We are often asked by agents and contractors about how they would go about increasing their bond capacity. The amount of things a contractor can do to accomplish this is, of course, relative to the amount of increased capacity the contractor desires.
Cash is king
Although the comments and suggestions I outline are not necessarily in the order of importance, I will say that one of the top things a contractor can do is remember that cash is king. It always has been. Surety underwriters are looking for liquidity and unleveraged capital in their evaluation of surety credit. Achieving this means that the owner/contractor must be on top of accounts receivable collection practices. Not only will poor or tardy collections inhibit the cash balances, a surety underwriter’s analysis of the financial statement will disallow any receivables (with the possible exception of retainage) that are three months or more old. The result will deteriorate working capital and often cause the contractor to utilize the bank line which is not only debt, but is interest bearing as well.
The 10% rule
The contractor and/or agent should be generally familiar with the industry standard 10% rule. This means that the underwriter is looking for working capital in the company which roughly equals 10% of the contractor’s work backlog. And to that end, it would also be helpful if the contractor and agent generally understands what the surety considers an allowable asset.
The right CPA
The receipt and analysis of the financial statement is key to our underwriting. In this regard, if the contractor provides only internal financials or compiled renderings they should consider upgrading to a review quality fiscal year end report from a construction oriented CPA.
We are often asked to consider bond credit based upon interim in-house financial statements. If the contractor’s internal financials recognize revenue on a different basis than the CPA statement (i.e. accrual versus percentage of completion) then it is very difficult to reconcile the financial trend because we are basically comparing apples to oranges. So it is important for the contractor, with the aid of their CPA, to convert the in-house accounting to percentage of completion and provide industry standard work in progress schedules that tie into the contractor’s balance sheet and P&L. The journal entries and in-house financials should be adjusted and updated at least monthly and provided to the surety on a quarterly basis.
Timing
The entries and numbers on the financials and work in progress schedules that the surety relies upon to evaluate bond credit originate in the field. Therefore it is very important for the surety to understand the contractor’s job costing process, how and when the results in the field are communicated to the office and bookkeeper (and ultimately the financial report) in order for the surety to gain comfort about relying upon the in-house financials.
Transparency, tax planning and succession planning
Other factors that might contribute to increased bond capacity would be for the contractor to demonstrate transparency in all regards but especially tax planning (artificially reducing profit in order to lower the tax bill), establishing or increasing the company’s bank line of credit, update the surety with resume’s and information on key employees and have a written succession and job continuity plan in place.
Finally, it is important for the contractor to understand that surety is not insurance, but rather we are co-signers to the contractor’s bonded contractual obligations thus forming a close partnership between contractor, agent and surety. For more advice on ways to increase your bonding capacity, or anything regarding surety and growing your business, contact an appointed agent, or reach out to an Old Republic Surety branch nearest you.
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