For construction firms that are required to provide performance bonds, bonding capacity is much more than a financial metric. It’s the key to sustaining long-term growth. Surety underwriters evaluate the economic health of contractors before issuing bonds as a means of assessing the contractor’s ability to execute their scope of work timely and on budget. Here are key items we’ve seen bonding agents consider, along with our approach to understanding your goals, assessing the risks involved, and identifying strategies to optimize your bonding performance.
Key Factors in Bonding Evaluations
Sureties assess several financial metrics when determining bonding capacity, including:
Cash is King
Cash is King
Users of the financial statements want to see that you run your business in a way that maintains and grows the amount of cash held in the company over time.
If the owners are taking excessive amounts of cash out of the company annually, this is not a good indicator.
Working Capital
Working Capital
The difference between current assets and liabilities, which helps indicate a company’s ability to cash flow the existing work on hand.
Quality matters here — sureties are looking for assets that will convert to cash in 12 months or less.
Net Worth
Net Worth
The Longevity Indicator
Describes the owner’s financial position and ability to sustain consistently profitable years.
Profitability
Profitability
The Truth Teller
Profitability is determined by gross profit margin. This includes your ability to estimate and manage administrative responsibilities in a way that doesn’t restrict your growth.
Work-in-Progress (WIP) Reports
WIP Reports
These reports provide insight into project profitability and cash flow management.
WIP reports include history of profit fades (how often does the contractor over-estimate their profitability on projects?) and history of performance (what is the largest project completed to date and did the company perform as expected? i.e. see history of profit fades).
Overall Leverage
Overall Leverage
Excessive debt levels put an unnecessary strain on the business and can restrict the company’s growth potential.
Key things we tell clients to up their bonding capacity:
At HORNE, we believe every client should surround themselves with people that improve their likelihood of success. Surety underwriters, legal counsel, insurance agents, and banking partners who specialize in commercial construction is an essential piece of that. We also believe that your CPA should specialize in construction. Examples of how we help clients improve their business include:
1
WIP Review
We help in understanding how likely it is that financial expectations will be met and in discovering solutions to help you meet those expectations.
2
Cash and Working Capital Review
You can’t manage what you can’t measure. This may include budget-building, job costing, understanding equipment costs, and implementing automation and dash-boarding tools to help analyze data in real time.
3
Balance Tax Strategies with Bonding Needs
While tax planning often focuses on minimizing tax liabilities, certain strategies that reduce taxable income can negatively impact your bonding capacity. We help clients consider both perspectives.
4
Forecast for Growth
Financial projections and planning can support efforts to increase bonding limits, reduce surprises, and help contractors anticipate and navigate opportunities, enabling them to pursue larger projects with confidence.
Bonding capacity is a key factor in a construction firm’s ability to grow and compete for larger projects. By working closely with a CPA who understands the industry, contractors can strengthen their financial position, improve their ability to withstand economic or project challenges, and ensure they meet bonding requirements.
