Main contractor: profit that is not in the bank

“My bookkeeper brings me the report: Valentyn, four million two hundred and ninety thousand net, our best year. I tell him: good, we pay bonuses. And he says: there is only five hundred and fifty in the account. The rest is with the clients.”

Valentyn Kramar heads a main contracting company in Boryspil. Retail units, small warehouses, refurbishments — sites of between two and five million. Nineteen years in construction, the last six in his own business. Eleven engineers on the payroll, every bit of building work on subcontract. The company is profitable and takes on more sites every year than the year before.

Fourteen sites in a year

Over the past year the company ran 14 sites. The average budget is 3 400 000 ₴, which gives a turnover of 47 600 000 ₴.

This is not a small business and not a large one. It is the typical regional main contractor that wins tenders from mid-sized clients and does the work with other people's hands.

Valentyn spent nineteen years going from site foreman to owner, and for most of that time he worked for the people who owned the machinery. He built his own business the other way round: not a single excavator, but a tender department and eleven engineers. That gives him a flexibility nobody running a plant yard has.

Main contracting is not building, it is an obligation

Valentyn has no crews, no concrete plant, no crane. What he has is estimators, supervising engineers, certifications, experience and the ability to sign a contract that makes him answerable to the client for everything. All the physical work is done by others.

• subcontractors: 33 320 000 ₴, that is 70% of turnover
• own direct costs: 7 140 000 ₴, which is 15%
• fixed costs: 2 850 000 ₴
• net profit: 4 290 000 ₴

For main contracting that structure is normal. Seventy percent of the budget goes to the people who lay the brick and run the services, and the main contractor lives off the difference between the client's price and the subcontractor's price, less his own cost of organising it all.

Which is exactly why main contracting looks like an easy business from the outside. There is no fleet of machinery to keep loaded, no crews to pay through the off-season, no stores. There are contracts, signatures and liability.

Who actually does the work

Valentyn has about twenty subcontractors, and with a dozen of them he has worked for years.

They take no part in the tender, do not read the client's specification, do not talk to the inspectors and do not sign the acceptance certificate for the site. Their job is simple and clear: turn up, do their section, get paid, move on to the next site.

And they are right to see it that way. A subcontractor does not get the nine percent the main contractor gets, so the client's risk is none of his business. He sells work, not a guarantee on it.

“My subcontractor has never heard the words retention money. He did the roof, handed it over to me, and in ten days he has to be paid. Not in forty-five, not after the certificate with the client, not less a retention. In ten.”

The year in figures

Nine percent net. For main contracting that is a decent result, and for two years Valentyn showed that line as proof that the company had reached a steady level.

The report is put together faultlessly. All five lines are reconciled with certificates, budgets and bank statements, and any audit will confirm every one of them. It simply shows what has been earned, not what is available, because that is what it is for.

The nine percent of main contracting

It should be said that those nine percent are honestly earned. The main contractor takes on what nobody else on the site takes on: subcontractors blowing their schedules, design changes from the client, complaints from the inspectors, injuries, the weather and the deadlines.

The difference between the budget and the sum of the subcontracts is the payment for risk. The question is not whether it is deserved. The question is where it is lying.

What retention is

Every contract with a client has two clauses that Valentyn signed for six years without looking at them particularly closely.

The first: the client holds back 10% of the budget until the acceptance certificate for the site is signed. The second: after the certificate, the client holds back another 5% for the twelve months of the warranty period.

For six years those two clauses looked to Valentyn like a formality. In the tender papers they sit alongside a dozen other conditions, nobody negotiates them, and every competitor signs the same thing. An industry norm stops looking like a financial decision precisely because it is a norm.

Retention is not written into the cost of the job

Those 5% are not a cost. They do not reduce the profit and they do not appear on any line of the report, because formally this is simply money that will arrive later. The bookkeeping sees work completed, a certificate issued and a receivable — all perfectly correct.

The profit is booked. The money is not there.

The five percent of retention money

Five percent of 47 600 000 ₴ is 2 380 000 ₴.

That sum sits with the clients for the whole of the warranty year. Part of it comes back in a few months, part at the end, part after an argument about whether a crack in a screed is a warranty case.

The warranty year does not start at the same time for every site. It runs from the date of the certificate, so at any given moment the clients are holding retentions from the sites handed over in the last twelve months. The sum barely ever drops — only its composition keeps changing.

Retention money is 55.5% of the annual net profit.

The holdback before the certificate

Now the second part. At the end of the year four sites out of fourteen are unsigned: one is waiting for a connection, two are on a snag list, and on one the client has been unable to get his commission together for a month.

Ten percent of their budgets is 1 360 000 ₴.

It should be said that none of those four clients is a problem client. All are solvent, all have paid before, none disputes the work. The delay is not a conflict but the ordinary course of things, and that is exactly why it alarms nobody.

Profit and available money are different lines

Those 10% come back faster than the retention money, usually within two or three months of signing. But the signing does not depend on Valentyn: it depends on when the client gathers his people and finds the time. Until then the money counts as profit and sits in somebody else's account.

How much is sitting with the clients

• retention money of 5%: comes back within 12 months of the certificate
• pre-acceptance holdback of 10%: comes back two or three months after signing
• neither of the two is a cost, and neither reduces the profit in the report
• both sit in somebody else's account while they count as earnings

Three million seven hundred and forty thousand out of four million two hundred and ninety. Eighty-seven percent of what was earned is physically not in the company.

Eighty-seven percent is not a disaster and not a sign of bad management. It is the arithmetic of two percentages: five and ten of turnover against nine of the same turnover. As long as the retentions together exceed the main contractor's margin, available profit will always be the smaller part of what has been earned.

What is left in hand

Available profit is 550 000 ₴. That is 12.8% of what the report shows.

The mirror figure is 87.2%: that is how much of the booked profit is not in the company. The available 12.8% is what Valentyn calls the most honest line in the whole report, because it alone answers the question of what the company can do this month.

“I saw it for the first time when I wanted to buy a site cabin for three hundred thousand. I opened the account — no money. I opened the report — four million. For two weeks I could not explain to myself how those two things fit together.”

The nastiest part is not the figure itself but the fact that it grows along with the business. More sites mean more retentions, and the available share stays exactly where it was.

Valentyn checked whether this was a quirk of his own company. He talked to two main contractors he knows of the same size — the same picture, to within a percent. The only difference is that one of them knows it, and the other still thinks he is simply short of working capital all the time.

The loan that covers the gap

There is a third layer, and it is the most expensive one.

The client pays 45 days after the certificate is signed. The subcontractor wants his money 10 days after handing over his section. The difference is financed by the main contractor, and he finances it with a credit line.

Thirty-five days of difference on every payment — and there are dozens of those payments in a year, because the sites do not run one after another but overlap. At any moment four or five sections are in progress that the subcontractors have already been paid for and the client has not yet paid for.

Valentyn's line is 2 800 000 ₴ at 20% a year. That is 560 000 ₴ of interest a year.

The cost of money is counted by the rate, not by feel

Put two numbers side by side. Available profit: 550 000 ₴. Interest on the loan: 560 000 ₴.

The interest for the year exceeds everything the company is able to spend.

That 560 000 ₴ of interest is 13.1% of the annual net profit, and 1.02 times more than all the available money. So the company is in fact handing the bank slightly more than it can spend on itself.

Why the subcontractor gets everything

The logical question: if the client holds money back from the main contractor, why does the main contractor not hold money back from the subcontractor?

The subcontractor will not agree to what you agree to

Because the subcontractor can say no. He has no tender obligations, no certifications covering the whole site, and no fear of losing his reputation with a client he has never met. What he has is a crew that needs something to do next week, and he will go to whoever pays without retentions.

For six years Valentyn signed one set of terms with clients and an entirely different set with the people doing the work. That is what the main contracting business consists of, it is just that nobody calls it financing.

What had been tried before

“I tried to talk clients into three percent instead of five. One agreed, and only because we had done six sites together. The rest said it is the industry standard, and they are right — it genuinely is the standard.”

• cutting the retention percentage: managed it with one client out of fourteen
• demanding faster payment: 45 days is a tender condition, not a negotiating point
• insuring the warranty obligations: the insurer asks more than the loan costs
• taking on fewer sites: the available share does not change, because it is a percentage

Valentyn went through all four options, and none of them produced anything, because all of them tried to change the client's terms. That left a fifth, which he did not want to go anywhere near for a long time.

The fifth option is unpleasant precisely because it is the only one that works. All the previous ones tried to change the behaviour of the client, that is, of the stronger party to the contract. This one changes the behaviour of the subcontractor, the weaker one, and Valentyn understood perfectly well how that looks.

Holding money back from subcontractors

Holding back 5% from the subcontractors would give 1 666 000 ₴.

That sum covers 70% of his own retention money. It looks like the obvious answer: the risk the main contractor carries towards the client is spread across the people who actually create that risk.

Valentyn asked ten of his subcontractors. The answer was the same from all of them.

Why it costs more

All ten said it could be done. On condition that the price goes up by three percent.

Here it is important not to confuse two numbers of completely different natures. One is a one-off shift of money in time, which in itself costs nothing. The other is a permanent increase in the cost of every site that follows, which will not go anywhere next year either.

A retention shifts money in time, a price rise is forever

Three percent of 33 320 000 ₴ is 999 600 ₴ every year. And a retention is not a cost: the money will go back to the subcontractor in a year anyway, so all the main contractor gets is the use of it during that year.

What does that use cost? At a rate of 20%, a year of using 1 666 000 ₴ costs 333 200 ₴.

So Valentyn would have had to pay 999 600 ₴ for something worth 333 200 ₴. Three times more.

The overpayment would come to 666 400 ₴ a year — the difference between the price rise and the real cost of the money. Over three years that is more than the company earns in a year in money it can actually spend.

The break-even price rise here is one percent. The subcontractors were asking for three.

“One of them put it to me straight: Valentyn, I am not your bank. You want my money for a year, pay for it. And he was right — he just asked three times the market price for it.”

What Valentyn changed

“I did not start holding money back. But I stopped thinking that I have four million of profit. I have five hundred and fifty thousand of profit and three seven hundred and forty of receivables that will arrive one day. That is an entirely different conversation with yourself.”

Available profit is a line of its own in the report

The main change was not in the contracts but in the report. Valentyn added a line that had never been there: how much of what has been earned is physically available, and when the rest comes back.

• the report now has two lines: net profit and available profit
• every retention has an expected date of return
• decisions about bonuses and buying machinery are taken on the available figure, not the net one
• the client's budget now carries the cost of money for the length of the retention

The fourth point is the real answer. If a retention cannot be cancelled and cannot be passed on to the subcontractor, then it has to be worked out and put into the price for the client — in exactly the same way as the risk of a schedule slipping is put there.

The cost of the work has not gone up. The only thing that has gone up is the price in the budget, and only by an amount Valentyn can name and justify to the client at any moment.

The money does not disappear — you simply do not see it

“For nineteen years I looked at the net profit line and thought it was money. It turns out it is a promise of money with various dates on it. And I do not buy bonuses and machinery with promises.”

Nothing in Valentyn's company has changed: not the clients' terms, not the subcontractors' rates, not the structure of the budget. Turnover is still 47 600 000 ₴, net profit still 4 290 000 ₴, the retention still five percent. The only thing that changed is that there is now a second number standing next to the profit — and it is that one that decides what the company can afford this month.

How to see this across your own sites

Everything above rests on one line the profit statement does not carry: how much of what was earned physically sits with clients, and until what date. While retention money and pre-acceptance holdbacks are not shown separately, the main contractor sees 4 290 000 ₴ of net profit and misses that only 550 000 ₴ can actually be spent — while the interest on the loan covering the gap has already exceeded that amount. When budgets, acceptance certificates, holdbacks and subcontractor payments are held in one place on their own, available profit becomes a figure of its own — which is exactly why owners of small and medium businesses use Finmap: to see the financial picture instead of assembling it at the end of the month.

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Topic foundation: Management Accounting Explained: What It Is and Why Owners Need It