In today’s economy, risk-averse project owners are more likely to require surety bonds. At the same time, cautious sureties have become more rigorous in their evaluation and approval of bond requests. So, it’s critical for construction contractors to show that they’re “bond worthy” and to implement strong business planning processes to do so. Here are five tips from Sandersen Knox & Company LLP for doing just that.
1. Make a strong statement
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.
2. Manage profits and net worth
A critical indicator for a surety is your company’s profitability. So manage the factors that affect profitability, such as overhead costs and bonuses.
Your net worth provides evidence of your ability to absorb losses. But 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. This is another example of how good business planning can keep a contractor competitive and in business in the current economic climate, or in any economic climate for that matter.
3. Work your 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.
4. Track your progress
“Profit fade” (where a contractor’s 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. Even profit gain can cast doubt on your estimating abilities.
Sureties also look at underbillings (billings that lag behind a job’s progress), which may point to cost overruns, inefficient management or lax billing practices. Overbilling can reflect effective cash management, but 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 reports to help you stay on top of your estimating and project management processes and correct problems as early as possible.
5. Prevent surprises
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.
Along with boosting your bonding capacity, these strategies can produce other significant business benefits — including making your construction company more attractive to lenders and investors. Working closely with your CPA will help you discover other ways that your business planning processes and your construction accounting system will help build your surety’s confidence in your business.
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