How to Determine if Your Company is Strong Enough for Bonding
If you are building a construction business, you will most likely want to bid on projects that require bonding. Public works projects especially require bonding to demonstrate your business is trustworthy and financially stable enough to take the project on, enough that a bonding company is willing to guarantee your performance. That presents a paradox for young businesses that lack the net worth and working capital to meet surety underwriting criteria. If they can’t meet the criteria, they can’t land profitable projects that require surety bonds. If they can’t land profitable projects, they can’t build the necessary net worth and working capital to qualify for surety bonds.
Contractors can break that vicious cycle by focusing on the key elements of their business that concern surety bond companies the most – working capital, equity, cash flow and work-in-process (WIP). Concentrate on improving those and you can effectively increase the bonding capacity of your company.
Working Capital and Equity
To sureties, your working capital is indicative of your company’s liquidity and its ability to fund its operations and service its debt obligations. The more working capital you can show on your balance sheet, the more bonding and licensing capacity you have. Equity is equally important as the surety typically factors in the lesser of the two when determining your bonding capacity. Licensing boards use these same criteria as well.
One way to quickly overcome the working capital and equity criteria is through an infusion of capital from management or an investor. A joint venture with a larger company could also help to increase your bonding capacity. In addition, restructuring debt could reduce the amount owed in the short-term and therefore increase working capital.
Sureties know that one of the biggest cause of contractor job defaults is weak cash flow, specifically weak cash flow from operations. Maximizing cash flow is critical to increasing your bonding capacity. Central to that is your ability to effectively forecast cash flow and take steps to improving your company’s cash position through improved financial management and operational efficiency.
For a favorable review by a surety or a banker, your company must show a demonstrative track record of steady work that is accurately estimated and tracked. If your jobs consistently fade without reasonable explanations, the surety will assume that you do not know how to properly estimate job profit and therefore not give you fill credit for the working capital shown on your balance sheet. It is critically important to have the right systems and processes in place to accurately compute WIP, not just for the surety, but for your own information so that you can make decisions based on accurate reporting.
Have a CPA in Your Corner
Whether or not a surety requires that the financial statements be compiled by a CPA, having one that understands your industry and the specifics of project accounting can make a significant difference in how a surety views your business. Since most sureties require the financial statements to be audited, reviewed, or at least compiled by a CPA,choosing a CPA that understands the construction industry and its unique financial requirements is critical. The right CPA can help you create an overall financial picture for the surety.