Performance Bond Basics – Working Capital

Working Capital is one of the primary underwriting considerations of the surety industry when considering an account for performance and payment bonds. Working capital is defined as the difference between current assets and current liabilities.

• Current assets are the most liquid of your assets, meaning they are cash or can be quickly converted to cash. 
• Current liabilities are any obligations due within one year.

Working capital measures what is leftover once you subtract your current liabilities from your current assets, and can be a positive or negative amount. The working capital is available to pay your company’s current debts, and represents the cushion or margin of protection you can give your short-term creditors.

If a company’s current assets do not exceed its current liabilities, then it may run into trouble paying back creditors in the short term. The worst-case scenario is bankruptcy. A declining working capital ratio over a longer time period could also be a red flag that warrants further analysis. For example, it could be that the company’s sales volumes are decreasing and, as a result, its accounts receivables number continues to get smaller and smaller.

A surety considering a company for performance and payment bonds will require a working capital position of 5 to 15% of the total bond program. This means if a contractor is looking for a $2mm in total bond capacity, the surety would want to see working capital of $100k to $300k.  The difference int he required working capital depends on several factors.  For instance, a contractor that has a high labor component will need more working capital than a General Contractor that subcontracts most of its work.