Of all of the financial components that a contract surety bond underwriter considers when reviewing a performance bond request, working capital is the the first. Healthy working capital is indicative of a contractor’s ability to service his or her short term obligations and has an effect on cash flow. While it is not the ONLY measure of a contract firm’s liquidity, working capital is the most important and the easiest to calculate when making a quick assessment. Working capital can also be used to determine how efficiently a contractor is operating. Accounts receivable values and if the contractor warehouses materials and supplies, then also inventory values are helpful in determining revenue trends and slow collections (inefficiency). The foregoing and the underwriter’s knowledge of the cyclical nature of certain classes of work are effective for developing an opinion on sufficient working capital levels. There are some weaknesses to pure quantitative analysis. The contract surety bond underwriter must also consider the following:
- The ability of a contractor to manage working capital as a firm grows can severely reduce liquidity. Meeting the cash requirements of a company generating $5mn per year in revenue is very different than that of a contractor generating $25mn.
- Operations that have very large current assets and very large current liabilities may be dangerously close to zero liquidity. Some underwriters refer to this as “compression”. It can be observed readily by observing the ratio of working capital to current assets.
- Improper reporting of the age and/or ability to collect certain contract balances can have severe effects on working capital
A positive working capital cycle is absolutely necessary for contractors. Especially in the case of small enterprises, maximizing cash flow and preventing erosion of working capital is imperative. Failure to manage the cycle properly will invariably lead to a denial of performance bond capacity even where revenues and activity is brisk. Resorting to bank lines of credit to fund operations rather than focusing on better management of cash flow can create a leverage problem and the interest due on this type of short term relief reduces the contractor’s profitability.
National contract surety leader, Surety One, Inc. focuses on supporting the performance bonding needs of the commercial, highway, heavy industrial and construction contracting industries. We offer performance bonds to construction and commercial service contractor applicants small and large. Visit SuretyOne.com, call (800) 373-2804, or email Underwriting@SuretyOne.com for a performance bond application package or information about any surety bonding need. Recuérde que le asesoramos en SU idioma, así que comuníquese con nosotros, SU compañía afianzadora preferida para la fianza.
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