LUTZ BUSINESS INSIGHTS
Paving the Way to Surety Bonds for Construction Projects
JARED HARDY, AUDIT SHAREHOLDER
The Peterson Construction Company is about to embark on a significant real estate project in a revitalized community in a neighboring city. The last step the company needs to take before the official start of work is to secure a surety bond. While all signals look good, John Peterson is not altogether certain the financial underwriter will deem his company a safe risk.
Sound like a familiar scenario? After all, surety bonds are commonly needed by construction companies. Often confused with insurance, these bonds work more like a form a credit—a guarantee that the construction company will carry out a contract within all applicable laws and regulations. In other words, if a company does not fulfill its responsibilities according to the terms of the bond, a project developer can file a claim and recover all financial losses.
Sureties primarily provide three types of bonds in the construction industry that provide varying forms of protection:
Protection provided to a project owner if a contractor backs out of a project after winning a bid or fails to secure a performance bid. This type of bid provides a guarantee that the project will be undertaken within the terms at which the contractor bid.
Financial loss protection provided to a project owner in the event that a contractor does not complete the project in accordance with the terms agreed upon.
Assurance that a contractor has the financial capability to compensate workers and suppliers for labor and material utilized in the project.
While most construction companies understand the necessity of being able to obtain bonding, the factors that are considered by underwriters in determining the associated risk, and therefore their willingness to bond, are often unclear. As the ability to secure bonding is dependent on risk, it is important to maximize the attractiveness of the company from an underwriter’s perspective.
The following three Cs of a company are evaluated by surety specialists when determining a contractor’s risk level:
Does the contractor have the necessary technical skills, knowledge, equipment, experience and staffing to complete the project? This question is answered by reviewing work in process (WIP) reports as well as previous jobs completed by contractors. WIP schedules are examined for contract prices, billings to date, costs to date and estimated costs to complete in order to determine job cost stability and profitability. Completed jobs provide a historical trend of overall profitability.
What type of reputation does the contractor have within the construction industry? Character is determined by evaluating a contractor’s history and relationships; reputation for taking unusual or unnecessary risks; integrity; commitment to obligations; and past and pending litigation against the company.
Is the company financially viable? As there is financial risk associated with construction projects, it is imperative that a company is able to demonstrate its ability to meet obligations, sustain adequate working capital and generate positive cash flows. The proof of a company’s financial stability is generally illustrated in a company’s reviewed or audited financial statements. Since financial statements play an important role in determining whether a surety bond will be issued, it is important for companies to work with reputable accounting firms that specialize in the accounting industry and understand an underwriter’s perspective.
By gaining a clearer understanding of how surety specialists use these three Cs to evaluate a construction company, you will be able to better understand how they will evaluate your company. Similar to assessing risks a company may face, analyzing your own company in this manner will allow you to make improvements and increase the likelihood of securing bonding.
ABOUT THE AUTHOR
JARED HARDY + AUDIT SHAREHOLDER
Jared Hardy is an Audit Shareholder at Lutz with over 13 years of experience. He has significant experience in public accounting providing accounting, auditing and consulting services to privately-held companies in a variety of industries.
AREAS OF FOCUS
AFFILIATIONS AND CREDENTIALS
- American Institute of Certified Public Accountants, Member
- Nebraska Society of Certified Public Accountants, Member
- Certified Public Accountant
- BS in Accounting, University of Nebraska, Lincoln, NE
- NOVA Treatment, Board Member
- Knights of Columbus, Member
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