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