#60: Capacity: 10 Magic Wands

Just like waving a Magic Wand over the company financial statement, here are ten strategic recommendations that can change everything from a bonding standpoint. They are a little more complicated than “Abracadabra!!!” but any one can be a game changer for contractors who need to qualify for bonds or increase their bonding capacity.

1. Pay back stockholder loan – Such “loans receivable by the company” are deducted from the Net Worth analysis. To avoid this detrimental effect, pay the loan back to the company.
2. Restructure debt – Convert short term debt to long term.
3. Add capital – Stockholders can add to the capital stock account at any time.
4. Add a corporate or individual indemnitor – Their financial position could be helpful if documented by presenting credible financial info.
5. Joint venture or teaming partner – Present their credentials, experience and financial info to the surety.
6. Update underwriters re FYE A/R collection – If old fiscal year-end receivables were collected, update the underwriter.
7. Provide collateral – Can be in the form of cash, an Irrevocable Letter of Credit or real estate (depending on the surety.)
8. Use joint checks – This is a relatively painless way of reducing the risk on the Payment Bond when applicants have some cash flow or credit weakness.
9. Bond subcontractors – Takes some risk off the Performance Bond
10. Use Funds Control – A professional Paymaster handles all the contract funds. Reduces the risk on the Payment Bond. And…
11. Bonus: Consider the SBA Bond Guarantee program

Think you can remember all these?

Good news: You don’t have to! We understand and utilize all these concepts and more to help our agent/colleagues serve their clients.

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Secrets of Bonding # 59: Bonding Specifications, Boilerplate That Bites

Does anybody really read this stuff? YEP, WE DO!fine print

Just like on insurance, there are written specifications (specs) for bonds, and if you don’t know what they are in each case, you could be setting yourself up for a disaster.  There can be serious consequences if a bid bond is rejected and a contract is lost.

So how do agents protect themselves from such an outcome? Step one is to obtain the written bonding requirements in every case. You may find they are open or they may be very narrow and specific.

Here is an example of one spec we recently handled: “The surety company shall hold a current certificate of authority as acceptable surety on federal bonds in accordance with the United States Department of Treasury Circular 570, Current Revisions.” (Read Secret # 23 about the T-list). To determine if you are in compliance with such a requirement, find the name of the surety exactly as it appears on the bond, and look it up here: http://www.fms.treas.gov/c570/c570_a-z.html
If the requirement goes on to say the Circular 570 dollar amount must be sufficient, compare the “Underwriting Limitation” amount to the dollar value of the bond. It must be is equal to or larger than the penal sum of the bond.

“No modification or waiver of any of the terms of the contract to be performed will in any manner discharge any surety liability thereunder.” This is commonly accepted language meaning the bond follows the contract even if the amount or terms are subsequently changed.

Normally the specs require a Performance and Payment Bond equal to 100% of the contract amount. Occasionally you may see a request 110% bonds. This is troublesome for the surety and they will resist issuing on this basis.

The boilerplate may require a bonding capacity letter issued by an acceptable surety in lieu of a bid bond.

Also note, bid bond percentages vary. Federal is normally 20% of the bid amount. Others are often 10%, but some are 5%.

The bid could also require a surety consent letter, promising to issue the P&P bond if awarded the work.

Federal Projects
On all federal projects where the contractor has a direct (prime) contract with a federal agency, the surety must be on the T-List and for a sufficient amount. Other owners sometimes choose to use this as part their own requirements.

On a prime federal contract you are also required to use the government bid bond form (Standard Form 24) and performance (25) / payment (25A) bond forms. Get them here: http://www.gsa.gov/portal/forms/type/SF

A.M. Best Ratings
It is not unusual for the specifications to require a minimum A.M. Best rating.  To confirm that the surety has a sufficient Best rating, look up the exact surety name in the A.M Best site: http://www3.ambest.com/ratings/default.asp

State Licensing
Another common requirement is that the surety must be “authorized to do business in the state of…” This means the surety must hold a state insurance department issued license (an admitted carrier). To check this, go to the insurance department for the state where the work is located. In our home state of New Jersey, we go here: http://www.state.nj.us/dobi/data/inscomp.htm

Bond Forms and Documents
You may run into mandatory bond forms. These are more common on private contracts than on public work. However, mandatory means just that. So it is important to 1. know if mandatory forms are stipulated and 2. confirm that the forms are acceptable to the surety and contractor. Sometimes on private work, they are strongly slanted against them.

Referring again to Secret #30, there is a significant risk for bond issuers, especially on bid bonds. Important: Agents should not rely on the bond request form prepared by the contractor. We often find this information incomplete and/or incorrect. To be sure you are issuing a valid bid bond that the obligee will accept, you must directly review the written bonding requirements

All the fine points we discussed can lead to a bond rejection. So get the boilerplate and take a bite out of it, before it bites you!

FIA Surety is a NJ based bonding company (carrier) that has specialized in Site, Subdivision, Bid and Performance Bonds since 1979 – we’re good at it!  Call us with your next one.

Steve Golia, Marketing Mgr.: 856-304-7348

First Indemnity of America Ins. Co.

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Secrets of Bonding #58: Bonus Edition

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Balance Sheet Bride + WIP Schedule Groom

In this article we will pull together some of the individual concepts that have been discussed and show how they are married in a contractor’s surety bond account.

In article #48 we talked about the different accounting methods that are utilized. We covered how to recognize the Percentage of Completion method and the Accrual method.  Accrual may be the one you see most often.

An important characteristic of the Accrual method is that it does not include Underbillings and Overbillings. Do you recall which method* does show these entries? Let’s consider the implications when these entries are not part of the underwriting.

In article #57 we reviewed how the Underbillings and Overbillings affect the Balance Sheet analysis.  Sometimes they help, sometimes they hurt.  Overbillings are a Current Liability.  Their effect on the Balance Sheet is that they reduce Working Capital. We all know that’s bad for bonding purposes.  It means less capacity for the client and maybe lower revenues.

Underbillings, on the other hand, are a Current Asset.  They increase the Working Capital calculation, and therefore the customer’s bondability. So you want them in the picture, but Accrual financial statements will not show either entry. Is there a solution?

With a correctly prepared WIP schedule in hand we can find the degree of completion, the correct billing amount, and then determine if the company is Under or Overbilled on each project. (If they were Underbilled $3 on one job and Overbilled $1 on another, the balance sheet adjustment would be the net effect: Underbilled $2.)

If a contractor has a Working Capital deficiency and the bonding capacity amount is inadequate, this calculation can help.  Bear in mind, it can also serve to reduce the bonding line if the net effect an Overbilled status.

The underlying reality is that, good or bad, these numbers must be known. Larger, more sophisticated contractors often use the Percentage of Completion method * which always includes Under and Overbillings – because they are relevant.  They are no less relevant for the Accrual method contractor.  On Accrual method financial statements, you should always analyze the WIP schedule to see if any significant Under or Overbillings could affect the Balance Sheet analysis.

The procedure we described is helpful for contractors when managing their projects, and for their underwriters.  It provides a sharper analysis and results in better management decisions for all parties.

FIA Surety is a NJ based bonding company (carrier) that has specialized in Site, Subdivision, Bid and Performance Bonds since 1979 – we’re good at it!  Call us with your next one.

Steve Golia, Marketing Mgr.: 856-304-7348

First Indemnity of America Ins. Co.

Secrets of Bonding #57: (4 of 4) Work In Process Schedules – Own Them!

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WIP Schedule, Effect on Balance Sheet Analysis

Now we pull it all together.

Here again is our sample contract.

Contract Price / Original % GP  /   Billed    /     Costs to Date  / Remaining Costs

$1,100,000     /        10%            /$550,000 /    $350,000      /  $700,000

What did we determine so far?

  1. We found that the job is 33% complete.
  2. The profit % has slipped from 10% to 4.5%
  3. The contract is Overbilled by $187,000

In addition to generating some discussion (What’s going on with this project?), these facts have an effect on the financial analysis and bond worthiness of the account. They could result in the bonding line being reduced and future bonds being declined.

How does this happen?

Remember the Overbillings are dollars the contractor has in hand, but at this stage of the project they are undeserved.  The dollars are comprised of costs and profits, and the profits are unearned at this point.

So where are these “undeserved funds” on the balance sheet?  There is no entry by that name on the Balance Sheet.  These dollars are sitting in the cash account, along with other cash owned by the company.  These dollars are not yet earned or deserved, yet they are sitting in the account looking normal.

The solution is to reconcile (recognize) the undeserved funds by creating a corresponding liability that offsets the Overbilling cash asset. This Current Liability will be called Billings in Excess of Costs and Estimated Earnings. In short, this is referred to as Overbillings.

In this case, there will be a $187,000 Overbilling Current Liability to offset the undeserved funds in the cash account (Current Asset).  This removes the extent to which the Overbillings inflated the Working Capital calculation (Current Assets minus Current Liabilities).

In an Underbilled situation, a Current Asset called “Costs and Estimated Earnings in Excess of Billings” would appear.  (Notice that it sounds like the opposite of the Overbilling title.) This adds to Working Capital by reflecting the earned funds that have not been collected because the billings are not current.

Here are some CPA comments regarding WIP schedules and their importance:


Conclusion: The analysis described in this series is critically important for contractors and their surety.  However, the analysis is impossible if the contractor does not keep valid records of the costs attributed to each individual project and then periodically re-estimate the Remaining Costs to Complete based on the actual realities experienced.

Watch for #58 – a Bonus Edition!

FIA Surety is a NJ based bonding company (carrier) that has specialized in Site, Subdivision, Bid and Performance Bonds since 1979 – we’re good at it! 

Call us with your next one.

Steve Golia, Marketing Mgr.: 856-304-7348

First Indemnity of America Ins. Co.




Secrets of Bonding #56: (3 of 4) Work In Process Schedules – Own Them!

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Profit Analysis

Every project starts with an estimate that attempts to predict the total Cost of labor and material needed to perform the work.  With this number and the contract price, we can find the Original Estimate of Gross Profit.  (Contract profits are always “gross” because overhead and other expenses have not yet been deducted.)

The same analysis can be performed during the life of the project to determine:

  1. if the contract is expected to produce a profit
  2. if the original project estimate was reasonably accurate in predicting the costs that are being incurred (and therefore the profit prediction is dependable)
  3. if field supervision and the labor force is as productive and efficient as expected
  4. if material costs are coming in as predicted

We use the original percentage of gross profit instead of the dollar amount so the contract performance can be compared over time, even if the contract dollar amount has changed by amendment.bookkeeper3

A short form WIP may not state the Current Estimate of Total Costs, or the Current Estimated Profit, but you can calculate them.

Formula to find Current Estimated Percentage of Profit:

On the WIP schedule, do you see, or can you calculate, the Current Estimate of Total Costs to Complete? (Discussed in “2 of 4”)

Find it by adding the Costs Incurred to Date to the Current Estimate of Remaining Costs to Complete.

To calculate the current estimated profit %, subtract the Current Estimated Total Costs from the Current Contract Amount (gives you the expected profit in dollars), then divide the profit dollars into the contract amount to find the profit %.  Try it on our sample contract.

Contract Price  /  Original % GP  /   Billed    /     Costs to Date  / Remaining Costs

$1,100,000      /     10%               / $550,000 /   $350,000     /  $700,000

Is the current estimated profit $50,000?    Yes, it is!

To find the % divide $50,000 into $1,100,000 which gives you .045 or 4.5%.

This means that now, after this project has commenced, a profit that was projected to be 10% of the original contract amount has now deteriorated to 4.5% of the current contract amount. This is vital info for the contractor to have during the project.  It shows a trend that must be controlled. Prompt action may prevent the project from producing a loss for the company or could even improve the final profit figure. The surety underwriter will monitor such projects, even if they are not bonded.

Critically Important: This analysis is impossible if the contractor fails to record the labor and material costs incurred specifically on each project. They must also make a CURRENT estimate of the remaining costs to complete. They cannot rely on the original estimate of costs and merely hope the profit will be there at the end.

Billings: Overbilled / Underbilled

Now let’s shift gears. The next point to determine is whether the project is billed ahead or behind the degree of completion.  For example, the contractor’s office may be slow in processing the invoices to the project owner, so they may not have collected funds that are rightfully earned (they are Underbilled).  Conversely, they may be billed beyond the degree of completion (they are Overbilled) and therefore have dollars in hand that are not yet earned. This is calculated in dollars by first comparing the % of completion to the % Billed to Date.  Try it on our example contract.

Here are the questions:

  1. What was the % of completion?
  2. What dollar amount is that percentage of the current/revised contract amount?  (This gives you the “correct” amount of billings at this stage in the project.)
  3. Are the actual Billings to Date more or less than this amount?  Are they Underbilled or Overbilled, and by how much?

OK, what did you get?

  1. The % of completion is 33.3%
  2. Therefore the “correct” billings are $363,000
  3. If the actual billings are $550,000, the company is $187,000 Overbilled on this project.

They have succeeded in billing the client beyond their current degree of completion. This may not be bad if the contractor knows they are overbilled.  Management should not be unpleasantly surprised when they are 100% billed but the work is still not complete (Yipes, no more money coming in! Who’s gonna pay for the labor and materials?)

Another issue: Overbillings can become a concern for the surety.  Overbillings (money) may be diverted by the contractor into another project.  In the event of contractor default and completion by the surety, this means there may be funds missing that rightfully belong in the project.  This could increase the surety’s net loss.

Underbillings may indicate an intentional, conservative billing practice on the part of the contractor – leave money in the project and take it out at the end when successful completion is assured.  If it is unintentional, they may be depriving themselves of earned profits that are currently needed.

Underbillings can also be an indication of poor management and / or administrative practices.

The point is that all these issues are important for the contractor and surety, and therefore, the agent.

Our last segment in this series will cover how all this affects the contractor’s financial statement.  Important!

FIA Surety is a NJ based bonding company (carrier) that has specialized in Site, Subdivision, Bid and Performance Bonds since 1979 – we’re good at it! 

Call us with your next one.

Steve Golia, Marketing Mgr.: 856-304-7348

First Indemnity of America Ins. Co.

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