Owners of construction projects often require contractors bidding on the job to secure bid and performance bonds.
If you’re not familiar with contract bonds, you might be surprised by the degree to which your company’s financials will be scrutinized as part of the surety underwriting process.
This begs the question of how well you’re keeping your books and whether you use a CPA to do your accounting. If you’re hoping to grow your company and compete for bonded projects, you’ll need to get your financial house in order. The more confident a surety company is about your financial condition, the faster and easier it will be for you to secure the bonds you need.
What is a bond?
A bond is a promise on the part of a surety company to make the project owner whole if the contractor fails to meet its contracted obligations. Generally, this means taking over a project if the contractor defaults. However, bonds also come into play if a contractor fails to pay its subcontractors or suppliers.
Before extending a bond to a contractor, the surety’s underwriters want to be certain the contractor has the capacity and experience to perform the work. They also want to know that the contractor has the capital to purchase supplies and materials, finance equipment, pay workers and finish the project.
It may seem that the surety is asking you for a lot of documentation, but it’s to protect all parties involved. Those include your company. When a surety issues a bond, it’s saying it has a high degree of confidence in your ability to complete the job.
Sound financial record keeping is a must
What kinds of financial information will a surety ask you to provide? How does keeping good financial records help you get bonded?
Let’s first look at what you’ll be asked to submit with your application for a bond. For small bonds, often written through a “fast” or “quick” bond program, you may need to provide only a credit report and some basic financial information. However, for contract bonds that require an examination by a surety underwriter, you’ll need to provide detailed financial statements.
For starters, you’ll need to have:
- CPA-prepared year-end financial statements going back three years
- Your most recent internally prepared financial statements
- A work-in-process (WIP) schedule
- Personal financial statements of the owners of the company
- A copy of your bank line of credit
Providing financial information to your surety doesn’t end once the bond has been approved. You’ll be expected to continue to provide financial statements, WIPs and accounts receivable reports.
While you may be able to provide an internally generated financial statement if you don’t have a CPA, you will eventually need to retain a CPA to prepare your year-end reports.
Partner with a construction-oriented CPA
Take the time to find a CPA who specializes in construction. Construction-oriented CPAs are familiar with the methods of accounting used in the industry and know how to prepare statements, schedules and notes that meet the requirements of sureties and lenders.
A construction-oriented CPA can help you take your accounting to the next level if you’re a small contractor ready to take on bigger projects. Contractors usually start off using cash accounting but soon find they can’t grow without more sophisticated financial tools. You’ll need to prepare your financials on a percentage-of-completion basis to qualify for larger bonds; otherwise, you’ll forever be limited to small bonds tied to your personal credit.
A CPA can prepare the schedules you’ll need, such as showing completed and uncompleted projects, aged receivables and your cash balance. A CPA can also give you advice on handling lines of credit, showing cash on balance sheets, reducing your debt and keeping retained earnings in the company.
Use financial reports to improve your operation
A balance sheet is a key financial report that sureties look at carefully. A sound balance sheet helps you qualify for larger bonds and secure better pricing. A balance sheet lists your assets and liabilities and is used to calculate your working capital and net worth. The stronger your liquidity, the more favorable you’ll be viewed by sureties.
Sureties also look at your income statement, which indicates how your company is doing over time, usually for a one-year period. An income statement shows your company’s income, expenses and net income. The surety wants to make sure you have income after you’ve paid your expenses, i.e., that you’re a profitable company.
These financial reports, and others a CPA can generate for you on a monthly or quarterly basis, can help you make more informed business decisions. With detailed and timely reports, you can better analyze costs and allocate job expenses, minimize profit fade and maintain cash flow. You can track your billings and backlogs, improve your income and run your company more efficiently.
A CPA specializing in construction can help you plan for the future, too. They can help answer questions like:
- How much profit should you take?
- What’s a good growth rate?
- Is it better to lease or buy?
- When should you use credit?
- How can you minimize your tax liability?
Construction-oriented CPAs also keep up with regulatory changes that affect the building industry. They can advise you on new rules that may impact the way you recognize income, meet your payroll or prepare financial statements.
A surety agent is a great teammate
Where can you find a construction-oriented CPA and get help securing a bond?
Your best resource is a surety agent, also known as a surety bond producer. An experienced bond producer knows the surety market and can successfully guide you through the process. The bond producer will prepare your bond submission and work with you to get it approved. The producer can also recommend CPAs and attorneys to help you with your business. Ask your commercial insurance agent for a referral.
In a nutshell, sureties are looking for CPA-reviewed financials, strong retained earnings and good cashflow. Do you have enough working capital to sustain your company? Are you keeping your expenses in line? Does your balance sheet show positive equity?
The more complete a picture you can provide of your financials, the more willing sureties will be to work with you. When a surety sees you have your finances in order, it’s more likely to approve your bond and give you a good price.
Learn More
To learn more reach out to Brett Findlay, Senior Vice President Business Risk Specialist at BFindlay@OneGroup.com.
This content is for informational purposes only and not for the purpose of providing professional, financial, medical or legal advice. You should contact your licensed professional to obtain advice with respect to any particular issue or problem. Please refer to your policy contract for any specific information or questions on applicability of coverage.
Please note coverage can not be bound or a claim reported without written acknowledgment from a OneGroup Representative.
Written content in blog post: Copyright © 2023 Applied Systems, Inc. All rights reserved.
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