Category: Construction

Maximizing surety credit

Surety credit
Make sure the job gets done!

One of the most valuable considerations in offering construction services is to establish and maintain good surety credit. It is critical that you are able to secure bonding when requested/required by a customer. The following is a discussion of ideas that I learned over twenty years as CFO for a highly successful General Contractor. I hope this will help you establish and maintain a solid surety relationship.

Don’t wait until you need a bond to know where you can get one

It’s important to establish a surety relationship before you need a bond. Find the right agent. They should have a reputation for being trustworthy and for keeping business information confidential. Ensure the agent has access to several underwriters. Make sure both your agent and underwriter(s) know the industry and your market well. The rating of the underwriter will be important to your customers. Furthermore, the agent’s knowledge can be a valuable resource in reviewing contracts and qualifying subs.

Maximize the amount of credit by knowing the underwriting criteria the underwriter will use

The surety will base their credit decisions primarily on a ratio of work program (the amount of uncompleted work under contract) to capital. The denominator in the ratio will generally be the lesser of your net worth or your working capital. You can command the best bond program/rate by maintaining a ratio of 20:1 or less.

The surety will make adjustments to your financial statement numbers in calculating your capital balance. For example, they will exclude older receivable balances even if management can establish they are collectible. Also, in measuring working capital, they will exclude prepaid expense balances but will include cash surrender value (CSV) of life insurance policies.

Here are a couple of tips:  1)  If the renewal of your insurance policies coincides with the beginning of your fiscal year, don’t pay or record a payable for the renewal deposit or first installment until after the first of the New Year.  Your working capital won’t be adjusted by the amount you “prepay”.  2)  If working capital contains perpetual, liquid cash reserves of any significance, consider buying key man life insurance via whole life policies.  Use the low-yield cash reserves to fund the CSV.  The CSV will carry a much higher yield and ultimately fund the death benefit.  Plus, the CSV is just a liquid as long as there are borrowing provisions in the policies.  Hence, you improve your investment yield and augment your surety credit.

Having an open line of credit agreement with a credible lender will greatly enhance your ability to obtain surety credit.

Keep your surety at the ready by having command of your numbers

Once the relationship is established, the surety will want numbers reported at least quarterly. You need to strive to report to them within 45 days after the end of the quarter. Reporting consistently and timely will instill confidence and trust into the relationship. You will need to submit a balance sheet and an income statement with revenues and work-in-process (WIP) balances calculated using the percentage of completion method. They will want to see an aged accounts receivable detail. They will also require a detail of the WIP.

Tips for reporting WIP: For significant jobs-in-process, the surety will monitor estimated profit against actual results. You need to keep close watch on your estimated costs to complete. Demonstrating a sound ability to estimate is as important as a strong balance sheet. Err on the conservative side. Write-ups are viewed much more favorably than profit fade.

Stay on top of your collections. Cash management and project management should be integrated. Your collection efforts will be much more effective if you put primary collection responsibility in the hands of the project manager.

The surety will need to monitor projected backlog and sales prospects. It will pay dividends if you can develop a mechanism to project sales and profit and report those to the surety on a regular basis.

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These are some of the more important things I learned over twenty years that help me and my employer maintain a strong surety relationship. We were able to earn the trust of both the agent and the underwriter. The Company was never denied a bond request during my tenure and we were eventually able to eliminate some of the collateral normally required. Sound management and financial practices over time will put you in a position to make commitments to your customers that they can have faith in.

If you think that I can help you in this kind of endeavor, don’t hesitate to contact me. Call 336-382-2841.  Or you can use the contact form from my website found here:  https://www.bartonltiffanycpa.com/contact/

The ABCs of accounting for costs incurred under long-term contracts

Actually, the title of this post should be the reverse, i.e. the CBAs of accounting for long term contract costs: Capitalize, Budget and Allocate. If you incurred costs under a long-term contract (i.e. a contract not completed during the accounting year in which it commenced) and are required to submit GAAP basis financial statements (i.e. for licensing purposes) or do not qualify for cash basis tax reporting, here are some basic principles that need to be applied in accounting for your costs. For most, this will be stating the obvious. However, over the years, I’ve seen several companies misapply these simple rules.

C – Capitalize direct and indirect contract costs in work in process

For GAAP purposes and for any method of tax reporting other than cash basis reporting, all costs directly and indirectly associated with the completion of the contract, from signing to completion, should be capitalized as job costs and not expensed as general overhead. In fact, certain costs may be incurred, e.g. design costs unique to the project, as part of the sales/procurement process, and must be capitalized in job costs. Architectural and engineering costs incurred in a building design would be properly capitalized in work-in-process and only expensed outside of job costs if the selling effort fails.

B – Budget all your production/construction costs by project

The primary method prescribed by both GAAP and IRC Section 460 for the recognition of revenue under long-term contracts is the Percentage of Completion Method (PCM) on a cost-to-cost basis. Simply put, you recognize revenue for at the end of each accounting period in the same ratio as Actual Costs incurred to Total Estimated Cost. You can’t properly account for your contract revenue unless you have an accurate idea as to what your final contract costs will be.

A – Allocate indirect costs

Many costs will be incurred where it is either impossible or not cost effective to directly charge them to the job. Such costs would range from labor overhead/burden to liability insurance to small equipment usage charges and production facility/shop/yard related overhead. Such costs are most effectively charged to jobs using any number of reasonable allocation methods. The impact of this is most critical if you are a smaller producer/contractor who qualifies for the Completed Contract Method of accounting for tax purposes. And, if you are using the PCM, don’t forget to factor such costs into your Total Estimated Costs as well.

Please forgive me if this is useless, old hat, news. However, if it raises questions about how you are recording costs related to a long-term contract, please feel free to contact me.

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