Irrespective of how good or bad the construction market may be, you can be sure of one thing -- your surety provider will want to take a close look at your numbers before it will issue bonding. What it finds on your balance sheet will influence whether you’ll get competitively priced bonding or not.
Ideally, the facts presented in your financial statement will show that your firm is in good financial health. Here are some measures that are commonly used to assess the strength of the balance sheet.
Working Capital
The amount of available working capital determines your company’s ability to finance current operations. Two key measures of the adequacy of working capital are the current ratio and the quick ratio (also known as the “acid test”). The current ratio is simply the amount of current assets divided by current liabilities. Ideally, your company should try to maintain a 1.2 to 1 or better ratio of current assets to current liabilities. The quick ratio is the amount of cash, cash equivalents, and short-term receivables divided by current liabilities. This ratio predicts your company’s ability to pay its current obligations with cash. One way to increase working capital is to use long-term debt instead of cash or short-term financing for fixed asset purchases.
Getting Paid
Slow collections are a serious problem for many contractors. You should monitor the amount of your accounts receivable over 60 days and try to hold that figure to a minimum. You can calculate the average number of days accounts are outstanding by taking net accounts receivable, multiplying by 365, and dividing the result by annual revenue. You can improve the number by sending bills out for work and materials as you complete each stage of the project. Be sure each bill clearly explains what stage of the work was completed. Send reminders when the customer doesn’t pay you within an allotted time. That usually works, but if you still don’t receive payment, you may have to threaten to stop work on the project until you’re paid.
Capitalization and Debt
Too little capital and high levels of debt can also make your balance sheet look extremely unattractive to a surety. One common way to measure a company’s level of capital is the debt to equity ratio. It is calculated by taking total liabilities divided by net worth. The higher the ratio, the greater the risk creditors face.
You also have to watch underbillings. Significant underbillings could indicate that your company is facing some problems on one or more jobs. You should be prepared to explain why costs that have been incurred cannot be billed currently.
Profitability
Low profit margins on too many jobs will limit your company’s future growth. You can measure profitability by using a return on assets ratio or a return on equity ratio. The first indicates your company’s profits generated from its assets and is calculated by taking net earnings and dividing that amount by average total assets. Well-run construction firms typically derive a 10% or higher return on assets. Return on equity measures the return on money invested by the owners. You can find this number by dividing net earnings by total net worth. It’s not unreasonable to expect to have a 15% or greater return on equity.
Analysis of your company’s financial statements can provide valuable information you can use to effectively manage the firm. By paying close attention to the balance sheet items that sureties focus on most, you can put your company in a better position to obtain the bonding it needs.
“Too little capital and high levels of debt can also make your balance sheet look extremely unattractive to a surety.”
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