Here are some points to consider as you work towards building your bonding capacity. Before getting into that we’ll say that there are no hard and fast rules, only guidance, when it comes to bonding. There are too many variables to consider here but remember – the decisions you make every day will eventually show up in your financials a.k.a. your “Report Card”! Most of these areas take time and consistent effort to grow but we’ll start off the list with a couple that are immediately actionable.
Increasing Your Bonding Capacity
- Teamwork. Starting out, invest in a strong team who can provide sound advice as you grow your business. This includes your CPA, banker, lawyer, and bonding agents. Pick team members who focus their practice on the construction industry.
- Build your personal credit score. If you’re just getting started, you can leverage a strong personal credit score to secure business assets and entry level bonding.
- Develop a formal Business Plan. Taking time to develop and put a business plan in writing is free. There are plenty of resources online that can help guide you. Not only will a business plan provide you with direction and milestones to reflect on, it provides creditors with a vision of where you’re headed.
- The best time to secure a bank line is when you don’t need it. Ask your banker early on what it will take to get a working capital line of credit. As with your bonding, it may take a while to establish and grow a bank line but having even a modest line of credit in place and lightly used is a positive underwriting factor.
- The math. Surety underwriting considers your Character and operational Capacity, but Capital is the C that provides the foundation. Your particular surety company may focus on working capital or net worth, but your bonding capacity will grow as the strength of your balance sheet grows. The guidance you will hear from your bond company is that your program is a multiple of your analyzed working capital or net worth.
- Follow the trend. A financial statement is a snapshot of one moment in time. Underwriting will rarely come down to looking at a single year’s financial outcome. Your surety underwriter will analyze a minimum of 3 consecutive years financials to develop a view of how your business is trending. Developing a trend of measured growth and profitability is a key to building your bonding capacity.
- Keep your profits in the company. Retained earnings is a clear indicator of long-term profitability. As hard as it can be to keep the money in the company, organic growth through profit retention is evidence of long-term financial health and gives an underwriter confidence.
- Cash is King. This is an easy one. As you retain profits, maintain focus on building your cash position. Nothing can help you survive a problem better than cash. Every contractor has a bad job now and again. Whether it was a problem in the estimate, a developer not paying, a subcontractor going broke, or the weather, having a strong cash position will help you get through it.
- Buy assets. Assets produce income and/or go up in value. Once you have the cash buffer in place, you could use excess cash to buy business related real estate (a modest office or yard for equipment) might make sense. We would also consider highly utilized construction equipment an asset as it produces income even though it depreciates in value.
- Smart use of debt. The strategic use of leverage can propel your company forward much faster than if you waited to buy the assets outright. But keep in mind your underwriter will be keenly focused on your debt to net worth ratio. Depending on the type of contractor you are, debt to worth of 2:1 or below could be viewed as healthy with 3:1 potentially falling outside of a sureties’ risk tolerance.
- It’s not how much you make, but how much you keep. Tax strategy is a critical part of successful business, but steps to mitigate or defer taxes can often hurt your bonding capacity. Buying a $50,000 truck to save $10,000 in taxes may sound good, but your surety would much rather you have the cash and pay the taxes.
- Timeless risk areas. As you work day-by-day to achieve the points laid out here and ultimately your bonding capacity, let these timeless risk factors guide you. We can assure you your underwriter is considering these risks when you ask for more bond credit. Take incremental steps in increasing single project size, clearly define your geographic footprint, stick to your specialty, manage turnover in key positions, and invest in your accounting department.
Surety Bond Agency
Are you working with the right surety bond agency? Whether you’re wondering how to get a bid bond, need assistance with your surety indemnity agreement, or need to apply for payment and performance bond, Schmalz & Associates has you covered. Let us help you with obtaining a surety bond in Texas or understanding surety bond requirements by state.