How do sureties calculate bonding capacity?

This guide is general information, not legal, tax or accounting advice. Laws, contract terms and exceptions vary by state, by claim and by contract, so confirm how any of this applies to you with an attorney or CPA licensed where you work.

Sureties calculate bonding capacity from an adjusted balance sheet. The underwriter starts with your year-end CPA statement, strips out assets it doesn't trust, and applies a multiple. Marcum LLP puts the usual range at "10 to 20 times the lesser of the adjusted working capital or equity of the contractor." Character, track record and the WIP schedule then decide where in that range you land and how the line splits between single-job and aggregate limits. These are rules of thumb, and every surety sets its own line.

How do I determine my bonding capacity?

You can estimate your own bonding capacity in three steps. Calculate working capital (current assets minus current liabilities) and net worth from your latest year-end statement. Adjust both the way an underwriter would. Then multiply the lower of the two adjusted figures by 10 for a conservative number and by 20 for the top of the range.

UHY describes the same method: sureties take "the lesser of 10-20 times working capital (current assets minus current liabilities)" and compare it with a multiple of net worth.

The second test is the 10% rule. Old Republic Surety says underwriters look for "working capital in the company which roughly equals 10% of the contractor's work backlog." Jordan Anderson, CCIFP, states it more precisely: "Working capital should equal at least 10% of your backlog cost to complete."

Here's an illustrative case. A mechanical contractor with $2.5 million of adjusted working capital and $4 million of adjusted net worth would start from the $2.5 million figure. At 10 to 20 times, that points to $25 million to $50 million of bonded work. The 10% rule gives the conservative end, $25 million of backlog cost to complete.

Boland and McCarthy of McCarthy & Company apply the 10% rule to both measures, describing it as "10% working capital and 10% equity of total cost to complete work on hand."

How do sureties set single-job and aggregate limits?

A bond line has two limits. The single-job limit is the largest contract the surety will bond. The aggregate limit caps all the bonded work you can carry at one time.

Construction Business Owner defines them plainly. The single limit is "the maximum dollar amount per project that you can bid on," and the aggregate is "the maximum amount of work you can do at any one time."

The same article shows how the two interact. A contractor with a $250,000 single limit and a $500,000 aggregate can't bid any one contract above $250,000. It could run two $250,000 jobs at once, or five $100,000 jobs.

Both limits come out of the same underwriting of your adjusted working capital, net worth and statements. Construction Business Owner notes sureties generally want those statements signed by an outside CPA once you move past small work.

Backlog growth gets its own scrutiny. In Construction Executive, Brent McAllister of Zurich says that when a contractor's balance sheet lags its backlog growth, underwriters do a "much deeper risk assessment of profitability trends, outlook for profit retention." A contractor that wants a bigger aggregate should expect the surety to look at whether retained earnings are keeping pace.

What are the three C's a surety will consider before bonding a contractor?

The three C's are character, capacity and capital. Merchants Bonding Company defines them this way:

• Character "refers to the reputation, integrity, and track record of the individual or entity seeking surety credit."
• Capacity "assesses the applicant's ability to perform the specific obligations outlined in the contract."
• Capital "represents the financial strength and resources available to support the obligations being guaranteed."

Capital is where the multiples and adjustments live. It's also the C a CFO can move fastest, by collecting old receivables, cleaning up related-party balances and keeping earnings in the company.

Capacity is judged contract by contract. The question is whether your company can perform the specific job in front of the surety.

Character rests on reputation and track record. Of the three C's, it's the one no balance sheet adjustment can fix.

Dave O'Brien, a construction CPA, sums up the underwriter's view in one line: "Sureties don't bond jobs. They bond businesses." The three C's are how they judge the business.

What do underwriters take out of working capital and net worth?

Underwriters remove or discount assets that may not turn into cash when a job goes bad. The adjustments vary by surety, but the common ones are consistent across surety and CPA sources:

Old Republic Surety's Darrel Lamb writes that underwriters "disallow any receivables (with the possible exception of retainage) that are three months or more old."

Underbillings get extra attention. Jason Bainter of CBIZ writes that "one job with underbillings greater than 25 percent of total equity gets its own page in the underwriting file."

Why do CPA-prepared statements and the WIP schedule matter so much?

The level of CPA work on your statements affects how large a bond program a surety will support. Bainter of CBIZ gives rough ranges: internal statements will "normally" support up to a $2 million program, a compilation about $3 million, and with a review "a contractor can generally get whatever program is needed." He reserves audits for very large programs.

Old Republic Surety advises contractors on internal or compiled statements to "consider upgrading to a review quality fiscal year end report" from a construction-oriented CPA.

The WIP schedule is where underwriters test whether your earnings are real. Bainter says underwriters "pull every completed job from your work-in-progress (WIP) schedule for the last 24 to 36 months" and compare original and final gross profit. Steady fade on closed jobs tells the surety your current estimates are probably optimistic too.

Dave O'Brien's warning is short. "WIP is the silent killer. If your Work in Progress schedule doesn't reconcile to the P&L and the balance sheet, underwriting stops listening."

Timing matters as well. Old Republic recommends updating in-house financials "at least monthly" and sending them to the surety quarterly.

How can a contractor increase bonding capacity?

The fastest gains come from moving dollars back into adjusted working capital. Because a surety multiplies that number, each dollar recovered counts several times over.

UHY puts a number on it. "Collecting $100,000 of A/R over 90 days outstanding can increase bonding capacity by approximately $1 million." That's the low end of the 10 to 20 times range applied to $100,000.

The steps that show up most often in surety and CPA guidance:

1. Collect receivables before they age past 90 days. Old ones get excluded at year-end.
2. Clear related-party balances. Repay loans to owners and affiliates before year-end, or expect them to come out of working capital and equity.
3. Subordinate shareholder loans to the surety. Marcum notes subordinated stockholder loans can count as equity.
4. Keep earnings in the company. Ben Williams, writing in Construction Business Owner, warns that "many accounts show a strong balance sheet midyear but distribute all the profits (or more) at year-end."
5. Upgrade the statement. Move from compilation to review if your program is growing.
6. Tighten the WIP. Reconcile it to the general ledger every month and address fade early.
7. Keep long-term debt long-term. Bainter notes underwriters add back the non-current portion of debt.

How does licensing revenue affect bonding capacity?

Cash from licensing your project records adds to current assets on the day it arrives. Whether it raises adjusted working capital depends on how your CPA books the license.

Under the revenue standard, ASC 606, a license that gives the buyer the right to use a fixed copy of your records is usually recognized at a point in time. Deloitte's revenue recognition guide says revenue from a right-to-use license "is recognized at the point in time when control of the license is transferred to the customer," and ASC 606-10-55-58C bars recognizing it before the copy is delivered. A one-time license that's paid and delivered usually leaves no deferred revenue behind.

Deferred revenue comes in when the timing splits. Money received before you deliver the records sits as a contract liability until delivery. A promise to deliver new years of records later gets its own share of the fee, held back until those records go out. RevenueHub, from the BYU School of Accountancy, describes that deferred revenue as an obligation to transfer goods or services a customer has already paid for, and it offsets the cash in working capital until it's earned. Whether a dataset counts as intellectual property for these rules is still a judgment your CPA makes.

ASC 606 defines revenue as inflows from an entity's "ongoing major or central operations." Licensing records isn't a contractor's central operation, so CPAs commonly present the income as other income rather than contract revenue. Taxes owed on the income can also reduce the working capital it adds.

Underwriters also weigh where profit comes from. In Construction Executive, Tim Holicky of The Hartford says "contractors succeed to the extent that they earn consistent profit at the project level," and Zurich's Brent McAllister points to "consistent profitability track records." License income sits outside job-level profit, so an underwriter may count the cash in working capital without treating it as repeatable earnings. Ask your CPA how it will be presented and talk to your surety broker before you count on it.

A license doesn't touch your contracts, WIP or job cost history. You keep the original records, and the license covers a copy. Conduit can't promise any change to your bond line. That's a call for your surety.

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