Construction Companies: Maintain Working Capital Basics

Group of civil engineers looking at blueprints at a construction site and wearing helmets

Working capital is the backbone of every construction business, and the ability to understand and maintain working capital is a vital component of long-term success. Why? Surety companies utilize a working capital calculation to determine bonding capacity.

Working capital may seem like a simple mathematical calculation: CURRENT ASSETS minus CURRENT LIABILITIES = WORKING CAPITAL. Or, 5-3=2. However, surety companies usually make a few adjustments to their calculation for “discounted working capital” when determining your construction company’s bonding capacity, i.e. 5-3=1.

Discounted Working Capital for Construction Companies

Surety companies usually eliminate the following items from a company’s current assets when determining discounted working capital:

  • Prepaid expenses,
  • Employee loans,
  • Stockholder receivables,
  • Related party receivables,
  • Current deferred tax assets,
  • Accounts receivable over 90 days old (or, in some cases, over 120 days old—depending upon the industry).

Additionally, they may discount the value of investments in stocks or mutual funds–if the stock market is volatile—and inventory assets by up to 50%, depending upon the type of contractor.

The cash surrender value of life insurance is typically added to current assets and current liabilities are usually unaltered.

4 Ways to Enhance and Maintain Working Capital

  1. Financing equipment

New vehicle and equipment purchases should be financed with long-term installment notes. Finance companies typically offer great interest rates on these notes.  But, even when buying used vehicles and equipment, it often makes more sense to keep your cash in the company and finance at a slightly higher interest rate.

  1. Utilizing Your Line of Credit

Are you utilizing your line of credit with year-end approaching?  It may be time to refinance your line of credit into a long-term installment note and secure the note with unencumbered equipment.  Otherwise, a limited credit line diminishes working capital.

  1. Consider a Loan to Increase Working Capital

What if your construction company still needs more working capital after following the advice in #1 and #2?  You may need to simply borrow as much as the bank will let you on your unencumbered equipment with a long-term installment note. The owners may also loan the company money personally and sign subordination agreements with the surety company agreeing not to repay the loan for a year. In either of these scenarios, be sure that your debt to equity ratio is acceptable.

  1. Be Careful Securing Debts

Never secure long-term debts with current assets such as CDs or savings accounts.  These will always be deducted from working capital.

CRI’s construction CPAs are here to advise you on the best choices for maximizing your bonding capacity while minimizing your taxes and trying to maintain working capital. We love complicated calculations, especially when we help your construction company find more concrete solutions that improve your profitability.

2018-11-12T15:52:58+00:00September 1st, 2014|CONSTRUCTION|