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Contractors who want to be considered for and take on larger, more complex construction projects typically need to obtain a surety bond. The higher a contractor’s bonding capacity, the larger the projects that may become available to bid on. Bonding companies look at a wide range of factors when determining a contractor’s bonding capacity, typically referred to as the three C’s of bonding capacity – character, capacity, and capital. Capital, including cash flow and access to working capital, is one of the most important factors, and one of the most challenging for many contractors. See below for some tips on how to improve cash flow and, in turn, your company’s bonding capacity.

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What Are Cash Flow and Bonding Capacity, and Why Are They Important?

A surety bond is, in essence, a type of insurance policy. It involves a three-way contractual agreement among a contractor, a property owner/customer and a surety. The contractor has a separate contract with the customer for construction services. If the contractor is unable to complete their part of that contract, the surety will step in to pay for the completion of the project up to the amount of the bond.

Because surety companies take a risk when they issue bonds to contractors, they will limit the amount of a bond based on their assessment of a contractor’s financial condition and work capacity. “Bonding capacity” refers to the maximum amount of credit that a surety company will extend in the form of a surety bond. The bigger your company and size of the projects that you complete, the larger your bonding capacity needs to be.

“Cash flow” is the amount of money coming into a business as revenue and going out as expenses. It is one of the most important indicators of a company’s financial stability. Better cash flow often leads to higher bonding capacity, which gives a contractor access to the bidding processes for larger projects.

How to Improve Cash Flow and Bonding Capacity

Contractors can boost their cash flow by increasing revenue or cutting expenditures. Both have value when it comes to increasing bonding capacity. The following suggestions can help contractors become more appealing to surety companies.

1. Build a Strong Reputation

A track record of successful projects and satisfied customers is one of the most important factors surety companies consider when determining whether to issue a bond and in what amount. A good reputation can also lead to sustained success. Building a successful track record may involve the following:

• • Completion of projects on schedule, within the budget and in accordance with all relevant quality standards;
  • Positive customer experiences, such as prompt responses to change orders;
  • Positive relationships with vendors, subcontractors, lenders, customers and others; and
  • Good standing with licensing boards and professional certification organizations.

2. Keep Up-to-Date Financial Records

A contractor needs a complete, detailed set of financial records to show their financial condition. Up-to-date records allow contractors to identify areas that require improvement, which can lead to improved cash flow. Records of completed projects can establish a contractor’s track record of success. In addition to keeping up-to-date financial records, it is a good idea to ensure that the financial records are in good shape and are regularly reviewed by the company’s management team. Some best practices to consider when reviewing the company’s financial records include the following:

• • Review of the project status, margins, and cash flows;
  • Review of the company’s accounts receivable for significantly aged items; and
  • Review of the company’s accounts payable to ensure that all financial obligations can be met and paid in accordance with the specified terms.

3. Keep Cash Reserves

Surety companies want to see that a contractor has sufficient cash reserves to handle any bumps in the road that may appear in the course of a project. Contractors can maintain cash reserves in a variety of ways, including the following:

• • Using long-term debt instead of cash for certain purposes, such as financing or leasing the purchase of large equipment and keeping cash on hand for other purposes; or
  • Keeping retained earnings in the company instead of paying that money out to the owner or owners.
  • Consider if you have enough cash on hand to have your cash work for you by investing it into either a money market account or an investment account to generate additional earnings.
    
    

4. Use Automation for Prompt Invoicing

Sending and following up on invoices is a vitally important part of running a contracting business. Unfortunately, it sometimes gets overlooked, particularly the following up on aged invoices. Automating this process with accounting software can improve a contractor’s receivables and increase their cash flow.

5. Accept Multiple Forms of Payment

Giving customers a variety of ways to pay their invoices improves the chances of getting them paid on time. Fewer and fewer customers pay by cash or check anymore. Contractors can improve cash flow by accepting electronic payments through an online portal, or other online/virtual payment services like GCPay, Excel, Procore or Textura.

6. Make Efficient Use of Fixed Asset Purchases

The more large equipment a contractor purchases in cash, the less working capital they will have. They might consider alternatives to equipment purchases, such as short- or long-term debt or leasing. If a contractor purchases a large fixed asset via debt or leasing, the company will keep larger amounts of cash on hand, instead of a single large cash outflow, the impact to the company’s records would come due over time based on the specific terms of the debt or lease agreement.

Learn More about Construction Surety Bonds

Construction is a difficult business, and maintaining a company’s financial stability can be challenging. Help is available to improve contractors’ bonding capacity, which can lead to business growth and greater earnings.

Want to learn more on how to manage your construction business? Read how to understand financial ratios and KPIs for your construction business here.

Have questions? We would love to help!

If you have any questions or would like additional information about anything mentioned, please comment below or email us at askus@lgt-cpa.com.