Industry Insights

Although company size and personal relationships are significant factors when determining a contractor’s bonding capacity, a surety also will review the company’s financial statements. In doing so, underwriters observe ratios and trends and assess the company’s financial stability. In the current economic climate, it’s more important than ever for contractors to understand what sureties look for in these financial statements.

Financial Ratios

One common method for establishing a contractor’s aggregate bond limit involves reviewing various financial ratios, including working capital and leverage ratios. Working capital is calculated by subtracting current liabilities from current assets. This ratio helps underwriters determine if a contractor has the ability to pay its upcoming debt obligations and is directly related to the bond limit.

While financing may help improve cash flow and provide funds for equipment purchases, it can be a double-edged sword for many contractors. As debt levels rise, working capital is reduced and cash flow is committed for coming years. Contractors should closely evaluate their leverage ratios, including debt/equity and current ratios. Underwriters compare these ratios with industry benchmarks to gauge how a company compares to its peers.

Supplemental Schedules & Gross Profit Percentage

A surety analysis also may include a review of supplemental schedules. Underwriters can compare jobs completed in the current year with work-in-process schedules from the prior year to identify changes in gross profit percentages. Consistent gross profit percentages suggest a contractor is effective at estimating costs and can finish projects in the allotted time. However, fluctuating gross profits may indicate the contractor is an ineffective project manager.

Sureties also may analyze the overall gross profit percentage on a work-in-process schedule and compare it to the gross profit on the completed job schedule for the same year. Work-in-process schedules may be considered “wishful thinking” when estimated gross profits differ from actual profits. Typically, if the overall gross profit for work in process is significantly larger than the profit for recently completed projects, an underwriter will question this discrepancy.

For more information, please contact your BKD advisor.