How to Take Your Business to the Next Level and Increase Your Bonding CapacityPosted by Wayne Messick, AFSB
Are you ready to grow your business? Maybe you’d like to bid on larger projects. Or the owner of your current job likes your work and wants to hire you for something bigger. How do you get to the next level?
It’s not as difficult as you may think to step up your game. All it takes is following some basic principles of construction accounting and management. It starts with getting your financial house in order, then hiring the right people to get the job done.
Hire a CPA to prepare your financial statements
So let’s look at some areas where surety companies like to see improvement before they’re willing to increase a contractor’s bonding capacity.
Often, taking your business to the next level requires hiring a construction-oriented CPA to help you organize your accounts and prepare a year-end financial statement. That means moving from cash or accrual accounting to preparing your financials on a percentage-of-completion basis.
A CPA can prepare your financials the way surety companies prefer to see them. This includes notes and schedules of completed and uncompleted projects. If you have a CPA compilation prepared, it’s also helpful to provide verification of your cash balance at the same time the statement is prepared.
You’ll also need to provide a complete personal financial statement. Many times we see incomplete information on a personal statement that makes us wonder about the reliability of the financials. For example, the net worth doesn’t equal assets minus liabilities, or the scheduled amounts do not match the balance sheet section. Your personal statement and company financial statement should have the same date so all related receivables and payables tie into each other.
Get ready for “picture day”
Most CPA-reviewed financials are prepared annually as of December 31. I refer to this as “picture day.” Everyone wants to look their best on picture day. Remember, your surety will use your fiscal year-end financial statement as the main source of underwriting for the entire year.
A few housekeeping items to consider before your fiscal year-end statement is prepared:
- Clear up all related-party receivables and payables.
- Pay down your bank line of credit as close to zero as possible.
- Do not include personal assets like cattle, condos or cars.
- Keep marketable securities to a minimum since the surety will discount them.
- Cash is king, so keep it as high as possible.
- Keep liabilities as low as possible, especially interest-bearing debt.
Prepare an aging of receivables
Smaller companies normally do a good job of collecting their receivables because they’re close to their accounts. Where we see room for improvement is in breaking down the age of receivables. You should always prepare an aging-of-receivables report that is the same date as your balance sheet. Aging will break out the receivables as 0–30 days, 31–60 days, 61–90 days and over 90 days. In addition, it’s important to break out your retainage in a separate column so the surety knows to count it as a current asset.
Get a bank line of credit
If you don’t already have a line of credit with your bank, you should establish one. Get as much as you can on an unsecured basis and then try to increase it over time (which will probably require using receivables or inventory as collateral). Surety underwriters like to see a line of credit that is equal to 10% of your backlog. So, if you have a backlog of $1.5 million, you should have a line of credit of at least $150,000.
A line of credit provides working capital when receivables are delayed and allows you to take advantage of discounts from material suppliers. However, you should strive to generate positive cash flow and not use a line of credit for an extended period of time. Always try to pay down your line of credit to zero at least once during the year.
Keep your retained earnings in the company
Sureties always like to see a company growing its balance sheet. They look for steady income being retained over several years. Pay yourself a salary during the year rather than taking out a large sum at the end of the year. When making distributions, be sure they do not exceed the net income for the year. If you’re making estimated quarterly tax payments, be sure to tell your surety. As a general rule, sureties will factor in a 35%+/- reduction in your income to pay for taxes, assuming your company is an LLC or S Corp. So letting your surety know you are paying income taxes during the year will be to your advantage.
Build your bench strength
Hire good people who can help you grow. Then learn to delegate so you can focus on building the company. You may not be able to pay a competitive salary at first, but perhaps you can offer other incentives such as favorable working conditions, good benefits, performance bonuses or equity in the company. When considering a larger project, be sure to have a resume for the person running the project. Sureties will look at your project manager’s prior experience, especially the size and scope of previous jobs they’ve managed.
Consider job history and experience when bidding on larger jobs
Keep these questions in mind when you’re trying to increase your bonding capacity:
- Have you worked with the owner or architect before?
- Are you an invited bidder where competition is limited?
- Do you have the personnel to handle all aspects of the job?
- Is the job local, and do you have any advantages over the competition?
- Do you have favorable terms such as no liquidated damages and no retainage?
- Is the job profitable enough, or will it put your balance sheet at risk?
- Do you have special vendor terms or a discount on materials?
- Do you have the equipment you need vs. having to purchase or lease it?
- Is the project the type of work you’ve done before?
- Do you have a COVID-19 plan that includes protective equipment, social distancing, etc.?
Being able to answer “yes” to the above questions will help you secure more favorable underwriting. Sureties will underwrite at higher levels if you can demonstrate that the project will be profitable, that there are other positive considerations such as working close to home and with a known owner, and that it makes sense.
It also makes a difference if you have solid, CPA-reviewed financials, strong retained earnings, good cash flow and experienced employees. Keep these factors in mind as you work towards taking your business to the next level.
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.
Wayne Messick is the Bond Manager for Old Republic Surety's Birmingham Branch. He has over 40 years of surety industry experience. He worked at Continental Insurance Companies, Lawyers Surety and CNA Surety before joining Old Republic Surety in June, 2011.