bonds

Secrets of Bonding #4: Working Capital

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The Magic Wand: WORKING CAPITAL.

Surety bond underwriters base their decisions on a wide range of factors including the contractor’s prior experience, quality of staff, credit history and financial condition.  Many of the factors are subjective but some are just cold hard facts. Working Capital (WC) is among the more straight forward elements, and is easily identified.  It’s worth knowing about because it is an unavoidable piece of the underwriting puzzle, and to many sureties it is one of the most important. If there is a magic wand you could wave over an account to get it accepted, this is it!

What is Working Capital and how do you find this element?

Working Capital is a prediction of the company’s future, near term, cash flow.  Based on one day in time, it predicts the amount of cash that will flow through the business to pay bills, finance new ventures and solve problems that arise.  These are all important factors for surety bond underwriters.

WC is located on the company’s most recent year-end financial statement (FS).  The most common date for this is 12/31 of the preceding calendar year. Turn to the Balance Sheet, then the Assets column, and then the subtotal called “Current Assets.”  Now find the corresponding figure in the Liabilities called “Current Liabilities.”  The difference between these numbers is called “Working Capital as Given” meaning it is taken right off the FS without analysis or adjustment. Underwriters will hope to find that the WC is about 20% of the single contract size the client wants to bond.

Example:

Current Assets: $600,000 – Current Liabilities: $400,000 = Working Capital of $200,000

$200,000 is 20% of $1,000,000 which could be the maximum single job size (assuming other factors are also in line.)

If the WC is too low, the account may be found financially deficient for the amount of capacity requested.

  • That’s the cut and dried part.  Now comes the art.  What can be done if the WC is insufficient? Some ideas:
  • First, it is important to review a draft of the year-end FS so an early version of the numbers can be evaluated. This is the time to make adjustments before the FS is carved in stone.
  • On the asset side, debt collection from stockholders / owners (money owed TO the company) directly helps WC.
  • Refinance fixed assets.
  • Unused equipment and other fixed assets such as real estate can be sold and the proceeds held as cash.
  • WC can be increased by shifting bank debt from current to long term.  Companies with all their debt as current should consider refinancing for a longer payback period.
  • Money can be loaned temporarily or permanently to the company by owners. If there is room to add bank debt, it could be beneficial if the payback is long term.
  • The draft FS is the key to this process.  Get the underwriter’s opinion regarding the capacity desired.  If the FS doesn’t support the figure, make adjustments now so that surety capacity will not be inadequate for the next 12 months.

Working Capital can be a magic wand if you know how to wield it!

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 #3: How Taxes Affect Bonding

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There are many factors that contribute to the underwriting decisions on bonds.  The contractor’s history is considered along with credit and financial analysis, estimating, project management, equipment – a variety of elements.

For many contractors the process of seeking surety bonds is mysterious and frustrating.  Not having them can prevent the company from graduating to larger projects and greater financial success. Seminar attendees often ask us for the silver bullet.  “What must I do to get bonded?” So now we reveal what, for many, will be the key to qualifying for bid and performance bonds:

Pay More Taxes!

Sound crazy?  Often company managers struggle to manage (reduce) tax payments.  They feel a low bill (or no tax bill at all) is proof of a successful financial strategy.  So why can paying more taxes help the company qualify for bonds?

Surety underwriters intend to write bonds for successful firms that are likely to succeed on their bonded contracts.  What better sign of success than to have made a profit in the prior year?  Profits prove the vitality of the company.  They show that company management acquired enough work, with a sufficient margin and controlled expenses, resulting in a net profit.  The point is – you only have taxes if the year was successful and the company made money.  The profits strengthen the foundation of the company assuring continued stockholder and creditor support.  Profits and growth are all elements that, when combined with other relevant factors, lead to confidence on the part of the underwriters.  That’s when bonds get issued!

Summary:

Paying taxes is an important part of bonding not because the taxes are beneficial; but because the tax payment is indicative of good record keeping, profitability, cash flow and growth all of which are good for the company and the surety that supports it.

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.

(Don’t miss our next exciting article.  Click the “Follow” button at the top right.)

Secrets of Bonding #2: Full Disclosure

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FULL DISCLOSURE: WHAT DOES IT MEAN? WHY IS IT IMPORTANT?

Bond underwriters intend to make a broad review of the applicant’s qualifications. This includes many aspects: Financial condition, technical expertise and prior experience, staff, equipment, banking and supplier relations, affiliates, legal issues and more.

Underwriters will avoid an account if there is a suspicion they are being manipulated. Underwriting questions are designed to reveal the applicants strengths AND weaknesses.

Certain aspects of the underwriting information are obtained from independent third parties such as CPA prepared financial statements, banking records, credit reports and supplier references. Other items may come directly from the applicant who is not independent but rather an “interested party.” This is a fact of life in the development of every bonding file. Therefore, the underwriter must rely on the applicant to be honest and forthright with the information. Without this certainty, there can be no underwriting relationship.

To foster this good rapport, the applicant can take these steps:

1. Answer questionnaires and forms completely and honestly. Sign and date the document. If there are negative items, describe them candidly but attach a written explanation or other documents that may help.
2. Be sure to include other owned companies, all lawsuits, and bankruptcies even if old. If there are banking or tax issues, describe them. The underwriters will probably unearth these during the process, and it looks better if you volunteer the facts and then take the opportunity to give your explanations.
3. Describe the strengths of the company such as bonus & employment agreements with key people. Include their resumes. Describe any special training, licensing and certifications, awards, and provide good guy letters.

Keep in mind that sureties make money by writing bonds. So even if it doesn’t always seem the case, they do have motivation to say yes.

Remember that, in effect, you are asking the surety to become your business partner. The surety will succeed on the project if you do. So how will you treat your new partner? Be candid and forthright! Don’t try to hide the negative factors – you probably won’t succeed, but you will do irreparable harm to the relationship.

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.

(Don’t miss our next exciting article.  Click the “Follow” button at the top right.)

Secrets of Bonding #1: Bonds are NOT Insurance

Steve Golia1 Comment

This is always where the conversation starts. Why? Because if you think a bond is an insurance policy, you will have the wrong set of expectations. If you are seeking a bond, you’re likely to become very  frustrated unless you have a correct understanding and the expectations to go with it.

Here are two basic differences between insurance and bonds:

1. Insurance transfers risk of a specific event from the insured (policy holder) to the insurer. (Example: The risk of financial loss due to fire is transferred from the insurance applicant to the fire insurance company.) With a bond, the bond applicant HOLDS the risk.

2. Insurers charge rates that expect a certain number of claims and losses. Sureties do not expect to have claims or losses and do not charge enough to pay for them.

There are other additional differences, but let’s focus on these two. With a bond, the surety is backing the bond applicant performance for the benefit of the party paying for the work. If a problem develops, it is still up to the applicant to solve it. In fact, contractors give their indemnity to the surety (promise to reimburse the surety if they fail to perform and cause a loss.) So when a bond is in place, it is even more important for the contractor to perform correctly. With insurance, you pay a premium to reduce your risk. With bonds you pay the premium, but have even more at stake than on an un-bonded project.

On the second point regarding rates, this helps explain why bonds are hard to obtain. If the surety has no tolerance for claim or loss, they can only provide bonds for the most qualified applicants. This means you must present yourself in the best manner possible if you hope to obtain a bond. Doing so requires good financial reporting, record keeping and complete disclosure. We’ll talk more about this later in this series.

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.

(Don’t miss our next exciting article.  Click the “Follow” button at the top right.)