In this edition of Secrets we will continue a discussion that began in #70 which covered “Labor, Contracts, and Labor Contracts.” Last time we concluded by describing a project with unusual characteristics:
Materials: 40% Labor: 60% Overhead/Profit: 0%
These percentages describe a job that is predicted to yeild no profit. Why would a contractor bid this way? Some possible reasons:
- Maintain labor force – The project will enable them to keep their valuable / long term employees working
- The revenues and cash flow will help with creditors
- There are design deficiencies that will result in profitable addendums to the contract
- Protect their relationship with a repeat customer (keep out competition)
- With the job in hand, additional profits can be squeezed out of the subcontractors and vendors
While these strategies (or others) could make sense to the contractor, it is likely the bond underwriters will be reluctant to support the project. Why?
Remember, if a default occurs, the surety may be required to step in and complete the project. Their primary financial resource will be the remaining (not yet paid out) contract funds. If the project was estimated with a 0% profit, it would be easy for increased costs or inefficiencies to result in a losing job – which means the surety would be forced to add funds in order to reach completion of the project.
Contract estimates are just that: Estimates or Guestimates. A job projected to produce a 10% profit may actually end up at 11% or 9% or Zero! Faced with this uncertainty, and the unavoidable responsibility to finish the work, a 0% profit projection may be too much risk for the surety.
The best way for contractors to avoid low profits is to not accept underpriced work. Whatever benefits they might perceive, the risks are a huge burden. Construction work is a challenge under the best of circumstances.
Starting with the expectation that you are on the verge of a loss only adds to the exposure faced by contractors and their bonding companies.
KIS Surety is the national contract bond underwriting department for Great Midwest Insurance Company, a national, corporate surety with an A-8 rating. We throw all this underwriting talent at your bond opportunities and support contracts up to $10,000,000.
If you have a contract surety case that needs a fast, creative response, call us: 856-304-7348
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