Ask most contractors how big their line of credit should be and you'll hear a guess or a rule of thumb, usually "10% of revenue." Both miss the point. A working capital line exists to cover one specific gap: the time between when you pay for a job and when the job pays you. Measure that gap and the right line size follows.
Why contractors run out of cash while making money
A profitable construction company can still miss payroll. The income statement says the job made 12%; the bank account says you're short on Friday. Four things cause the gap:
- Payroll is weekly. Your crews get paid every Friday no matter what the owner's accounts payable department is doing.
- Pay applications are monthly and slow. You bill at the end of the period, the architect and owner review it, and the check arrives 30, 45 or 60+ days later. If you're a subcontractor under a pay-when-paid clause, add the GC's lag on top. That's covered in factoring for construction.
- Retainage. Commonly 5–10% of every progress payment is withheld until the project, or a phase of it, is complete and accepted. On a long job it piles up quietly.
- Mobilization. Bonds, insurance, equipment, deposits and the first weeks of labor all come before the first pay app. More on that in financing mobilization costs.
The sizing method: measure the gap, not the revenue
Work out each piece separately, because each one behaves differently and may need a different tool.
1. Labor float
Weekly payroll (with burden: taxes, insurance, benefits) × the number of weeks from the average day you spend the money to the day the payment clears. If you bill monthly and get paid 45 days after billing, the average lag is about two months, or eight to nine weeks.
2. Materials beyond supplier terms
If your supply house gives you net 30 and the cash arrives at day 60, you're carrying about 30 days of materials. Better trade terms shrink this piece at no interest cost, so ask for them before you ask for a bigger line.
3. Net retainage
Retainage held from you minus retainage you hold from your own subs. Run it at its peak, usually near the end of your biggest job, not today's figure.
4. Subtract what you can cover yourself
Cash you can commit to operations without touching your emergency reserve. The line covers what's left.
A worked example
Illustrative numbers, not a quote. A commercial subcontractor running about $400,000 a month in billings:
| Piece of the gap | Inputs | Cash tied up |
|---|---|---|
| Labor float | $40,000/week burdened payroll × 8.5 weeks | $340,000 |
| Materials past terms | $120,000/month materials, paid day 30, collected ~day 60 | $120,000 |
| Net retainage at peak | 10% held on a $1.8M job, less 10% held on $600K of subs | $120,000 |
| Total gap | $580,000 | |
| Less cash the owner commits | Operating cash above a 60-day reserve | −$180,000 |
| Line to target | Before cushion | $400,000 |
The "10% of revenue" rule would say roughly $480,000 on $4.8M a year. That's close in this case and wildly off in others. A contractor with a fast-paying private owner and net-60 supplier terms might need half; one carrying a public job with heavy retainage might need double. Your customers' payment habits drive the number, not your top line.
The retainage problem most owners discover too late
Here's the trap in the example above. Many receivables-based lines set a borrowing base: you can draw a percentage of eligible receivables, often in the 70–85% range, and "eligible" commonly excludes invoices over 90 days old and retainage. So the $120,000 of retainage may not support a single dollar of borrowing on that line, even though it's real money you're owed.
Ask any lender, before you size anything: "How do you treat retainage and receivables over 90 days in the borrowing base?" Plan to fund retainage from equity, profits held in the business, or longer-term money, not the revolver.
Match each piece of the gap to the right tool
| Need | Usually the better fit | Watch out for |
|---|---|---|
| Recurring payroll float | Revolving line of credit | Annual clean-up requirements and covenants |
| Slow-paying GC or owner | Invoice factoring | Pay-when-paid language and notification requirements |
| Start-up costs on a new job | Mobilization financing | Repayment timing vs. the first pay app |
| Machines bought with operating cash | Equipment financing to free the cash back up | Don't put long-lived equipment on a short revolver |
| Retainage | Equity or term money | Often excluded from borrowing bases |
Merchant cash advances deserve a specific warning here. Most are repaid by daily or weekly debits, while construction pays monthly or slower. The repayment drains the same cash the advance was supposed to replace, and contractors who stack two or three of them are a familiar story. If you're already in one, a plan to refinance out of it is worth more than another advance.
What a lender will want to see
A contractor line is underwritten on how well you know your own jobs. Expect requests for:
- Business bank statements, tax returns and interim financials
- An accounts receivable aging, with retainage split out
- For larger lines, a WIP schedule: contract value, cost to date, estimated cost to complete, billings, and over- or under-billing by job
- Your backlog, and your bonding capacity if you're bonded
Chronic under-billing reads as weak job costing; heavy over-billing can mean you're funding today's jobs with tomorrow's work. More on how these files are read in business loans for general contractors and what lenders actually check. No one can promise an approval or a rate before seeing your file, and you should be wary of anyone who does.
Mistakes that shrink a line or sink it
- Waiting until you need it. A line is easiest to get while the numbers are good. Apply before the big contract, not the week payroll is short.
- Running it at the limit all year. A balance that never comes down tells a lender the line is funding losses or equipment, not timing. Some bank lines require a period each year at a zero or reduced balance.
- Buying equipment with it. Ten-year iron on a one-year revolver leaves no room for the float the line was built for.
- Sizing it to today's backlog. Size it to the backlog you're bidding toward, so a win doesn't create a cash crunch.
The short version
- Pull your last six months of pay-app dates and payment dates; calculate your real collection lag.
- Multiply weekly burdened payroll by that lag in weeks.
- Add materials carried past supplier terms and net retainage at peak.
- Subtract the cash you'll commit, add a slow-payer cushion.
- Ask every lender how retainage is treated before you compare offers.
A well-sized line is boring. It draws when payroll goes out and pays down when the pay app clears, and nobody thinks about it. That's the goal.
Common questions
How much working capital does a contractor need?
Enough to cover the gap between paying for a job and getting paid: weekly payroll × weeks of lag, plus materials past supplier terms, plus net retainage, minus cash you'll commit. A percentage-of-revenue rule ignores how slowly your customers actually pay.
Can I borrow against retainage?
Often not on a standard line. Many receivables-based lines exclude retainage from the borrowing base until it's due. Some specialty lenders will advance against it at a lower rate. Ask how a lender treats it before you size the facility.
What do lenders want for a contractor line?
Bank statements, tax returns, interim financials, an AR aging, and for larger lines a WIP schedule showing cost to date, billings and over/under-billing by job. Clean job costing matters as much as the totals.
Is a merchant cash advance OK for payroll between draws?
Usually an expensive mismatch. Daily or weekly debits against monthly pay apps drain the same cash the advance was meant to replace. A revolving line, factoring or mobilization financing usually fits construction cash flow far better.