Maximizing Your Bonding Capacity For The Changing Surety Market

Most contractors would not have found an article of this nature appealing 5 years ago. Bonding capacity in the surety market was plentiful. However the surety market has gone through remarkable changes over the last 2 years. A majority of surety companies lost money in 2000 and 2001. The effects of September 11th and the downfall of Enron have added to the problems in the industry. It is estimated that 15% to 20% of all contractors lost their surety capacity in 2001. The surety underwriting process has gone through significant tightening and this trend will continue in the future.

As most contractors begin to close the books on 2001, there is a need to refocus on taking the necessary steps to maximizing bonding capacity. The following are a list of some financial statement strategies that a contractor should consider at their companies.

• Line of credit facilities – Most contractors have line of credit facilities both to provide working capital and give comfort to the surety that cash is available when needed. If borrowings are outstanding on a demand line of credit facility, consider establishing a revolving credit facility with a due date at least one year beyond the current balance sheet date. This will increase your working capital position and many surety companies will consider this a long-term liability.
• Term out short-term borrowings – If you have used cash or line of credit facilities to purchase equipment, consider financing these through long- term debt arrangements. This will provide cash or reduce short-term debt and thus increase your working capital position.
• Minimize costs and earnings in excess of billings - Most contractors will have some amount of costs and earnings in excess of billings at the end of a reporting period. It is important to minimize these amounts as much as practical, possibly through more aggressive billing practices. In addition, if a larger than normal underbilling exists, be prepared to explain the causes to your surety. Also, consider disclosing any billings and collections on these amounts after year-end.
• Cash value of life insurance – Although this amount is usually presented as a long term asset, most surety companies will give credit for the cash value of life insurance in the working capital calculations. It is important that the cash value amount is presented in the financial statements to insure that the surety makes the proper working capital adjustment. In addition, consider borrowing against the cash value on the policy. The cash proceeds received will be added directly to cash and working capital.
• Other current asset detail – The financial statements typically reflect various other current assets as one amount in the current asset section of the financial statements. If the surety is unsure of what accounts are contained in this amount, they may discount it when calculating your working capital. Make sure that your surety has the detail on what makes up this balance to insure proper treatment in the working capital calculation.
• Limit shareholder/related party receivables – Related party transactions have always been scrutinized by surety companies. It is expected that this scrutiny will increase in light of changes to the underwriting process. Make every attempt to clean up receivable issues prior to year-end. If certain receivables are collected after year-end, be sure to disclose these facts.
• Income taxes for S-Corporations/LLC’s - With these types of entities, the shareholder/member of the entity is responsible for paying the tax liability, typically through distributions from the entity. If it isn’t evident to the surety, they will typically reduce your working capital based on their calculation of the expected tax liability. Make sure, either through disclosure or communication with the surety, that they understand exactly what the impact is or will be in the future so that they do not over-estimate this amount.
• Use your team of professionals - With the surety market in a state of change, it is vital that you stay in contact with your team of representatives (CPA, banker, surety company and agent) throughout the year and consult with them on any potential changes in your business in a proactive manner.

The above items are only a few of the steps you can take to improve your capacity. Our Construction Services Group has extensive experience in guiding our clients through these matters. Should you find your company having problems with your surety relationship or bonding capacity, we would be more than happy to consult with you. Please contact a representative of the group for a consultation.

Thomas J. Menk, CPA, is a Shareholder and Director of the Construction Services Group of Alpern Rosenthal, one of the largest certified public accounting and business consulting firms serving Western Pennsylvania. He can be reached at 412.281-1566 or at tmenk@alpern.com.