Masonry Magazine February 2003 Page. 46
Legal Advice
When reviewing the Profit and Loss Statement, the bonding company is looking for cash, easily convertible stocks, bonds, short term investments, current accounts receivable, trade receivables, retainage receivables and possibly solid, short term loan receivables. They will not consider most inventory, owner or employee loans as an asset. This number is compared to the total liabilities that the contractor owes. I use the analogy with my customers that if an ax were to fall today, this minute, and all work ceased, how much cash would you have left over if you paid off every single bill you owed in full. This is the same number the bonding company is looking for and this is considered your Net Working Capital. The Bond Company will usually take this number, apply a multiplier of ten, and that will be your total Work Program. For example, if your Net Working Capital after you subtract total liabilities is $50,000, the total amount of work to have on hand at any one time will probably be around $500,000.
Bond companies will evaluate your net worth to determine two basic issues. First, they want to see that you historically have made a profit year after year and secondly, they want to make sure that the profits, at least a significant portion, stay in the company and are not withdrawn by the owners for personal use. The balance sheet is a method for tracking historical profits, as well as making sure the contractor is building up assets so that they can survive during lean times. Most importantly, does the contractor have sufficient funds to carry the cash flow demands of the total work in progress, usually determined on a cost to complete basis, that the contractor desires.
When understanding how bond companies operate and evaluate a contractor, there are a few more "rules of thumbs" that you need to be aware. For example, the bonding company will require a list of all the larger jobs that you have successfully completed and the margin you cleared on each job. Normally, a bond company will allow you to bid and bond only jobs less than two times greater than a similar one you have successfully completed. This helps control the growth of your company, as too rapid of growth often leads to extremely poor cash flow and the possibility of financial failure.
Another good rule of thumb is not to use your construction company to build or develop for yourself. Most bond companies frown on a contractor who uses the resources of their company to float personal development of speculative building investments. If you plan on doing this, set up a separate company.
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