Bonding and the Importance of Quality Financial Information

By | April 5, 2011

By Randy C. Emery

Company Financial Statements:

Providing your bonding company with timely and accurate financial statements can be the most critical and influential aspect of not only maximizing the extent of your surety credit, but qualifying for it all together.  Yes there are a lot of other elements to qualifying for bonding; experience, management, credit, etc.  But without the surety’s ability to fully understand the full financial picture of their contractor client, they can’t make accurate decisions.

 

Too often good contractors are unable to obtain the level of surety credit they deserve because the bonding company lacks confidence the in financial information being provided.  Equally as often no bonding credit is provided at all, for the same reason.

 

Quality Financial Statements:

To the bonding company a complete financial statement consists of; balance sheet, income statement, and corresponding job schedule (completed & in-process), at a minimum.  Supplemental information when available should be provided as well; notes on financial details, A/R, A/P aging reports and related entity statements if not already consolidated.

 

Generally speaking there are two basic types of financial statements; cash accounting and accrual accounting. Accrual based accounting is the generally accepted accounting format.  But it gets more specific.  Within the definition of “Accrual Accounting” there are a number of different formats that fall within the basic General Accepted Accounting Principals.  In the bonding world the only acceptable accrual based format is that of “Percentage-of-Completion” accounting.  This requirement can’t be stressed enough!

 

In its simplest form, percentage-of-completion accounting requires the contractor to recognize the profits or losses of work in process.  This

Percentage-of-completion accounting is the most accurate form of accounting for a contractor.  However, it’s only as accurate as the in-house job progress billing and record keeping, which is another critical issue.

 

There is an IRS ruling that stipulates that contractors above a certain size must do percentage-of-completion accounting.  This applies to their tax accounting.  If your CPA is advising you that percentage of completion accounting is not required for your company, they are speaking from an IRS perspective.  Taxes can be prepared on one format, and financial reporting on another.  As for that other; the statements prepared for the bonding company needs to be on the percentage-of-completion basis, regardless of how the tax statements are prepared. It can’t be stated any simpler.

 

CPA vs. In-House Accounting:

As a general rule most bonding companies will accept quarterly in-house financial statements with year-end CPA prepared financial statements.  However, the format of those in-house financial statements needs to be the same; “percentage-of-completion” accounting.  If in-house accounting is not prepared with the percentage-of-completion format, you’re losing surety credit and frankly are not getting the management information you need.  Nor is your bank or bonding company for that matter.

 

Get up to speed, the sooner the better.  In today’s advanced software world, there is no reason not to adopt a qualified accounting system which will allow your business to prepare quarterly in-house financial statements on a percentage-of-completion bases.  At minimum, contractors can utilize the help of their CPA to make the necessary quarterly adjustments to existing in-house accounting so a quarterly percentage-of-completion statements can be provided.

 

Besides the bonding company’s requirement for in-house percentage-of-completion accounting, this more accurate information and will help the contractor better manage their jobs and their respective financial progress.  Keeping this data up-to-date during the year will reduce the CPA’s work load at the end of the year and should help reduce year end accounting costs.

 

CPA’s generally prepare 3 types of financial statements; Compiled, Reviewed, and Audited.  Without getting into the specifics, compiled statements are not satisfactory to the bonding companies.  These are viewed as little better than acceptable in-house financial statements.  “Reviewed Statements” are the most common and generally will be adequate for most contractors.  The larger the contractor and the larger the surety credit being requested the more likely an “Audited Statement” will be required.

 

Another important note on CPA prepared financial statements is the timeliness of them.  If you’re CPA can’t produce year-end financial statements within 4 months of the year end one of two problems exists:

 

1)      You’re not providing them with the necessary data they need to complete these statements.

2)      You’re not important to the CPA, they are over loaded, or simply not getting the work done on time.

 

Whatever the problem, you need to get it fixed; it’s costing you bonding credit.

 

Even though your CPA produces a year-end financial statement and does it in a timely fashion, you still need to be able to provide the bonding company with an in-house year end financial statements as well.  The more accurate the better, but year-end CPA adjustments to modest levels are to be expected.

 

Delayed financial information causes a number of concerns from the bonding company’s perspective:

 

Does the contractor really know how they are doing and how can they manage

1)      without accurate timely financial information?

2)      Is the contractor stalling because things don’t look very good?

 

Complete Financial Information:

Complete financial information is just that, complete, everything and then some.  Without going into the legal or accounting details, it’s important that financial information complies with the Federal “Sarbanes Oxley” regulations and is consolidated with all related entities.  Separate from the consolidated financial statements, the bonding company will request financial details on other significant business or financial interests of the owners of the construction company.

 

It is important the bonding company have a clear picture of the global financial condition of both the business as well as its owners.  If this information is not being shared it raises questions at to why?

 

Personal Financial Statement:

Personal financial statements generally do not need to be CPA prepared, but they do need to be reasonably accurate.  Too often the owner embellishes the value of their personal assets in an effort to convince the reader (bank and bonding company), and maybe themselves, they are worth more than they are.  It’s not necessary.  In reviewing personal financial statements banks and bonding companies get their biggest insight to the financial character of the owner more than anything else.

 

Send the reader the message that you are conservative, realistic and don’t have an inflated self value.  It’s a good message.  “This is someone we can rely on”.  “This is someone who will not embellish the reality of things”.

 

Bottom Line:

Financial information is a tool necessary for the bonding company to properly evaluate the merits of the account.  Without quality tools the work suffers.  Sometimes it doesn’t get done at all.


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