In the construction world, there can be a sense of uncertainty about how a job will unfold. Jobs can go south quickly with issues that can be out of your control. For this reason, many companies get bonded. Bonds are how companies can insure themselves against potential losses from unsuccessful jobs. This article will explain common bonds needed in the construction industry, what bonding agents are looking for, the construction bond requirements, and crucial tips to help you with your bonding needs.
Common Bonds for Your Construction Company
You created a contract, but the project was not followed through to the specifications you had set. You ended up losing more money than you gained. The person you hired is acting unethically. You completed a job and were not compensated fairly. Does any of this sound familiar? If so, you will benefit from applying for bonds. Consider the following bonds to protect yourself and your work:
- Bid Bonds
- Payment Bonds
- Performance Bonds
- License Bonds
These four bonds all serve their own purpose, but despite their different abilities, each bond is intended to protect contractors, project owners, suppliers, and laborers.
What is the main purpose of a bid bond? To provide a guarantee to the project owner that the bidder will complete the work if selected. Additionally, they help prevent contractors from submitting inappropriate or unseemly low bids.
Bid Bonds are low-priced at a flat fee per contract, providing protection to project owners and contractors. If the contract is not completed, then the surety pays the difference. Bid Bonds are used alongside Performance Bonds—as soon as the contractor is awarded the project, the bidding company is required to have a Performance Bond submitted and the Bid Bond will be used as collateral until this is accomplished.
What is the main purpose of a performance bond? Performance Bonds ensure contractors perform according to their set contract specifications.
Performance Bonds are typically required for government-related projects but are also used in the private sector to protect against unsatisfactory work and mistakes. The cost of Performance Bonds is usually 1-3% of the overall contract price.
What is the main purpose of a payment bond? To protect property owners, subcontractors, suppliers, and laborers against nonpayment. If a party does not pay their obligee, the other party/parties can file a claim on the bond to receive compensation.
In Payment Bonds, the beneficiary is ranked lower than the General Collateral (GC). This bond needs to be bought during the bidding process. Payment Bonds cost around 3% of the contract but can differ depending on your surety bond quote.
Contractor License Bonds
What is the main purpose of contractor license bonds? To ensure contractors will act in an ethical and lawful manner with building codes and other applicable rules.
Contractor License Bonds do not pertain to a specific project; however, they are commonly required as a condition of a permit granted by a government authority. Depending on credit and other factors—Contractor License Bonds can cost between 1 and 5% of the total bond amount.
Complying with Bonds
To establish surety bond compliance, there are heavy repercussions for failing to meet and uphold bond requirements. This can be highly costly to the obligee to the bond. No matter which bonds you choose, pay careful attention to the criteria and language in said contract.
Steps to Obtain a Construction Bond
Now you know about the bonds available to you, but how can you obtain one? The following sections will guide you through obtaining a construction bond successfully.
- Decide on a bond right for you.
- Find a bonding agent and submit an application.
- Prepare financial documents, contracts, and other documents for examination. Your project and past work trends will be under scrutiny. They will likely require a job cost schedule, inventory schedule, and /or forecasting report.
- Receive a quote.
Construction Bond Requirements & Components Reviewed by Bonding Agents
Primarily, bonding agents want to look at what business plans the company has via identifying the following: description of the work, geographic location of the work, and resumes/skillsets of key personnel. They will want to see work in process schedules and backlog schedules for larger jobs. Agents will be looking to see if the company can perform jobs in proportion to the loan being requested. After the bonding agent gets a good sense of whether the company can perform adequate work and can secure jobs, they will want to see the numbers that are displayed through financial statements.
Typically, an agent is looking for the past three years of financial statements prepared by a Certified Public Accounting (CPA) firm. Financial statements prepared by third-party professionals will have the impact of lower risk, as there are less likely to be misstatements in the numbers. The three main statements examined are:
- Balance sheet
- Income statement
- Statement of cashflows
Balance Sheet Requirements for Construction Bonds
The key inspection points of the balance sheet are the relationship between assets and liabilities. Two main calculations in this process are the current ratio (current assets divided by current liabilities) and working capital calculation (current assets less current liabilities).
The agents want to see you are financially independent and have enough assets to cover your debts. The current ratio should be above one and your working capital should not be negative. If a company has too much debt the bonding agents may have doubts about getting paid back.
Income Statement Requirements for Construction Bonds
The income statement shows the profits of your company. It is especially important to bonding because it will be used to determine your company’s financial stability. In turn, this will help determine eligibility when seeking a bond. The agents will look at both your gross profit and net income for the past several years. Gross profit tells how profitable your jobs are as it takes your revenue less your direct expenses. Net income is the final profit for the year after all expenses and revenue. Bonding agents want to see a healthy trend of profitable years.
Cash Flow Requirements for Construction Bonds
Finally, the cash flow statement is looked at to see how cash is being used from year to year. A company that has trends of using their cash to pay down their debts and to reinvest in their company is more favorable than seeing cash taken out of the company by owners. Also, seeing a positive cashflow shows the bonding agent that their debts can be repaid.
How Ryan & Wetmore Can Help
To keep your bonding agents happy and to give yourself the best chance of securing a bond—keep the above information in mind and show financial independence and decent work capabilities. A bonding agent wants to ensure they will be repaid, a job will be completed as per the initial request and will do so by analyzing your financial trends over the years.
At Ryan & Wetmore, we help clients by producing financials and computing the key ratios needed to secure bonds. We provide strategic, calculated tips to our clients who have chosen us as their business partner on how to improve their financial statement strength. As a result, our construction clients are able to enter and maintain jobs with confidence.
For financial statement help, needs, and navigating the requirements for construction bonds, please contact us, and the construction team will be happy to assist you.
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About Jason Dudas
Director & CPA
Jason is a Senior Manager in our Vienna, VA office. Since joining the firm in 2009, he has worked closely with clients on tax, audit and accounting issues. Jason has become an expert in construction accounting and is a member of the Real Estate and Construction CPA’s. He also has experience with research and development credits, and tangible property regulations.
Read Jason’s full bio.
About Justin Gipp
Supervisor & MBA
Justin Gipp is a Supervisor at Ryan & Wetmore. Since joining the firm in 2014, Justin has been guided from a broad accounting background to a concentration in construction accounting. Recently Justin has been attending networking events affiliated with the Association of Builders and Contractors and the Maryland Construction Network. Justin obtained a BS in Accounting with a minor in Business from Mount St. Mary’s University, along with an MBA in Business Management from Mount St. Mary’s University.