A high bonding capacity is a strategic objective of many construction businesses. 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. And this goal has become even more important since the passage of the Infrastructure Investment and Jobs Act.
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.
A strong foundation for bonding capacity starts with numbers. Your construction company might 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. Be prepared to provide other documentation as needed, such as owners’ personal financial statements. Also, minimize year-end adjustments by generating high-quality interim financial statements.
One critical indicator that sureties look for in financial statements is profitability. Make sure you’re actively managing the factors that affect your bottom line, such as indirect costs and bonuses.
“Profit fade” — when gross profits shrink over the course of a job — will undermine a surety’s confidence in your financial strength. It can signal several weaknesses, including inaccurate estimating and sloppy project management. Massive profit gain, however, isn’t necessarily a positive either: It can cast doubt on your estimating process.
In addition, 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 could 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 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 other items readily converted into cash, such as short-term receivables and certain inventory. In contrast, illiquid assets might 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.
A shaky thing
We’ve discussed here just a few of the many details that sureties commonly investigate. Bonding capacity can be a shaky thing — especially with inflation on the rise and many construction markets facing varying degrees of instability. Contact us for help gathering the right data and documentation and, of course, for assistance in generating accurate financial statements.
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