What Do Sureties Look For in a Contractor?

By Tim Ayler, CPA, Partner and Shaun King, Audit Senior | Members of the Construction Services Group

As the economy slowly begins to stabilize, so too is the construction industry. In turn, more contractors will be in demand for work. To help obtain this work, contractors across the state are relying on surety bonds. A surety bond is a guarantee from a surety to a project’s owner that a general contractor will adhere to the provisions of a contract.

There are several different types of bonds and they work similar to a credit guarantee. If the contractor fails to perform according to the contract, the surety will pay the owner the damages and the contractor must then reimburse the surety for this payment.

Diamond shoppers are not the only ones looking for three C’s. Sureties also have traditionally looked at the following three C’s when deciding whether to issue a bond to a contractor:

Capital – the company must have the necessary working capital, or access to it, in order to finance the job and absorb some losses.

Capacity – the company must have the necessary skills, experience, knowledge, and equipment to perform the job

Character – the company must have a strong management team that is responsible in fulfilling obligations and contracts

While the three C’s provide a good base for obtaining bonding, sureties will be looking for more. Some of the other items that sureties look for are:

Profitability – Sureties look at the company’s gross profit percentage and net income as a percent of revenue compared to industry averages. They also make sure there is sufficient backlog gross profit to support general and administrative expenses.

Sureties will analyze job schedules on a job-by-job basis, making sure profit margins are consistent between jobs and between completed and uncompleted work. They also look for any significant profit fade on a job-by-job basis. When total gross profit percentage on a job ends up being much less (usually greater than 10%) than originally estimated, it creates concerns about management’s ability to estimate jobs. Therefore, a contractor should be careful not to be too optimistic before the job begins, but rather set realistic expectations of job profitability.

Liquidity – Some sureties look at high under billings (unbilled costs and estimated profits on open jobs) as a sign of untimely billings (unless the contract specifically does not allow billings until certain points in the job) or that costs on the job are exceeding what was estimated. If over billings (billings in excess of costs and estimated profits on open jobs) are high and there is little cash in the bank with a maxed-out line of credit, sureties may also be concerned whether there will be cash to finish the job as the early billings are being spent on other jobs.

Not all sureties look for the same things, therefore, having a good relationship with a bonding agent is important; as the agent is usually the person who will determine which surety is best suited for your company. A properly prepared financial statement goes a long way toward adding comfort to the bonding agent and surety. For any additional questions regarding sureties, please contact Tim Ayler, CPA at 317-260-4401 and tayler@greenwaltcpas.com or contact your bonding agent.