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Performance Bonds – Quality Financial Reporting

Performance Bonds – The Importance of Timely and Quality Financial Reporting

If you’re reading this, then you most likely know about surety bonds.  If you’re in the construction industry, then you definitely know about performance bonds.  You may think they’re a necessary evil or you may think they’re an asset to your business.  Regardless, if you’ve been through the surety approval process before, you recognize just how important financial statements are when you establish your surety line of credit.

Why is Timely Financial Reporting So Important?

The timing of your financial reporting is important because surety companies continually evaluate your bond program.  Surety bond capacity – the total amount of surety credit allowed at one time – changes depending on new work added to your program and old work which has been completed.  New work which is added during the year decreases your surety bond capacity.  Work which is completed either entirely or a percentage thereof adds to surety bond capacity.

For example:  Let’s say your surety company offers you an aggregate surety bond line of credit in the amount of $2 million.  This means the surety company will provide performance bonds as long as your company’s total work on hand does not exceed $2 million.  Now let’s say you have roughly $1 million of work currently underway or in process and you pick up another $500,000 project.  This means you have $500,000 of surety bond capacity remaining ($2 million less $1.5 million equals $500,000 in remaining capacity).  Now let’s use the same example of $1 million in work in process but let’s assume you’ve completed $500,000 of the $1 million in process.  This means you now have $1.5 million in remaining surety capacity ($1 million less $500,000 equals $500,000 in process).

Constant and consistent financial updating keeps the surety company in-the-know about your company and its activities.  It allows surety bond underwriters to approve performance and payment bonds quickly.  This means there’s no last minute rush to provide a financial statement for that last minute bid bond request.  It also means that any questions the surety company have regarding your financial statements have the opportunity to be answered before a last minute request.  Basically, it results is a much smoother process which, in turn, allows for quicker turnaround for your bonds and a better surety relationship.

Why does the type and quality of the financial statement I send to the surety company matter?

Surety companies rely on a few key factors when determining how large of a surety bond program to give a client.  One of those factors is a contractor’s financial statements.  Financial statements tell a story about your company.  They show profit (and losses), free cash flow or the lack thereof, debt levels, and all sorts of things that are important to any provider of credit.  Your financial statements are the lifeblood of your surety bond program and can make or break that next bid bond or final performance bond request.

Because financial reporting is very important to a surety company, the type and quality of the financial statements you provide is key.  We mentioned above that your performance bond program is constantly being evaluated.  In theory, the higher the level of financial reporting, the higher bonding capacity a company can expect to receive.  The last statement was qualified as there are other factors that ultimately determine your maximum surety bond capacity.  Meaning, a surety company is probably not going to provide a $2.5 million performance bond regardless of the level of financial reporting when the largest project you’ve completed is $250,000.  However, if you’ve completed a $2 million project in the past, an upgrading your financial statement from a CPA Compilation to a CPA Review (see below) can make all of the difference.

The different types of CPA prepared financials and what they mean to a surety

CPA Compiled – This type of CPA financial statement is prepared when the CPA has collected your books, records, etc. and compiled them into a balance sheet and income statement.  It also means the CPA has not verified any of your information such as cash balances, receivables, and other information which is valuable to an underwriter.  The CPA offers no assurances as to the accuracy of the financial statements.  As such, the surety company will often ask for cash verifications and aged receivable schedules to verify the amounts listed on your balance sheet.  A compilation is typically the least expensive method of financial statement preparation.

CPA Reviewed – A CPA reviewed financial statement is one that has been reviewed by a CPA.  The CPA performs checks by verifying bank statements and other financial information but does not perform many of the functions required of an audit.  These statements generally include notes to the financial statements regarding revenue recognition, receivables, loan information, and other important events.  The surety underwriter gains a greater understanding the company’s financials over a compiled statement as they consider a CPA reviewed financial statement more reliable and trustworthy.  However, although a CPA can offer certain assurances with a reviewed statement, they cannot express an opinion as to the fairness of the financial statements as a whole.  A reviewed financial statement’s cost varies depending on the detail and amount of work required.

CPA Audited – A CPA audited financial statement is the highest level of CPA preparation.  Various auditing techniques are performed by the CPA to ensure the financial statements are accurate and presented fairly.  The CPA will offer either an unqualified opinion, a qualified opinion, or an adverse opinion.  An unqualified opinion means the CPA believes the statements to be both accurate and in accordance with generally accepted accounting principles (GAAP).  A qualified opinion means the CPA feels that the financials are prepared fairly with the exception of scope limitation or limited departures from GAAP.  An adverse opinion means the CPA does not feel the financials are represented accurately.  A surety company gives the greatest weight to CPA audited financials because it has a high level of certainty the financials are accurate and reliable.

A final word on financial reporting and performance bonding

Timely financial reporting and quality financial statement preparation will help you maximize your surety bond capacity.  It demonstrates to your surety bond underwriter consistency, reliability, and trust.  These three items will do more to help establish and grow a surety company relationship than almost anything else.