Retention vs. Bank Guarantee
What is retention? Retentions or ‘retention funds’ are a means of warranty. They are commonplace in the construction industry, but are in other industries also.
Typical in the construction industry retention funds are set as a % of a contract value, with varied timeframes. Some are 6 months, others out to 1-2 years & beyond.
Retention funds pose problems for businesses in the construction industry, namely;
No, or delayed, return of funds.
Administrative requirements.
Drain on working capital.
What if the company retaining the funds goes out of business?
Practically little to no real control over payments.
No security for retention funds.
Difficult to keep track of across multiple projects with different values, timeframes, contracts etc.
One way to remove or limit the pain of retentions is via a bank guarantee. With a bank guarantee in place the business owed the retention is paid their retention amount immediately. A bank provides a guarantee to the counter-party to supply funds should a warranty issue arise during the agreed timeframe.
Why use a bank guarantee?
Do you sometimes wonder where all your profit is? The profit & loss statement says one thing, the bank account another… Are your “Days Creditors outstanding” higher than you expect? Is your accountant telling you your cash flow cycle is out of whack?
If your industry involves retentions, then the answer to these questions probably has something to do with the amount of funds being held as part of your warranty / invoicing process.
We often have clients tell us they have heard of bank guarantees, but thought they were frankly a bit useless. Why pay interest for money you know you’ll get later on? Fair question… let’s consider it…
What if your retention funds were swapped for bank guarantees? This could;
Reduce overall funding costs, improving profitability.
Increase operating cash flow.
Simplify retention administration.
Show a builder your business is professional.
Remove the risk of not being paid a retention should the builder collapse.
Imagine having all the cash tied up in retention funds actually in your bank account.
Receiving retention funds via the normal invoicing program can significantly impact how easily a business can grow.
For instance, assume a project has a 10% profit margin, and 5% is held on retention for 12 months. That 5% retention is actually 50% of the job profit. A bank guarantee brings this profit forward, allowing it to be directed toward whatever the growth initiatives of the business may be. This enables a business to fund its own growth, and take on more work safely..
Lastly, there is an administrative benefit not to be underestimated. Your bank guarantees will have expiry dates which align to the date you would have normally had your retention funds returned. These retention commitments will disappear automatically on expiry.
What next?
If you feel your business is being hamstrung by the amount of funds being retained by your customers, get in touch with Right Brain Insights. We are happy to conduct an analysis of your retention funds situation and advise whether this strategy is appropriate for your business.