CONSTRUCTION Accounting ARTICLE -
Build Your Bonding Capacity with a Solid Foundation
Target Audience: Construction Industry Professionals, General Contractors, Construction Accountants
A high bonding capacity is something for which just about every contractor strives. Knowing you can get the necessary underwriting from your surety gives you the freedom to bid on jobs well suited to your strengths — not to mention bigger projects with greater potential for profitability.
But how do you build that kind of lofty capacity? With a solid foundation. And what makes up that foundation? Not cement mixed with rocks, that’s for sure. Here are a few critical elements to mix in.
Your company may be financially healthy. But, if you can’t demonstrate this to your surety, obtaining bonds will be a challenge.
Make sure your financial statements are complete, accurate and timely. And provide other documentation as needed, such as owners’ personal financial statements. Also, minimize year end adjustments by preparing high-quality interim financial statements.
A critical indicator for a surety is your company’s profitability. So manage the factors that affect profitability, such as overhead costs and bonuses.
“Profit fade” (where gross profits shrink over the course of a project) will undermine a surety’s confidence in your financial strength. It can signal a number of weaknesses, including inaccurate estimating and sloppy project management. But, in the eyes of sureties, profit gain isn’t necessarily a positive either: It can cast doubt on your estimating abilities.
Your net worth provides evidence of your ability, or lack thereof, to absorb losses. Sureties also look “behind” this number at the quality of the underlying assets. They may discount the value of riskier assets, such as aged receivables and inventory. Cleaning up your balance sheet by removing risky assets and reinvesting profits in the business can help boost your bonding capacity.
Strong working capital
Sureties want to see strong working capital, which is defined as current assets minus current liabilities. Current assets include cash and assets readily converted into cash, such as short-term receivables and certain inventory. In contrast, illiquid assets may include your facilities and equipment.
In measuring working capital, sureties typically discount riskier assets, such as aged or related-party receivables or prepaid expenses. So, to improve your working capital, consider accelerating collection of receivables, deferring payment of year end bonuses or other expenses, or refinancing short-term debt with long-term debt.
Sureties look at underbillings (billings that lag behind a job’s progress), which may point to cost overruns, inefficient management or lax billing practices. They also scrutinize overbillings. Although overbilling can reflect effective cash management, it can also be a sign of “job borrowing” — that is, overbilling on some projects to compensate for fading profits on others.
To instill confidence in your surety, prepare timely, accurate work-in-progress (WIP) reports to help you stay on top of your estimating and project management processes and correct problems as early as possible. Ideally, your reports should be sorted by categories such as:
- Job type,
- Project location,
- Owner background,
- Contract size, and
- Project manager or estimator involved.
That way, you and your surety can gain valuable insights into the factors that are affecting your construction company’s profitability.
For sureties, there’s one thing that’s worse than bad financial news, and that’s bad financial news that they weren’t expecting. For instance, what if an owner or key employee dies, becomes disabled or suddenly retires? Make sure you have a well-designed succession plan to provide assurance that your long-term prospects are strong.
In addition, to increase your surety’s comfort level, maintain ongoing communication regarding any developments that are affecting your financial performance. Doing so not only helps demonstrate your good intentions, but also gives you an opportunity to explain any financial difficulties and outline your plans for turning things around.
Ways to improve bonding capacity
Bonding capacity can be a shaky thing — especially in an uncertain economy and within unstable construction markets. Be sure to stay on top of yours and always be looking for ways to improve both it and the relationship you share with your surety.
Find out how our expertise in construction accounting can add value to your business. Email us or call us at 1 (888) 875-9770.
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