Secrets of Bonding # 128: The Unexpected Cause of Contractor Failure

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?


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.


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.

Secrets of Bonding #113: Your 1st Bond – Choose Door #1 or 2?

Every week we get inquiries regarding clients who need their very first bond.  This is a great question and one we love to answer.  It is particularly gratifying to give a new client their first bond – of many!

There are different paths forward depending on the circumstances.  Each door has different aspects.  Let’s go over them.

Door Number 1:open_door3

Use this door for contracts (federal and all others) up to about $350,000.  This is the fastest / easiest program with the first bond approval coming over in about 1 day!  Only a one page application is needed – no financial statements.  The program is predicated on the work being simple and normal for the contractor, and personal credit reports of owners and spouses must be acceptable.

This door is perfect for companies that are not pursuing contracts in excess of $350,000.  Other applicants can also use it as a quick way to start while completing the application process for higher amounts.

As with all the doors, there is no charge to get pre-qualified for bonding!

Door Number 2:

This is for contracts up to about $500,000.  Similar to Door Number 1, but now add “in house” company financial statements and / or tax returns. A longer questionnaire is needed, and supporting documents such as resumes, references and personal financial statements may be required.

Door Number 3:open_door1

For contracts in the $500,000-1,000,000 range, plan on a CPA prepared Compilation statement.  This is the lowest level (least expensive) CPA financial report.  It is needed once per year.

Door Number 4:

Contracts over $1 million may require an annual CPA Review financial report.

Number 5:open_door5

For large contracts in excess of $10 million, a CPA Audit may be required by the underwriters.

It makes sense that as the obligations become larger, higher quality, more complete information is needed.

Is there some flexibility?  Sure!  It may not seem so, but underwriters are motivated to be flexible and find ways to write the business.  After all, no bonds = no revenues.  They must find ways to say yes.

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 #74: Twofers

A Basic Question

 Talk to the experts, and you may get different answers to this extremely basic question: “What is the maximum potential loss for the surety on a Performance and Payment Bond?”

If you have experience producing surety bonds, you know that a 100% Performance Bond (equal in amount to the contract) is priced based on the contract amount. If the bond rate is 2.5% of the contract amount on a $100,000 project, the Performance Bond cost would be $2,500.

How much would it be for a Performance and Payment Bond? It seems logical that if you add to the exposure, you must charge more – but the cost is the same. Surety rules typically say that the Payment bond is provided at no additional charge. Is this because the surety is being generous, or is the exposure amount not actually increased?!

Surety Practices

We have established that bonding companies do not charge twice as much for a P&P bond.

When it comes to the use of the contractors bonding capacity, they use “1 x” here too.  For the contract in our example, $100,000 of capacity is consumed by the P&P bond, not $200,000.

Combined Bond Forms

Look up New Jersey law “N.J.S.A. 2A:44-147” and you will find it stipulates a combined Performance and Payment Bond form for public work in the Garden State. The penal sum (maximum dollar value of the bond) is stated once in support of a two-headed obligation. This may lead the reader to conclude that the single bond penalty is shared by the surety’s two legal obligations. That would justify not making an additional charge when including a Payment obligation with the Performance Bond.

Bond Specifications

On public work, such a federal, state and municipal contracts, the bonding requirement may indicate “100% Performance Bond and 100% Payment Bond” or “100% Performance and Payment Bond.” In the context of this article, the implications may be obvious, but it appears contract officers use them interchangeably.

Federal contract officers, on other other hand, can be quite specific on this point and expect the surety to assume a 200% exposure for the 1 x bond fee.

Federal bond forms require a separate instrument for Performance and another one for Payment, each with its own penal sum.  The Surety may attach them both as a single document and even give them one bond number.  But the government clearly is buying a guarantee with a combined value of 200%.


The reality is that, despite the pricing methods and handling procedures used by sureties, the bonding company IS responsible for 200% if they issue two instruments each stating a 100%  obligation. This is the twofer that sureties willingly offer. You can have Performance only, or get Performance and Payment, twofer the price of one!

The Irony

Surprisingly, obligees may not position themselves to obtain maximum value and protection from the bonds they buy, and sureties may give away coverage rather than charge for it. fia_surety_logo


FIA Surety / First Indemnity of America Insurance Company
2740 Rt. 10 West, Suite 205
Morris Plains, NJ 07950
Office: 973-541-3417
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We are currently licensed in: NJ, PA, DE, MD, VA, NC, SC, WV, TN, FL, GA, AL, OK, TX

Secrets of Bonding #47: Compilation, Review, Audit?

When it comes to Bid and Performance Bonds everyone knows that financial statement numbers are important.  But before surety underwriters get to them, they evaluate the method of financial presentation, its quality and credibility.

  • Is a CPA needed or can a PA or Tax Preparer be used?
  • Audits are expensive.  Can contractors avoid the cost?
  • Are there times when you can’t you use the same accounting method for tax and financial reporting?

There are a number of variables to consider.  Let’s go over what to use and when.

Accounting Professionals

A CPA is a Certified Public Accountant. These people are the premiere accounting professionals.  Bonding companies expect contractors to have a CPA prepared fiscal year-end (FYE) financial statement if individual bonds will be in the range of $1 million or more.

Below a CPA is a PA, Public Accountant, and then there are bookkeepers and tax preparers. Accounting professionals with lower credentials should only be used by contractors with small bond needs.

Accounting Methods

There are four accounting methods.  Any can be used for tax purposes, but banks and bonding companies are more selective.

  1. Accrual Method – probably the most common for construction companies.  May be acceptable for all bonding situations.
  2. Percentage of Completion – more sophisticated than Accrual.  Often used by larger contractors.
  3. Completed Contract – used by contractors that have multi-year projects such as road and bridge builders.
  4. Cash Method – acceptable for tax purposes, but not for financial reporting to banks or sureties.

Financial Presentation

The presentation can vary greatly. This too, is an important element. Surety underwriters expect to make a number of financial evaluations.  If the presentation is inadequate, they will not have info they need (schedules, notes and other elements).you-decide

Audit – the accountant’s cover letter states an “unqualified opinion” meaning they vouch for the accuracy of the report without reservation.  This is the most expensive presentation and is required when bonds and bank credit are in high amounts ($2 – 5 million and above).

Review – This report includes some “review” and verification by the preparer, but less than an Audit. Review reports are required by bonding companies starting with projects around $1 million.

Compilation – This is merely a typing job by the accounting firm, using the numbers provided by the client.  They make no verifications with outsiders and may not even double check the arithmetic. Normally this is acceptable for clients needing bonds below $1 million.

QuickBooks – Financial Statements produced from the client’s computer may be adequate for small bonding lines, or to provide a mid-year update.  “Internal” financial statements are not used as primary underwriting info for sizable obligations.

FIA Surety / First Indemnity of America Insurance Company
2740 Rt. 10 West, Suite 205
Morris Plains, NJ 07950
Office: 973-541-3417

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Secrets of Bonding #25: World’s Cheapest Audit

When it comes to financial statements prepared by a CPA (Certified Public Accountant), there are three levels of presentation:

Compilation – This is the lowest level and does not include any checking or verification of the numbers by the accounting firm. The numbers are merely “compiled” by the CPA.

Review – Some checking and “review” by the CPA.

Audit – The CPA performs analysis and verifications to authenticate the numbers.

Bond underwriters expect better prepared financials for higher amounts of surety credit.  This means contractors that have large bonding lines must provide Audited company financial statements (FSs).  Sureties and bankers are more confident when analyzing an audited FS – we assume everyone would have these high quality financial reports if it wasn’t for the cost.

Because of the time and human resources involved, a Review is less expensive than an Audit, and a Compilation is the least expensive of the three.

So in comes your contractor client who, for a number of reasons, decided to have a Compilation at the last fiscal year-end.  Now a large project needs to be bonded, and from a size standpoint, the underwriter normally expects a Reviewed FS.  If it is not practical to go back and upgrade the Compilation to a Review, what are your options?

The underwriter may be willing to work with the Compilation FS if some key elements are documented and / or verified.  Such an analysis is the heart of the difference between a Compilation and a Review.

At the minimum the underwriter is likely to ask for proof of cash, aged receivables (A/R) and payables (A/P), and a Work in Process (WIP) Schedule.  Let’s go over each one briefly.

Cash: If the FS date is 12/31, the idea would be to provide proof of the cash amount shown on the FS on that date.  If the FS shows $52,125 cash, you need bank or brokerage statements adding up to that figure for 12/31.

A/R & A/P: These reports should be as of the FS date and add up to the receivable and payables listed on the FS.  The A/R should be broken down by age showing how much is current, 60, 90, and over 90 days old. Retainages should be identified since they are not regular “trade receivables.” It is also beneficial to indicate which receivables were subsequently collected after the fiscal date. Payables should also be aged.

WIP Schedule: Needed as of the fiscal date to support the analysis of the company balance sheet.

This strategy is not as good as actually having a CPA Review, but the analysis performed by the underwriter could substitute for a Review and justify issuance of a bond. Plus, such services performed by the underwriter are free!  So, even though this is not really an Audit or Review, you can think of it as the “World’s Cheapest Audit.”  It can be just what you need to get a bond and keep moving forward with the file.

For the future, if similar sized bonds are likely, the client should plan on having a Review performed at the next fiscal year-end – it will help with surety and bank credit.  Added bonus: The company will have better documents for management review and the accountants will provide professional guidance that is not included with a Compilation.

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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