Building a solid foundation for a good relationship with sureties is important to every contractor. Just as with any relationship, it must be built on trust, mutual respect and honest communication. Sureties want to work with contractors that are accountable and proactive. They also expect contractors to have good management skills so that a profit is realized on the majority of their projects.
The ability for contractors to grow is generally contingent on a surety’s willingness to increase its bonding capacity. Without surety credit, most contractors will not be in the position to take on more projects or bid on larger jobs.
Sureties factor their decision to issue a bond on a contractor’s capital, capacity and character (the three Cs). These indicators help sureties form an opinion on the company and if it is creditworthy. Sureties also look the following contractor characteristics.
A contractor’s gross profit percentage and net income as a percent of revenue should be comparable to industry averages. Sureties want to know that the contractor is bidding and completing jobs profitably. This clearly indicates to the surety that the contractor is executing good estimating practices and completing jobs on budget or better. It also demonstrates to the surety that projects are being managed properly.
Job Status Reports
Contractors should provide sureties with a job status report on all projects (bonded and non-bonded). Contractors should have monthly reports available to give to the surety upon request. Contractors should also be proactive and send the surety a job status report on a bi-monthly or quarterly basis, even if it is not required. This will give the surety information on how well the company is performing and meeting its goals. Sureties look at a contractor’s management skills and business acumen when making a bonding decision. The numbers reported on a job status report will give them the tools to make an assessment.
Key Performance Indicators
Sureties will analyze month-over-month and year-over-year KPIs to determine if a contractor’s performance is in alignment with past periods, benchmarks on similar companies and industry trends. Sureties want to see consistency in performance and that the contractor is operating as well as or better than other companies in the same market.
If the total gross profit percentage on a project is less than the original estimate, sureties will question a contractor’s ability to estimate job costs. The contractor should determine what is causing a profit fade to understand how to run their business more efficiently. Sureties want to see that expectations on job profitability are realistic and contractors are running a lean operation.
Billing less than specified in a contract is typically a red flag to sureties that unapproved change orders are included in the contract or the contractor is overestimating profit. In addition, it can indicate that the contractor is not billing a client for work completed on the project on a timely basis. Sureties want to see that contractors are billing in accordance with the terms of a contract. They do not want to see that the failure to bill on time adversely affected cash flow.
Sureties can become concerned when the estimated costs to complete a job exceed the remaining unpaid contract balances. This excess amount is known as job borrow. Overbilling can cause cash flow to be negative in the amount of the job borrow for the rest of a project. However, sureties generally look favorably on the contractor if the overbilled amount is in the company’s bank account as it shows the contractor is adept at job borrowing from their customers.
Having enough working capital to meet short-term expenses is necessary for a contractor to realize the expected profit margin on a job. Otherwise, the project may have to be financed, which will increase costs and reduce profits. Sureties like to see jobs come in under or on budget. They also like to see that contractors are fiscally responsible. Avoid buying long-term assets if working capital is tight and lease or finance equipment instead.
Liquidity ratios (current ratio, quick ratio and operating cash flow ratio) measure a company’s ability to pay debt obligations. Sureties will look at a contractor’s liquidity ratios to determine if the company is highly leveraged and using a high percentage of its revenue to pay off debt. Consider debt reduction strategies such as an equipment sale or leaseback arrangement.
Work with an accountant who is familiar with the construction industry and up to date on the tax laws to ensure that all applicable deductions and tax credits are taken. Sureties want contractors to work with professionals who know the tax elections for contractors that can help reduce the company’s tax obligation as that only helps the contractor improve cash flow.
In addition, sureties look for a history of successful projects and work experiences, a succession plan to ensure that a contractor will stay in business if a member of its management team leaves unexpectedly, a history of solid banking relationships and a short- and long-term business plan. A properly prepared financial statement also goes a long way toward building credibility with sureties.
Sureties do not like surprises and will respect a contractor that brings an issue(s) to his/her attention. When doing so, be prepared to discuss a plan to rectify the situation. Develop a written plan outlining exactly what will be done and provide proof that the plan is realistic and achievable. Include the company’s accountant and CFO or controller in the conversation to answer questions.
It is important that a contractor works with a professional agent who specializes in surety and is respected by the underwriters in their markets. The agent is the contractor’s advisor and representative. The level of underwriting expertise and respect the agent has in the underwriting community can make the difference between a bond request getting approved or denied, especially if it is challenging. The same can be said about the contractor’s accountant and some of his/her other professional advisors.