How to enhance your Company’s surety relationship

1. Surety Bonding – What
You Don’t Know Can Hurt
You
Lee Building Industry Association
Commercial Contractors Council
Luncheon
April 6, 2011
6
©2011 LarsonAllen LLP
1

2. Today’s Presenter
y
• John Reed, CPA, CCIFP
239.226.9903, jreed@larsonallen.com
239 226 9903 j d@l ll
Principal, Construction and Real Estate
p
LarsonAllen LLP, Fort Myers
http://www.larsonallen.com/Construction_and_Real_Estate/
Masters of Accounting, Nova University, Fort Lauderdale
CPA licensed in Florida
Certified Construction Industry Financial Professional
Certified Specialist in Estate Planning
Certified Information Technology Professional
rsonAllen LLP
Practice exclusive to construction and real estate in Florida
©2011 Lar
2

3. Today’s Agenda
y g
• The Contractor/Surety/Owner Surety Relationship
• Trends in today’s surety markets.
• How does a Surety look at your information?
– Working capital with surety adjustments
g p y j
– Liabilities to equity
– GAAP versus tax basis financial statements
– Job schedules
– Do-s and Do Nots - What do Sureties like and not like?
• Surety information checklist
rsonAllen LLP
©2011 Lar
3

4. The Contractor/Surety/Owner Surety
Relationship
3. And Contractor Surety 2. Then Surety pays to
reimburses Surety for complete work on owner’s
their payments job, or pays the unpaid
labor, material and
subcontractors
Contractor Owner
1. If contractor fails to
complete bonded job, or
p j ,
leaves unpaid labor, material
and subcontractors
rsonAllen LLP
©2011 Lar
4

5. Trends in Today’s Surety Markets
y y
• Bonding is getting more difficult to obtain, but bonding is
available for well capitalized companies. Bonding has become
a competitive advantage for those who have it. We are seeing
more reliance on alternative arrangements like Funds Control
and Asset Pledging
Pledging.
• There is increasing surety and bank pressure on contractors to
g y
upgrade financial statements from reviews to audits, and from
compilations to reviews
• Subcontractors are being asked to bond more work
• Less government work is expected this year as state and local
rsonAllen LLP
governments deal with budget issues. What work is being bid
is expected to be even more competitive than last year.
©2011 Lar
5

6. How Does a Surety Look At Your Information
y
• Financial stability is one of the most important
factors in obtaining surety credit.
• While most clients focus their attention on their
income statement, the most important section of
their financial statement to a surety is the
balance sheet.
rsonAllen LLP
©2011 Lar
6

7. Key Financial Ratios for Sureties
y
• Working Capital: Current Assets minus Current
Liabilities
• Adjusted Working Capital: Working Capital from above,
less adjustments to back out unproductive current assets
such as:
– Shareholder, officer, and related party receivables
– Prepaid E
P id Expenses
– Some portion of inventory (often 50%) that is not on a job site
– Under billings
– Bond programs are usually based on some multiple of (often 10
times) adjusted working capital
• Liabilities to Equity
– The ratio of all company liabilities and debt to stockholder equity.
rsonAllen LLP
As a general rule, sureties like to see a ratio of 2 to 1 or less.
g
©2011 Lar
7

8. Working Capital Example (With Surety
Adjustments)
ASSETS
As Adjusted
On Books By Sureties
y LIABILITIES AND STOCKHOLDERS EQUITY
STOCKHOLDERS'
CURRENT ASSETS
Cash and Cash Equivalents $ 750,000 $ 750,000
Securities Available-for-Sale 555,000 416,250 CURRENT LIABILITIES
Accounts Receivable: Current Maturities of Long Term Debt
Long-Term $ 783,000
783 000
Current Billings on Contracts 2,945,000 2,945,000 Accounts Payable:
(Surety Adjustment for Over 90 Days) (250,000) Current 1,940,000
Retainages on Contracts 380,000 380,000 Retainage 300,000
Other Current Noncontract Receivable 125,000 125,000 Billings in Excess of Costs and Estimated
(Surety Adjustment for Related Party Receivables) (75,000) Earnings on Uncompleted Contracts 450,000
Allowance for Uncollectible Accounts (100,000) (100,000) Accrued Expenses 475,000
Costs and Estimated Earnings in Excess
g Income Taxes Payable
y 110,000
,
of Billings on Uncompleted Contracts 50,000 -
Inventories 165,000 82,500 Total Current Liabilities 4,058,000
Prepaid Expenses 37,000 -
Deferred Income Taxes 15,000
15 000 -
Working Capital (Current Assets
Total Current Assets 4,922,000 4,273,750 minus Current Liabilities 215,750
rsonAllen LLP
©2011 Lar
8

9. Debt to Equity Example
q y p
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES LONG-TERM LIABILITIES
Current Maturities of Long-Term Debt $ 783,000 Long-Term Debt (Less Current Maturities) 407,000
Accounts Payable: Deferred Income Taxes 100,000
Current 1,940,000
1 940 000
Retainage 300,000 Total Long-Term Liabilities 507,000
Billings in Excess of Costs and Estimated
Earnings on Uncompleted Contracts 450,000 Total Liabilities 4,565,000
Accrued Expenses 475,000
Income Taxes Payable 110,000 STOCKHOLDERS' EQUITY
Common Stock - No Par Value; 100,000 Shares
Total Current Liabilities 4,058,000 Authorized, 50,200 and 50,000, Respectively,
Shares Issued and Outstanding 60,000
Debt to Equity Retained Earnings 2,050,000
(Total Liabilities / Total Equity) 2.14 Times Unrealized Gains on Securities 25,000
Total Stockholders' Equity 2,135,000
Total Liabilities and Stockholders' Equity $ 6,700,000
rsonAllen LLP
©2011 Lar
9

10. GAAP vs. Tax Basis Financial Statements
• Sureties want GAAP (Generally Accepted Accounting Principles)
financial statements. Tax basis statements lower the ability of the surety
to l
t rely on your financial statements and reduces your ability t get a
fi i l t t t d d bilit to t
bond.
• Th purpose of GAAP based fi
The f b d financial statements i t f i l present a
i l t t t is to fairly t
Company’s financial position, results of operations, and cash flows.
GAAP contractor financial statements are (almost) always on a Percent
Complete basis
• The purpose of Tax basis accounting is (or should be) to show as little
income as possible, as late as possible. This is counterproductive to
Surety credit.
• Cash, Accrual, and Completed Contract are tax methods
rsonAllen LLP
• Section 179 (writing off asset purchases in the year of purchase) and
Bonus Depreciation are tax methods.
©2011 Lar
10

11. Job Schedules Should Be Included In a
Contractor’s Financial Statement
• Include separate schedules of open and closed jobsjobs.
This should be a complete listing of all contract activity.
• All direct and indirect costs (such as equipment
depreciation, fuel, payroll taxes, workers compensation
insurance, etc.) should be job costed and included in the
, ) j
schedules. If your accounting software can’t do that
these costs must be allocated (and you should look for
new software).)
• There should be a summary schedule that MUST equal
the total revenue and direct costs on the income
statement. There should be no unallocated costs or
rsonAllen LLP
revenues.
©2011 Lar
11

12. Example Summary Job Schedule
p y
SCHEDULE I - EARNINGS FROM CONTRACTS IN 2010
FOR THE YEAR ENDED DECEMBER 31 2010
31,
(SEE INDEPENDENT ACCOUNTANTS' REVIEW REPORT)
Contract Cost Of
Revenues Contract Gross
Earned Revenues Profit
Contracts Completed
During 2010 $ 14,550,000 $ 12,730,000 $ 1,820,000
Contracts In Progress
At Year End 3,950,000 3,550,000 400,000
$ 18,500,000 $ 16,280,000 $ 2,220,000
rsonAllen LLP
Per I
P Income Statement
St t t $ 18,500,000
18 500 000 $ 16,280,000
16 280 000 $ 2,220,000
2 220 000
©2011 Lar
12

13. Do-s and Do Nots – What do Sureties like and not
like?
• Do-s of Surety
y
– Maximize profits
– Minimize overhead
– Surround yourself with good people
– Make a business plan and follow it
– Make a plan for business continuity
– Fund the continuity plan
yp
– Stay focused on construction
– Consult surety agent and CPA before significant financial
decisions
d i i
– Avoid litigation
rsonAllen LLP
– Establish a good line of credit with your bank
©2011 Lar
13

14. Do-s and Do Nots – What do Sureties like and not
like?
• Do Not's of Surety
y
– Invest in any kind of speculation
– Buy planes, trains, or boats
– Borrow money from the business
– If a Sub S Corp - don't take excessive distributions
don t
– Make loans or guarantee obligations of others
– Jump from one surety to another
p y
– Allow the business to buy out a stockholder before consulting
your surety agent and CPA
– D not get your bonds f
Do t t b d from an agency th t doesn’t have
that d ’t h
specialists in surety
rsonAllen LLP
– Do not use QuickBooks for your job cost accounting system
y j g y
©2011 Lar
14

15. Continuity Plans
y
• Wh t would h
What ld happen t your C
to Company,
employees and jobs if you were killed or hurt in
a car accident tomorrow?
• A continuity plan addresses th
ti it l dd these contingencies.
ti i
The documentation showing you thought
through that process is a Continuity Plan
Plan.
• S ti lik t see th t a Company h a
Sureties like to that C has
Continuity Plan in place.
rsonAllen LLP
©2011 Lar
15

16. Surety Information Checklist
y
 Independent audited/reviewed Financial Statements
within 90-120 days of year end
90 120
 Aging of AR and AP
 Analysis of overhead costs (supplemental information)
 Equipment schedules
 Outline of bank agreements
g
 Quarterly internal financial statements
 Quarterly up to date open and closed job schedules
 Comprehensive business plan, forecast or strategy
 Resumes of key employees and management
 Personal and corporate indemnity
 Personal financial statements
rsonAllen LLP
©2011 Lar
16

17. 17
Questions?
©2011 Lar
rsonAllen LLP