" in Canada and "retainage" in the US. Retainage was developed in the UK 180 years ago to protect customers from deficient or unsatisfactory work. A percentage, typically 10% of subcontractor invoice amounts, is withheld, with 5% released at the project's end and the balance 5% at a later designated time.
Assuming you have retained 10% of the invoice amount, 5% is released as payment to the subcontractor once the project is complete and deemed satisfactory. The remaining 5% can be released later or at the end of the warranty period.
Manage Retainage on AP vs. AR
In a typical construction project, the customer is at the top of the hierarchy, followed by a general contractor and several subcontractors and specialists.
Regarding accounts receivable (AR) management, a general contractor may assume that the customer retains 10% of the payment and pass on that retainage to the accounts payable (AP) side subcontractors.
However, there is significant variability in the approach to retainage across the construction industry. Many construction companies may believe they follow best practices, but their retainage policies differ. For example, while the customer may withhold 10%, the general contractor may withhold 12% from subcontractors, or some companies may only withhold 5%, putting them at risk.
This inconsistency in retainage practices can create confusion and lead to payment disputes and delays. That is why it is crucial to establish clear and consistent retainage policies across all parties involved in the project. By doing so, construction companies can protect their financial health and maintain positive relationships with customers and subcontractors.
Mitigate Cashflow Risks
If a general contractor only withholds 5% from subcontractors, despite the customer withholding 10%, there is a risk of a cash flow crunch.
Construction projects typically have thin margins, with profit margins ranging from around 10% to 20%. Mismanagement of projects on both the accounts receivable (AR) and accounts payable (AP) sides can result in negative cash flow. Therefore, the contractor may end up funding the project for the customer at 0% interest or, worse, put the business at risk.
Another factor to consider is the cost of purchasing materials, particularly with inflationary pressures. Even if retainage is balanced, negative cash flow can occur because retainage does not apply to suppliers. In such cases, the contractor must pay the total cost of materials.
Contract negotiations play a critical role in managing retainage and material costs. For example, retainage is typically 10% of every payment in a fixed-price contract. In a time and material or cost-plus warranty, the general contractor may inform customers that they can only withhold retainage on subcontractor costs, not materials costs.
Managing both the AR and AP sides of a project and negotiating clear contract terms can help prevent negative cash flow and protect the financial health of the construction business.
Why Software? We are using Excel.
While withholding retainage is essential, paying it out to subcontractors correctly and on time is equally critical.
For general contracting firms that subcontract out most of the work on a project, manually managing retainage for 20 to 30 subcontractors can be time-consuming and prone to errors. Mistakes can lead to legal issues, such as property liens.
Research has shown that up to 30% of projects struggle with managing retainage, both on the general contractor and subcontractor side. Busy project managers can overlook sending retained invoices and this would lead to payment disputes.
Implementing software systems is crucial to ensure all stakeholders are on the same page. NetSuite ERP, implemented by a solutions partner with expertise in the construction industry, can provide accurate and timely reports to keep retainage management on track.
By using NetSuite and Appficiency, construction companies can:
- - Enable retainage from the first period and transaction where it is relevant
- - Capture retainage on a per-project basis to accommodate different retainage rates
- - Generate customer-facing forms that show retainage aging and scheduling
- - Reconcile each line of every transaction to ensure that every payment is retained and applicable to recovery depending on its categorical qualification.
- - Provide multicurrency support in multiple regions and localizations for taxation.
- - Complete reconciliation for the accounting team
- - Deliver an integrated proposal from estimate through project closure
Using software systems to manage retainage, construction companies can reduce errors, save time, and maintain positive relationships with customers and subcontractors.
For Instance:
If a $40,000 invoice has a 10% retainage, the amount withheld would be $4,000 and postponed to a future date.
Once the transaction is processed, the ERP system begins aging the receivable on the customer side and the payable on the AP side. It is essential to track the retainage balance and reconcile it against the general ledger to ensure that the project manager has a balance, by project, for the total or vendor-side retainage in effect. All transactions are visible in a cash flow report.
When creating a catch-up invoice against the retainage balance, the system depletes the retainage balance ledger and generates a new aging report as a new invoice.
The construction industry has unique administrative and accounting needs. Contractors need management software optimized for their operations, from digital invoicing to lien management to retaining and paying retainage. Cloud-based financial management software tailored to a firm's business processes can help track the cashflow, increase customer satisfaction, and make subcontractors enjoy working with the contractor.
An ideal system should automate invoicing, with specific line items for retainage in accounts receivable and accounts payable. Contractors should be able to standardize their processes across all projects, increasing efficiency, paying subcontractors more quickly, reducing errors and risks, and freeing up resources to focus on clients.
Without Technology, What could happen?
Retainage is essential for protecting all parties involved in a construction project. However, it must be consistently managed, accurately and automatically to preserve relationships and work best.
Calculating retainage may seem simple, but it can become highly complex, especially when dealing with multiple projects and various work codes. Additionally, contracts signed by numerous parties, potential communication breakdowns, scheduling delays, and the domino effects of non-payment can further complicate the process. Therefore, construction firms must leverage technology to ensure the retainage process works as intended and protects all parties involved without generating new problems.
Using technology to manage retainage, construction firms can streamline the process, reduce errors, and maintain positive relationships with customers and subcontractors. This will ultimately protect the financial health of the construction business and ensure that projects are completed on time and within budget.
Conclusion
In conclusion, the construction industry is complex and requires careful management of financial relationships between customers, general contractors, and subcontractors. Retainage is a critical tool used to protect all parties involved in a construction project and incentivize subcontractors to deliver quality work and complete the project on time. However, retainage can also be a source of confusion and potential disputes, primarily when managed manually. By leveraging technology like cloud-based financial management software, construction firms can streamline the retainage process, reduce errors, and maintain positive relationships with customers and subcontractors. This leads to improved cash flow, increased efficiency, and, ultimately, successful project outcomes.
