Performance Bonds – How to Increase Bond Capacity

Despite the sequester, there is little doubt the U.S. economy is starting to pick up.  With this pick up, there is more construction, and with more construction, there inevitably will be a need for a lot of contractors to increase their ability to bond more work.  There are a lot of private owners that did not require contractors to post bonds prior to the recession, only to be stuck with liens and uncompleted work as contractors went out of business in record numbers during the recession.  After being burned, a lot of private owners have seen the benefit of required bonds on work.

Many contractors have been able to get by using the various short form programs offered by a plethora of surety companies. These programs, while a valuable tool, do not accommodate growth.  As a contractor that has out grown the short form program, the next step can be overwhelming.  The financial reporting requirements associated with obtain larger surety bonds grow exponentially as the job size increases.  How can a contractor get to that ever elusive next level?

Step 1

Get your financial house in order.  These means hiring a bookkeeper with knowledge of the construction industry that is capable of providing the surety with accurate financial statements  preferably prepared on a percentage of completion basis.  While a quick books or peach tree accounting system can accommodate smaller contractors finical reporting needs, they still require some industry knowledge to be relevant. Chances are the contractor is good at; well construction and maybe not as good at this aspect of running a business.

Step 2

Job costing will be an important part of increasing a bond line. The short form programs rely almost exclusively ion credit. Once a contractor grows out of the short form programs, there will be a lot more scrutiny on the individual job management capabilities of a contractor.  A successful  contractor can provide an open job schedule that reflects:

1. Contract price
2. Billings to date
3. Costs to date
4. Estimated cost to complete.

The surety will look at these job reports and will want to see a track record of job cost stability.  Be conservative because a history of declining job profits as a job progresses is a big red flag for the sureties (surety speak for this is profit fade).

Step 3

Be sure progress billings are up to date and encompass the work you have performed.  The surety underwriters look at under billing (costs & earned profit in excess of billings as potential job losses.  Conversely, if the contractor is aggressively billing, billing in excess of costs and estimated earnings, the financials statements have to reflect enough cash to eventually complete the work the contractor has already been paid on.

Step 4

Stay on top of receivables.  The surety underwriters are not going to give a contractor any credit for receivables past due 90 days.  Those receivables will be eliminated for the net worth and working capital calculations used by the sureties.

With accurate  in-house financial statements, a contractor can qualify for bonds larger bonds, if the analyzed net worth and working capital support jobs of that size.  If the quality of the internal statements is questionable (not in percentage of completion and not supported by job schedules) a contractor will still find it difficult to grow the performance and payment bond line and will inevitably pay more for the bond.

Next step is hiring a good construction oriented CPA.  This is required if a contractor is going to grow into a company doing million dollar jobs.  See our blog post about the three levels of CPA prepared.

We will blog more on this subject soon.