Whether general contractor or sub, many construction company owners spend a considerable amount of time every year thinking about bonding. And you should — without adequate surety underwriting, you're severely limited in the number and size of jobs on which you can bid.
Entering the 21st Century
The surety industry has learned some tough lessons over the past fifteen years — and, in particular, earlier this decade, when it incurred substantial losses because of many contractor defaults and some huge claims. Indeed, sureties paid out over $11 billion between 1994 and 2008, with half that amount being paid between 2002 and 2005, according to the Surety & Fidelity Association of America (SFAA).
That should explain the tightening of underwriting standards and tougher project analysis you likely noticed if you were in business in 2005. Since then sureties have done much better: The $718 million in claims paid out in 2007, according to the SFAA, was a big improvement from the $1 billion paid out in 2005.
Of course, in light of the recent recession, the economic landscape has changed yet again. Sureties are expecting the construction industry to slow down as contractors burn through their backlogs while residential and commercial developers soft-pedal new projects in light of the tight credit market. And with growth in many sectors looking dubious, the bonding horizon may seem dim.
But don't be so sure. Sureties are much better equipped to deal with economic uncertainties now than they were earlier in the decade, so bonding should be available. Plus, the stimulus package passed in February is driving infrastructure construction, which may put underwriters at ease while other sectors catch up.
Tried and true measures
One thing's for certain — sureties will be cautious and continue to demand complete, accurate, and timely financials before underwriting projects. Thus, maintain an active dialogue with your surety (they hate surprises!), choose your jobs carefully — with an eye toward profitability — and be organized and prepared when presenting your financial statements.
Also, continually work to improve your cash management and balance sheet. It can be a delicate balance, but consider deferring payment on accounts payable or speeding up billings for accounts receivable to improve year end cash balances. And watch key ratios such as working capital, debt to net worth, net worth to backlog percentage and earned revenue to net worth.
Specifically, look at the portions of your financial statements that outline your debt structure. Say you have used a $500,000 line of credit to buy $160,000 worth of heavy equipment, intending to repay the borrowings within three to four years instead of structuring a long-term debt agreement and creating another debt facility.
To improve your current ratio and increase working capital, you might consider refinancing the equipment with a four-year term loan. Doing so would leave only 12 months of principal payments classifiable as short-term debt. Your surety could then consider the remaining obligation long-term, greatly improving your bonding capacity.
Now look at the other side of the coin — notes receivable. Say you have a $100,000 receivable from another entity in which you have a 50% interest. If this note goes unpaid for a 12-month period, your surety will likely begin to exclude it from working capital.
To improve your bonding situation, you could arrange a plan with the related entity to show repayment intent and convert the receivable to cash.
Inventory composition
Another critical area addressed by your financial statements is inventory. Perhaps you're in the habit of buying large volumes of inventory for upcoming jobs just before year end to take advantage of the discounts that suppliers typically offer at that time. If you have never disclosed this inventory's composition to your surety, your agent may believe the items are unusable and greatly discount their value.
A potential solution: Break out your inventory's main components in your financial statement footnotes and disclose their planned use. Doing so often results in contractors earning full credit for the inventory from their sureties, preventing a bonding capacity reduction.
Hidden treasures
Sometimes it may seem like your bonding capacity is written in stone. Yet even now, that's not necessarily so. Among all of those columns of numbers on your financial statements may lie a variety of hidden treasures capable of giving you the boost you need. Ask your CPA to help you start digging.
