As an agent, as a contractor and as a surety, there are a lot of terms to understand. Here is a simplified listing of contract bond terminology.
This is an indication of how often the account collects their receivables which may have tremendous impact on how the account pays its bills.
The amount of protection the obligee has in the event the low bidder doesn't enter into the contract. It allows the obligee to then negotiate with the second bidder and be reimbursed by the surety company for the difference.
Bid bonds are usually 5%, 10% or 20% of the amount bid.
If your contractors regularly come to you at the last second for bids try to teach them to give you more time.
If the request is for a performance bond, always ask for bid results. We want to know, prior to executing the performance bond, if our contractor's bid was in line with the other bidders. If, for example, our contractor bid $100,000, and all the other bidders were $120,000 or above, then we have some questions to ask. Were there any errors? What's their profit on the job? Why are the others so much higher? What is the engineer's estimate? Keep in mind that not all contracts are competitively bid. Some are negotiated, so there wouldn't be any other bidders. Also, some private owners or general contractors may not release other bids after the fact.
Like the start date, the completion date is an indicator of how long the surety will be on the exposure. It also shows if the time frame for completion is too tight. Most contracts have a specified completion date, such as "120 calendar days," "90 work days," or a specific date in the future. If the time for completion is very short, we want to visit with our contractor to make sure they are geared up to get it done on time. If the time for completion is far into the future, the surety's exposure will be extended as well, and we need to know that going in.
If the request is for a bid bond, this is the estimate of the amount of the bid. Because the contractor may not have all the prices firmed up yet, this number may be an estimate at the time of the request. Estimates are okay, just make sure they are on the high end of the range. If the request is for a performance bond, let the surety know what is the final contract price ended up being.
Like the start date, the completion date is an indicator of how long the surety will be on the exposure. It also shows if the time frame for completion is too tight. Most contracts have a specified completion date, such as "120 calendar days", "90 work days", or a specific date in the future. If the time for completion is very short we want to visit with our contractor to make sure they are geared up to get it done on time. If the time for completion is far into the future, the surety's exposure will be extended as well, and we need to know that going in.
Keep in mind that the surety may have numerous accounts with very similar names. Be specific. Precisely, who will be the principal on the bond?
This is a ratio which shows how much the contractor owns vs. how much the contractor owes. A debt/equity ratio of 2:1 indicates that the contractor has two dollars of debt for every dollar of net worth.
Some contractors, especially those specializing in heavy construction, end up with a high volume of financed equipment and no quick way to pay it off. They end up with a yard full of machinery; much of it sitting idle. Even with all of this "iron" they are cash poor and may not survive.
Public jobs (states, counties, and cities) are usually funded. On all private work it's important to know if the owner has the money to pay the contractor for the project. This can be a dangerous situation for the contractor, and we need to know about it up front. If the job is private, ask how it is funded.
These are assets which, by themselves, have no value. They are normally not considered by the surety in its analysis. Some examples are goodwill, non-compete agreements, etc.
This describes the name and nature of the project. It's important to be specific with the description. Don't just offer the project number or name. A brief description of the type of work to be performed will help the surety understand the exposure. Be specific!
Typical contracts allow for a one-year guarantee of workmanship and materials. The cost for this coverage under the bond is included in the premium for the performance bond. Often obligees ask for longer maintenance periods; some are for two years, and others for more. There is an additional charge for terms longer than one year. The surety will need to analyze its exposure for longer maintenance terms.
Difference between total assets and total debt.
Who is the beneficiary of the bond? It's pretty straightforward when the obligee is a public body such as the state, county or a city. Be specific as to the department or bureau. The surety will have experience with numerous departments, and they don't all have the same idiosyncrasies. If the obligee is a private enterprise, try to give the surety information as to what type of business it is, who the owners are, etc. What is their entire street address?
These are billings made by the contractor over and above what the contractor should have billed based on job progress. Overbillings are a liability on the balance sheet because they represent work which needs to be done in the future.
Most contracts include penalties for late completion. They are represented by flat dollar amounts such as "$200 per day". Some high exposure public projects can go much higher. Penalties are prevalent in projects where time is of the essence such as school jobs that must be complete prior to school starting. Penalty levels are reviewed in conjunction with the time for completion mentioned above. Short completion times and high penalties can make for a dangerous project for both the contractor and the surety.
Whether a contractor is going to perform the entire job or sublet the work to others is a major part of the underwriting equation. We are typically interested in the major subs.
Most, but not all, contracts require a 100% performance and 100% payment bond. Some only ask for a performance bond. Some only require a 50% payment bond. Lastly, some contracts only require a flat performance bond amount regardless of the amount of the contract, or in unusual cases, a performance bond larger than the contract.
Many contracts allow for only partial payment to the contractor each month. Some retainage money is held back by the obligee to protect itself in the event of a dispute or other problems. Typical retainage is 5% or 10%. The higher the retainage, the more strain there will be on the contractor's working capital until the contract is closed out and final payment is made.
This is the date the contract is expected to start. It's important to know if the contract isn't expected to start immediately as a late starting project extends the surety's exposure farther into the future.
This is an IRS tax election whereby the corporation's profits are not taxed through the corporation but instead through the stockholder's personal tax returns. The ability to pay this tax is usually achieved by means of declaring a corporate dividend after the fiscal year end.
Occasionally, a surety may require creditors to subordinate their interest in a promissory note to the surety. Doing this prevents the note from being paid without the surety's okay, thereby safeguarding the liquidity in the contractor's balance sheet.
This information is often missing on many bond requests. The number represents the outstanding amount of work the contractor has at the time of this bond request. The number needed is the estimated cost to complete all outstanding work. For example, if the contractor has a $100,000 job in progress and it's 90% complete, then the estimated cost to complete on this job is approximately $10,000. Work on hand numbers are often estimates unless the contractor does monthly work on hand reports and can supply specific information. However it's presented, the work on hand information is a key ingredient in the underwriting process. It represents how much exposure the contractor has right now, how extended the contractor's working capital and net worth are at the moment, whether the contractor has enough crews or equipment to take on additional work, etc. We need to know how much of the uncompleted work is bonded by us and by others and how much is unbonded.
The difference between current assets and current liabilities. It represents the available funds the contractor has in the short term.