Revenue Recognition for Holdbacks in the Construction Industry
Holdbacks provide a particularly interesting challenge in the construction industry. They tie up 10% of your cash – 10% of your profit margin – before you even leave the gate, forcing many contractors and subtrades to carry a line of credit from the bank to allow them to accept those lucrative contracts. Often, I see this 10% deducted, not only from the invoice, but from the revenue as well. While not technically incorrect, you can provide a much stronger financial picture to the bank by simply adjusting this revenue recognition policy.
When progress billing a job, revenue for the entire completed work should be recognized at the time of the billing; the holdback should be deducted – and tracked in a holdbacks receivable account on the balance sheet. This not only gives you an immediate 10% boost to your revenue in the financial statements you provide to the bank, but it allows you a foolproof method of tracking your holdbacks to ensure you never miss invoicing those important funds. And don’t worry – your accountant will defer the revenue at tax time so you don’t pay taxes on it before you absolutely have to.