Surety Bonding What Surety Bonding – What You Don’t Know Can Hurt YouLee Building Industry AssociationCommercial Contractors Council LuncheonLuncheon

April 6 2011April 6, 2011

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Today’s Presentery• John Reed, CPA, CCIFP

239 226 9903 j d@l ll239.226.9903, jreed@larsonallen.com

Principal, Construction and Real EstatepLarsonAllen LLP, Fort Myers http://www.larsonallen.com/Construction_and_Real_Estate/

Masters of Accounting, Nova University, Fort LauderdaleCPA licensed in FloridaCertified Construction Industry Financial ProfessionalCertified Specialist in Estate Planning Certified Information Technology Professional

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Certified Information Technology Professional

Practice exclusive to construction and real estate in Florida

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Today’s Agenday 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 adjustmentsg p y j– Liabilities to equity– GAAP versus tax basis financial statements

Job schedules– Job schedules– Do-s and Do Nots - What do Sureties like and not like?

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P• Surety information checklist

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The Contractor/Surety/Owner Surety RelationshipRelationship

Surety 2. Then Surety pays to complete work on owner’s job, or pays the unpaid labor, material and

3. And Contractor reimburses Surety for their payments

OwnerContractor

labor, material and subcontractors

OwnerContractor

1. If contractor fails to complete bonded job, or

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p j ,leaves unpaid labor, material and subcontractors

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Trends in Today’s Surety Marketsy y• Bonding is getting more difficult to obtain, but bonding is

available for well capitalized companies. Bonding has becomeavailable 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 Pledgingand Asset Pledging.

• There is increasing surety and bank pressure on contractors to g yupgrade financial statements from reviews to audits, and from compilations to reviews

• Subcontractors are being asked to bond more work

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• Less government work is expected this year as state and local governments deal with budget issues. What work is being bid is expected to be even more competitive than last year

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is expected to be even more competitive than last year.

How Does a Surety Look At Your Informationy

• Financial stability is one of the most important factors in obtaining surety credit.

• While most clients focus their attention on theirWhile most clients focus their attention on their income statement, the most important section of their financial statement to a surety is thetheir financial statement to a surety is the balance sheet.

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Key Financial Ratios for Suretiesy• Working Capital: Current Assets minus Current

Liabilities

• Adjusted Working Capital: Working Capital from above, less adjustments to back out unproductive current assetsless adjustments to back out unproductive current assets such as:– Shareholder, officer, and related party receivables

P id E– Prepaid 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

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• Liabilities to Equity– The ratio of all company liabilities and debt to stockholder equity.

As a general rule, sureties like to see a ratio of 2 to 1 or less.

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g

Working Capital Example (With Surety Adjustments)Adjustments)

ASSETS

On BooksAs Adjusted By Sureties LIABILITIES AND STOCKHOLDERS' EQUITYOn Books y LIABILITIES AND STOCKHOLDERS EQUITY

CURRENT ASSETSCash and Cash Equivalents 750,000$ 750,000$ Securities Available-for-Sale 555,000 416,250 CURRENT LIABILITIESAccounts Receivable: Current Maturities of Long Term Debt 783 000$Accounts Receivable: Current Maturities of Long-Term Debt 783,000$

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 Income Taxes Payable 110,000 g y , 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

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Deferred Income Taxes 15,000 -

Total Current Assets 4,922,000 4,273,750 Working Capital (Current Assets minus Current Liabilities 215,750

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Debt to Equity Exampleq y pLIABILITIES AND STOCKHOLDERS' EQUITY

CURRENT LIABILITIES LONG-TERM LIABILITIESCurrent 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 000Current 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 475,000Accrued Expenses 475,000 Income Taxes Payable 110,000 STOCKHOLDERS' EQUITY

Common Stock - No Par Value; 100,000 SharesTotal 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

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Total Liabilities and Stockholders' Equity 6,700,000$

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GAAP vs. Tax Basis Financial Statements• Sureties want GAAP (Generally Accepted Accounting Principles)

financial statements. Tax basis statements lower the ability of the surety t l fi i l t t t d d bilit t tto rely on your financial statements and reduces your ability to get a bond.

Th f GAAP b d fi i l t t t i t f i l t• The purpose of GAAP based financial statements is to fairly present a Company’s financial position, results of operations, and cash flows. GAAP contractor financial statements are (almost) always on a Percent Complete basisComplete 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 toincome as possible, as late as possible. This is counterproductive to Surety credit.

• Cash, Accrual, and Completed Contract are tax methods

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Cash, Accrual, and Completed Contract are tax methods

• Section 179 (writing off asset purchases in the year of purchase) and Bonus Depreciation are tax methods.

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Bonus Depreciation are tax methods.

Job Schedules Should Be Included In a Contractor’s Financial StatementContractor’s Financial Statement

• Include separate schedules of open and closed jobsInclude separate schedules of open and closed jobs. 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 , ) jschedules. 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

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the total revenue and direct costs on the income statement. There should be no unallocated costs or revenues.

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Example Summary Job Schedulep ySCHEDULE I - EARNINGS FROM CONTRACTS IN 2010

FOR THE YEAR ENDED DECEMBER 31 2010FOR THE YEAR ENDED DECEMBER 31, 2010(SEE INDEPENDENT ACCOUNTANTS' REVIEW REPORT)

Contract Cost OfContract Cost Of Revenues Contract Gross Earned Revenues Profit

Contracts CompletedDuring 2010 14,550,000$ 12,730,000$ 1,820,000$ 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

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18,500,000$ 16,280,000$ 2,220,000$

P I St t t 18 500 000$ 16 280 000$ 2 220 000$

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Per Income Statement 18,500,000$ 16,280,000$ 2,220,000$

Do-s and Do Nots – What do Sureties like and not like?like?

• Do-s of Suretyy

– Maximize profits– Minimize overhead– Surround yourself with good people

Make a business plan and follow it– Make a business plan and follow it– Make a plan for business continuity– Fund the continuity plany p– Stay focused on construction– Consult surety agent and CPA before significant financial

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decisions– Avoid litigation– Establish a good line of credit with your bank

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Establish a good line of credit with your bank

Do-s and Do Nots – What do Sureties like and not like?like?

• Do Not's of Suretyy

– 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– If a Sub S Corp - don t take excessive distributions– Make loans or guarantee obligations of others– Jump from one surety to anotherp y– Allow the business to buy out a stockholder before consulting

your surety agent and CPAD t t b d f th t d ’t h

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– Do not get your bonds from an agency that doesn’t have specialists in surety

– Do not use QuickBooks for your job cost accounting system

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y j g y

Continuity Plansy

Wh t ld h t C• What would happen to your Company, employees and jobs if you were killed or hurt in a car accident tomorrow?a car accident tomorrow?

A ti it l dd th ti i• A continuity plan addresses these contingencies. The documentation showing you thought through that process is a Continuity Planthrough that process is a Continuity Plan.

S ti lik t th t C h

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• Sureties like to see that a Company has a Continuity Plan in place.

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Surety Information Checklisty Independent audited/reviewed Financial Statements

within 90-120 days of year endwithin 90 120 days of year end Aging of AR and AP Analysis of overhead costs (supplemental information) Analysis of overhead costs (supplemental information) Equipment schedules Outline of bank agreementsg 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

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Personal and corporate indemnity Personal financial statements

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Questions?

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