Most contractors know that one goal of theirs is to maximize bonding capacity, but they sometimes don’t know where to start.
What is Surety Bonding?
Many people (and even some contractors) get confused when they first become involved in surety bonding and
incorrectly think that surety bonding is insurance. However, insurance has different underwriting guidelines than surety bonding. The biggest difference between insurance and surety bonding is that there is no expectation of loss when you apply for a surety bond. What this means for a construction company owner is that your financial statement and credit worthiness carry more weight in the surety bond underwriting process than they would with regular insurance.
Surety Claim Activity
Underwriters and executives for surety bond companies are concerned that surety claims are going to increase in the future. This potential growth in claims is due to the down turned economy of the past 24 months. If these claims do start to increase, it will have a direct impact on the entire construction industry as more claims will mean a tightening of surety credit that will make an already difficult economic time even harder.
3 C’s Used to Maximize Bonding Capacity
There are 3 C’s used in underwriting surety bonds. They are:
- Capital is the net worth and working capital of the company. A good construction CPA can get involved to help improve capital under certain circumstance by reviewing your financial statements prior to year-end for opportunities, but the company’s management needs to always be mindful of net worth and working capital.
- Capacity and character are just as important as capital when working to maximize bonding capacity. Surety underwriters will judge a contractor’s character in many ways, but primarily they want to see a good and honest business that has the right foundation, provides quality workmanship, and consistently states job positions accurately in their financial statements (both during the year and at year-end).
- Capacity is another major factor in the surety underwriting process, and they want to know that you have the capacity, expertise, personnel and equipment to complete the stated project. Typically, the capacity portion of review is where the surety company can get itself into trouble; therefore, the underwriters want to be confident that a construction company can manage and complete the project.
Maximize Bonding Capacity and Tip the Scales in Your Construction Company’s Favor
It’s best to not wait until year-end to get your CPA involved. Instead, get your advisor involved earlier in the process to help maximize potential bonding capacity by also maximizing working capital, net worth, and profitability. This preparation will help to enhance the bonding capacity of the contractor throughout the year. Even though financials are a history of what happened in a year, this planning allows contractors to prepare the financial statements to tip the scales in your favor at year-end. This process is done is several ways, but a few are preserving cash, financing equipment on long-term basis, and reviewing job positions all of which can improve a contractor’s working capital position. Of all the things for which a surety company looks, the working capital piece is probably the most important.
Are you currently working to maximize bonding capacity? Call CRI’s construction CPAs for help.