Bidding on a number of construction projects at once can stretch your surety bond line to the max. When a contractor runs up against their bond limit, it can stop them from bidding or performing on any further projects until they’re increased.
But there’s no big secret to increasing your bond lines. There are several practical steps which you can take, which will allow you to raise your limit and continue taking up projects.
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What Are Bond Limits?
Before we look at how you can improve them, it’s important to understand how bond limits work. Also known as a bond line, a bond limit is the size of the bond a surety is willing to provide to a contractor.
When you apply for a construction surety bond to bid on a project that requires a bond, the bond will be issued to cover the amount of the project.
But when issuing bonds to contractors, sureties will typically set a limit or bond line that determines the dollar amount of a project that you can get bonded for. This is your single limit – the maximum amount per project that the surety will back for you. Your aggregate limit is the maximum amount of total bonds you can currently get.
So if you have a single limit of $100,000 and a bond line of $300,000, you can get three separate bonds on projects that are $100,000 or six bonds on projects that are $50,000, etc. But if you want to grow your business and take on more work, you must do something to increase your single and aggregate limits.
Sureties determine a contractor’s bond line mostly based on their personal credit score – in particular for contracts that are less than $350,000. The higher your credit score is, the more likely it is for the surety to offer you a high bond line. Whereas, if your score is low or your credit history indicates that you cannot handle your finances well, the surety will act more cautiously and offer you a lower bond limit.
How Contractors Increase Their Bond Limit
While fixing your personal credit score is imperative, it’s not the whole story. There are other steps a contractor will need to take to increase their bond limit.
Work with a CPA and provide proper financial statements
An important next step towards your goal is to start working with a good construction CPA who can prepare the right type of financial statements for you. There are different financial statements formats and different accounting methods that your CPA can use when you are applying for a higher limit.
The main financial statements types are:
- A compilation report – the simplest type of statement which will typically allow you to get your limit up to $500,000 at most
- A reviewed report – along with the proper accounting method, this type of financial statement should be enough to get your aggregate limit up to as much as $20 million
- An audited report – this is the most complex and thorough type, and it is highly unlikely that you will require this type of statement
The accounting methods which a CPA may use when preparing your statements are:
The cash method is the simplest possible accounting method which works fine for smaller bond lines but is not sufficient for large contracts. Under this method, revenues and expenses are recognized when they are received or paid.
The accrual method is somewhat more complex and includes accounts receivable because revenue is recognized when it is billed.
The percentage of completion method (POC) is typically considered optimal for most contractors. Here the percentage of completion is calculated not on the basis of billing but one the basis of an estimate of the relative completion (cost incurred) to the total estimated cost or value of a project.
The completed contract method (CCM) – This is the most complex type of accounting method. Under this method, profits on a contract are only recognized after the completion of the project
Presenting well-prepared business financial statements of the right kind and with the right accounting method by a professional CPA is one of the best things you can do to improve your bond lines.
Improve Your (Personal) Finances
Increasing your net worth and liquid assets can also help you increase your bond lines. While you may not want to increase your net worth for tax reasons, sureties consider applicants with greater net worth and liquidity more reliable. When looking at your assets, sureties pay greater attention to liquid assets or those that can be liquidated faster if a bond claim should occur.
In striving to increase your net worth, you may at some point also consider selling corporate stock to increase equity positions. Another way to increase net worth is to decrease expenses by, for example, renting or leasing equipment, instead of buying it.
In summary – low debt, high credit, and substantial net worth and liquidity are important elements when you are convincing your surety to increase your bond limits.
Showcase Your Success and Expand Carefully
Building up a portfolio of successful projects builds trust with your surety because it speaks of your ability to manage and complete projects. On that note, the more successful projects you pile up, the easier it will become to convince your surety of increasing your bond line.
At the same time, a certain amount of cautiousness in taking up projects that are outside of your scope of expertise may be necessary. While it is good to expand over time, throwing yourself into entirely unfamiliar terrain is usually perceived as high-risk by the surety.
The surety will likely look at your backlog of construction projects when considering your bond line. If they believe that a contractor is overextending themselves or taking on more work than they can handle, that can be a warning flag.
Choose a Reliable Surety Partner
Your choice of surety agency may also determine the extent to which you can expand your bond lines. Agencies work with surety companies – these companies issue and back the bonds that you need on projects.
When you go looking for a surety agency, make sure it works with stable and reliable companies that are “A-rated and T-listed”. These companies are among the most professional and financially stable in the country and will be capable of meeting your surety bond line needs.
Would you recommend other ways in which a contractor can increase their bond lines? Leave us a comment below!