Financial Planning Guide For Small Contractors To Maximize Bonding Capacity

A contractor’s aggregate bond limit is largely determined by their firm’s working capital, net worth and leverage positions as reflected in their fiscal year end financial statements. The year end statement is a tool primarily used to establish the following year’s bonding program with an interim statement, typically six months from the year end, used to support the same or possibly an increased capacity.

Proper planning is critical. As the end of the year nears, we recommend planning in advance  with your CPA to be sure that the numbers and ratios are strong enough to support the credit that you need.  Keep in mind that your fiscal year end statement will be the basis for your bonding credit for the entire year.  Also, results reflected on this financial statement will follow you for three to five years since banks and bonding companies typically look for three to five years of financial history prior to making a credit decision.  

The aggregate limit is the dollar value of the total work program that a surety feels comfortable supporting a contractor.  This generally includes both bonded and unbonded work.  It is not the accumulation of the contract prices, but rather the evaluation of the costs that need to be incurred from the current date to complete the contracts in progress.  Since the aggregate level is largely determined by a firm’s financial statement, it is critical that these financial statements be as strong as possible.  Generally speaking, surety companies are looking for a balance sheet working capital position (i.e. Current Assets minus Current Liabilities) equal to at least 10% of a contractor’s aggregate limit.

We recommend making that first impression of the financial statement to be a favorable, long lasting one.  Of course, there are a number of issues that need to be addressed in this process:

1) First, tax-planning.

2) Second, the firm’s true financial position.  It is easier to make your firm look good when your firm is truly enjoying a good financial position.  If the firm is on the brink of bankruptcy, very little window dressing will hide this. 

3) Third, full disclosure CPA prepared financial statements including footnotes and supporting schedules are essential.  The percentage of completion method of accounting is always preferred by the surety.   CPA reviews are required for most bond programs over a $500,000 aggregate.

The balance sheet is simply a snapshot of a firm’s financial position at a particular point in time.  Cash could be zero on December 31st and $1,000,000 on January 2nd.  The firm has not changed except that a $1,000,000 account receivable came in.  Still, aesthetically it looks better to have $1,000,000 in cash versus zero.  Of course, if your firm recognizes revenue on the cash basis for tax purposes, tax planning may dictate bringing the cash balance as low as possible.

As long as it is not contrary to tax planning:

  • Cash should be maximized. Cash is king, no doubt about it. Nothing is more important to a bonding company than liquidity. Yes, it is true that when you do this at the end of the year your accounts payable will be higher than if you used your cash to pay them. The working capital number does not change, but cosmetically, its looks better to have more cash.
  • Receivables, especially those over 90 days, should be collected.  Work very hard in the last month or so to collect as much money as possible.
  • Projects should be billed as much as possible.  It is preferable to be overbilled on each project rather than underbilling, especially if your cash balances are very strong. Underbillings often raise concerns about a project’s profitability.
  • Inter-company transactions should be eliminated as of the date of the Financial Statement.  Again, the goal is to keep the balance sheet of the construction company as clean as possible.
  • Loans to shareholders and employees should be cleaned up by the end of the year. The bonding company will not consider these amounts in their analysis.  This could have a serious impact on the credit granted.
  • Bank debt should be reduced as low as possible, preferably to zero.  This implies that you are not too dependant on the bank.
  • Defer ‘all cash’ equipment purchases or purchases that require significant down payments.  Equipment is a “long-term” asset which does not contribute to your working capital calculation.  What is actually reflected on the financial statement is a replacement of a current asset, cash, with a long-term asset, negatively affecting working capital.  Also, whenever possible, consider using long-term financing.
  • Try to keep stockholder distributions to a minimum.  If you are an “S” Corp., try to take distributions only in an amount sufficient enough to cover any tax obligations.  It is your money, but it is important to keep enough in the company to support the credit you need to operate and grow your business.

These ideas are designed to present your company in as favorable a light as possible.  If your goal is to increase your firm’s bonding capacity, then you will probably pay slightly more in income taxes.  Sometimes it comes down to:  Do you want to increase bonding capacity or not pay taxes?  Ultimately it is a business decision that only you can make.  If you are interested in maximizing your bonding program, please give us a call at 610.617.1052 or email us at to discuss further.

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