Month: June 2016

Secrets of Bonding #129: What It Takes To Get a $1 Million Bond

Steve GoliaLeave a comment

Here is a common fallacy held by observers of the surety bonding industry: whellbarrow money

How much cash do you need to get a $1 million bond?  The answer is NOT $1,000,000. Surprisingly, you only need a fraction of the $1 million, but you do need other elements as well.  Let’s dive in!

Our readers may be familiar with the 3 Cs of Surety Bond Underwriting: Coercion, Corruption, Cowardice.  Actually they are Character, Capacity and Capital. These describe areas of analysis that are important to the bond decision-makers.  Cash falls under the Capital heading.  Other factors are also important.

  • Character includes the applicant’s credit rating and operating history. Bill paying habits are reviewed along with references from suppliers and lenders. Character evaluates if the applicant is likely to honor their obligations under the contract and bond.
  • Capacity cover the skills of key people, company experience overall, plant, equipment and other factors.
  • Capital includes all financial resources, including Cash.

The Magic Number

Stacks of US currency

There is no magic number. When underwriters review the company financial statement they do look at the cash position.  In addition, they evaluate the Working Capital, which is the sum of cash, accounts receivable, inventory, and other items, minus Current Liabilities.  Working Capital consists of elements that will become cash during the current fiscal period (the accounting year).  For example, a dollar of “good” receivables is the same as cash to credit analysts.  So to this extent, less pure cash is needed.

Financing New Projects

One of the reasons contractors need Working Capital (WC) is to finance the start of new projects.  They must mobilize the job site, pay laborers and purchase materials – all out of their pocket initially.  As the project proceeds, it starts to fund itself. 

For the $1 million contract with the $1 million bond, would it take $1 million to finance the start?  No, it would just be a percentage of the $1 million.

The Two-Part Answer

Many bundle of US 100 dollars bank notes

This brings us to the answer. Cash is one component of Working Capital, and underwriters expect WC to equal about 10% of the bonded exposure. This could mean that the $1 million bond requires less than $100,000 cash when combined with other working capital components. However, cash alone doesn’t get bonds approved.

All of the 3 Cs are equally important. Cash is not the sole basis of the decision.  A cash rich company with bad credit or weak prior experience will still be declined.  Cash cannot overcome these deficiencies.

FIA Surety is a NJ based bonding company (carrier) that has specialized in Site, Subdivision and Contract Surety 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 # 128: The Unexpected Cause of Contractor Failure

Steve GoliaLeave a comment

Why do construction companies go out of business? What reasons have you heard for companies shutting down?

  • “The economy is terrible.”
  • “There’s no work.”
  • “Too many bidders. You can’t get a decent profit and I won’t work for nothing.”

All these explanations amount to the same thing: A lack of projects resulting in low revenues, low profits and no cash flow. The situation seems obvious. When there isn’t enough work available, many contractors are forced to shut down. So is this THE BIG cause of contractor failure? Surprisingly,  no!

closed1Many construction companies fail because they have too much work. Is it possible that too much of a good thing spells disaster? We’ve all heard the stories about lottery winners who say the money ruined their lives. Suddenly they’re rich, but they weren’t ready for it. The very thing they wanted more of, turned out to be their undoing.

For construction companies, the mission is to acquire and perform profitable contracts. A tremendous amount of effort is spent in the pursuit of new work. So what can go wrong to make the volume a disadvantage, causing the demise of the enterprise?

Capital

One answer is the Lack of Sufficient Capital – both the money kind and people. As companies grow, more liquid resources (cash) are needed to finance the start of new projects and solve problems. Human resources are needed such as field supervision and back office support. Companies can fail when the office staff is unable to keep pace with the paperwork. Billings don’t go out on time, receivables are not collected, cash flow is choked off.  It is management’s responsibility to anticipate these needs and prevent the deficiencies.

Field production can suffer when the supervisory staff is inadequate. This leads to reduced gross and net profits, less available cash, the beginning of a downward spiral.

Managmentclosed2

Consider the Corner Office: Poor leadership, lack of business knowledge and inadequate financial management can be catastrophic. In addition to setting the tone and establishing the company mission, the bosses must have the technical knowledge a larger company requires.  They must be sophisticated financial managers to control resources and garner needed support from financial institutions. The successful manager of a mid-sized business is not necessarily equipped to run a large company.

New Geographic Territory

Management’s pursuit of growth can lead the company into new geographic markets (the grass is always greener.)  This may present unexpected challenges and obstacles including local union resistance, unfamiliar underground conditions, logistics problems, reduced labor productivity rates, adverse weather conditions, etc.  On the east coast (I’m a New Yorker), bond underwriters have long shared stories of NY contractors who ventured to Florida and got their butts kicked…  They say “Florida beaches are littered with the bones of NY contractors.”

Adding New Type Work

Some companies have strayed from their normal type of work in the pursuit of added revenues. They get in trouble trying to enter and compete as newcomers to the field. The company may lack the expertise (estimating, field management) for the new type work. How can you be successful in a competitive bidding environment when going against companies already entrenched in the market?  Do you take work cheap and hope for the best? “We’re losing money but we’ll make it up on volume.”

Our point of view is based on surety bond underwriting. All these issues are well known to bonding companies. When their construction clients want dramatic growth, new types of contracts or transition to a new geographic market, that’s a red flag. They come back with the hard question, “Tell us: Why this is a good idea?”closed3

Contractors may feel that sureties hold them back. Maybe they are too conservative. Do they really want contractors to grow? They think they know better than the contractor?

Actually, the surety and the contractor succeed or fail together. Having seen good clients encounter unexpected problems, underwriters know firsthand how quickly things can unravel.

Writing more bonds and bigger bonds is how bonding companies grow. Certainly, construction companies must grow to survive, and being bigger can be better.  But uncontrolled growth is the major cause of contractor failure that sureties, and contractors, must avoid.

FIA Surety is a NJ based bonding company (carrier) that has specialized in Site, Subdivision and Contract Surety 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.

Not available in all states including Idaho.