In today’s economic environment, with increasing wages, inflation, and rising interest rates, contract prices are under upward pressure. Contractors should closely monitor their surety program limits and be aware of any constraints or concerns from their surety. As your backlog and individual project sizes grow, you may need to increase your surety program limits accordingly.
Here are six key considerations if you want to grow your surety program:
1. Working Capital
Sureties evaluate your working capital when determining the single project size they are comfortable supporting. They typically prefer working capital to be 5-10% of your project size, with 10% being the industry standard. This calculation excludes receivables over 90 days, related party receivables, 10-20% of marketable securities/investments, and prepaids.
2. Net Worth
Net worth indicates the total surety program a surety will support and reflects how much loss a company can absorb while remaining operational. Sureties typically prefer a net worth that is 10-20% of your total program. This total program includes both bonded and unbonded projects, run-off since issuance of the Work-in-Progress (WIP) report, and any outstanding projects or bids awaiting award. Again, this calculation excludes receivables over 90 days, related party receivables, 10-20% of marketable securities/investments, and prepaids. In addition to the current asset discounts, the surety will also take out any Goodwill included in your long-term assets.
3. Liquidity
Liquidity is crucial for surety underwriters. Maintaining a strong cash balance, staying on top of collections, and keeping a low bank line balance are key factors that sureties consider when assessing how a contractor manages their business. Your access to cash and ability to cashflow your projects without bank support in relation to your single project size and total work on hand plays a key role in the surety’s comfort level with extending surety credit.
4. Cash Flow from Operations
Consistent positive cash flow from operations is vital for gaining the surety’s confidence. It demonstrates your ability to meet short-term liabilities and invest in new projects. Regularly monitoring and managing your cash flow can showcase your financial stability and operational efficiency.
5. Underbillings and Overbillings
Effectively managing underbillings and overbillings is essential. Underbillings can indicate poor project management or financial distress, while overbillings might suggest aggressive revenue recognition or include deferred profits. Late stage underbillings will be scrutinized by your underwriters, and may cause concern. Without a sufficient cash balance to offset overbillings or an explanation that overbillings include deferred profits, a large overbilled position could be viewed negatively. Both can be red flags for sureties. Accurate billing practices that reflect the true progress and financial status of your projects are crucial.
6. Stable Profit Margins
Maintaining stable and healthy profit margins is key. Sureties favor companies that consistently achieve their profit targets. Fluctuating or low profit margins can signal potential issues with cost control or project management. Focus on efficiency and cost management to ensure robust profit margins.
By focusing on these six areas—working capital, net worth, liquidity, cash flow from operations, underbillings and overbillings, and stable profit margins—you can better position your company to grow its surety program. This proactive management will help ensure you can take on larger projects and expand your business successfully, even in a challenging economic environment.
