Understanding Surety Bonds: How to Increase Your Bonding Capacity While Lowering Your Bonding Rate
Whether you are new to the construction industry or have been working in it for years, you have probably realized that understanding and getting the proper surety coverage can be overwhelming. Surety bonds are a risk mitigation insurance that helps insure those involved in a contract through all phases of the project, from the bidding process all the way through performance and final payment. With the many different types of surety bonds, it is important to identify the type of bond that is necessary for your phase of the project and to mitigate your company’s exposure and ensure you have a high level of coverage if some portion of the contract fails.
In order to be successful in anything, it is important to surround yourself with a strong team and to have the right people in the right place to set yourself up for success. This applies not only to your organization, but with professionals who help support your efforts and objectives (bonding agent, CPA, attorney, etc.). Your bonding agent is vital in keeping you informed of the different types of bonds, ensuring that your company is properly covered and that you are aware of your level of risk if a situation should surface.
While all of this may seem easy enough, your company’s bonding capacity and bonding rate is only as good as the surety’s analysis of your business. A surety is backing your company to follow through on your obligations and as a result they need to be comfortable with that decision. The surety is looking for long-term survival and stability of a company. Some factors used for analysis include analyzing the contractor’s experience, the organization’s management team and employee group and, most importantly, the company financials.
Financial stability plays a significant role in your bonding limitations. Numerous ratios and other metrics are used to analyze your financial data; however, the primary areas analyzed are the company’s equity, debt, and liquidity. Sureties focus on the strength of equity in comparison with levels of debt and the amount of backlog being carried. A contractor’s ability to operate their business without dependence on outside financing is ideal for a surety and results in the greatest level of support. Liquidity is vital in any business, but especially in the construction industry. Rarely in other industries are companies expected to front large sums of money for customers for 60 to 90 days and on top of that they hold back 10 percent retainage. However, this is the norm in the construction world. In order to operate under these circumstances, surety companies evaluate the company’s liquid assets and working capital. These amounts are compared to the remaining costs to complete their backlog projects in order to determine the company’s ability to meet their short-term needs.
Most sureties require financials statements to be audited, reviewed, or at the very least compiled by a CPA. Bonding rates and bonding capacity are directly related to the surety’s level of comfort with the company including the quality of their financial data. Accurate, detailed, and timely financial information is essential. Having up-to-date work in progress (WIP) and job costing allows a project manager the ability to correct problems in a timely manner and prevents projects from sliding. Accurate estimating and WIP analysis when compared to the final contract will build confidence and trust in your financial data. It is important to choose a CPA who understands the construction industry and the unique aspects of construction accounting in order to put the best foot forward with the surety company. With a good understanding of the surety’s perspective and the right team in place to support your organization, you can set your business up for long-term success.
If you have questions or need assistance with strategically positioning your company for bonding, please contact Yeo & Yeo’s Construction Services Group.