What Does a Surety Look for in a Contractor's Financial Statements?

A surety typically looks at much more than whether a construction contractor is profitable.

Financial statements can help the surety evaluate whether the contractor has the financial strength, liquidity, project performance, and management capacity to complete current work and take on additional obligations.

Areas commonly considered include:

• working capital;

• net worth;

• leverage;

• liquidity;

• backlog;

• WIP;

• overbillings and underbillings;

• job-margin consistency;

• cash flow;

• debt; and

• management capability.

The financial statements tell part of the story.

The WIP schedule and underlying trends often tell the rest.

Why Sureties Analyze Contractor Financial Statements

A surety is taking on risk when it provides a bond.

It wants to understand whether the contractor is financially and operationally capable of completing the work.

That means evaluating questions such as:

• Does the contractor have enough working capital?

• Is the balance sheet strong enough to support the backlog?

• Are projects performing as expected?

• Are margins stable?

• Is cash available to fund the work?

• Is debt manageable?

• Is the contractor growing faster than its financial capacity?

• Does management understand its projects and financial position?

Strong financial reporting makes those questions easier to answer.

Working Capital Is Often Important

Working capital generally reflects:

Current assets − Current liabilities

For a contractor, working capital can indicate the resources available to fund short-term operating needs.

That can include:

• payroll;

• materials;

• subcontractors;

• equipment;

• insurance;

• and other project obligations.

A growing contractor may be profitable and still have inadequate working capital to support a larger backlog.

Not All Working Capital Is Equal

The composition of working capital matters.

For example, current assets could include:

• cash;

• accounts receivable;

• retainage;

• contract assets or underbillings;

• inventory;

• related-party receivables; and

• other balances.

Some may be more liquid or collectible than others.

A surety may therefore look beyond the headline working-capital number to understand what supports it.

Receivable Quality Matters

A large accounts receivable balance may strengthen current assets on paper.

But the surety may want to know:

• How old are the receivables?

• Are customers paying on time?

• Are any balances disputed?

• Is there significant customer concentration?

• How much represents retainage?

• Are large amounts tied to troubled projects?

A $1 million receivable that is current can look very different from a $1 million balance that has been outstanding for six months.

Net Worth Helps Show Financial Strength

Net worth, or equity, provides another view of the contractor's financial capacity.

Sureties may consider:

• retained earnings;

• accumulated profitability;

• owner contributions;

• distributions;

• debt levels;

• and changes in equity over time.

A contractor that consistently retains a portion of earnings may build a stronger balance sheet over time.

Owner Distributions Can Matter

Owners may understandably take distributions from a profitable business.

But significant distributions can reduce:

• cash;

• working capital;

• net worth; and

• capital available to support future projects.

That means distribution decisions can have implications beyond taxes and owner cash flow.

They can affect the contractor's financial capacity.

Leverage Matters

Sureties may evaluate how much debt the contractor carries relative to its financial resources.

Debt can support:

• equipment;

• acquisitions;

• working capital;

• and growth.

But increasing leverage also creates:

• principal payments;

• interest expense;

• liquidity demands; and

• financial risk.

The surety may want to understand both the amount of debt and why it exists.

Liquidity Matters

Liquidity answers a basic question:

Can the contractor meet its near-term obligations?

Cash is part of that analysis.

So are:

• receivables;

• payables;

• current debt;

• underbillings;

• overbillings;

• lines of credit;

• and expected project cash flows.

A healthy bank balance by itself does not always mean liquidity is strong.

Why Cash Can Be Misleading

A contractor can have significant cash because it has billed customers ahead of earned revenue.

That may improve current liquidity.

But if the related projects have substantial future costs remaining, some of that cash will be needed to complete the work.

The surety may therefore look at cash together with:

• overbillings;

• remaining costs;

• backlog;

• and project commitments.

Related Resource: Why Do Construction Financial Statements Sometimes Look Different From the Bank Balance? →

WIP Is a Major Part of the Story

The WIP schedule can help the surety understand what is happening inside active projects.

It may include:

• contract value;

• estimated total cost;

• costs incurred;

• estimated cost to complete;

• percentage complete;

• earned revenue;

• billings;

• gross profit;

• overbillings;

• underbillings;

• and backlog.

That information can reveal risks that are not obvious from the income statement alone.

Related Resource: What Is a Construction WIP Schedule? →

Sureties May Look for Margin Consistency

One project with a margin problem can happen.

Repeated margin deterioration across many jobs may indicate a broader issue.

A surety may look at:

• original estimated margins;

• current expected margins;

• completed-job margins;

• margin gains;

• margin fade;

• and trends over time.

Consistent execution can support confidence in the contractor's estimating and project-management processes.

Margin Fade Can Be a Warning Sign

Suppose several jobs begin at:

20% estimated gross margin

and consistently finish around:

12% to 14%.

That could indicate issues with:

• estimating;

• labor productivity;

• change-order management;

• project supervision;

• cost tracking;

• or cost-to-complete forecasting.

The surety may want to understand why.

Related Resource: What Causes Job Margins to Fade? →

Margin Gains Can Also Deserve Questions

Large favorable margin changes can appear positive.

But unusually large gains may prompt questions too.

Why did the margin improve?

Possibilities include:

• strong operational execution;

• favorable procurement;

• conservative estimating;

• incomplete cost estimates;

• missing commitments;

• or overly optimistic forecasts.

A reliable WIP process should be able to explain both gains and fades.

Overbillings Can Support Cash Flow

Overbilling occurs when billings exceed earned revenue.

This can be useful because the contractor may receive cash before incurring all of the related project costs.

But overbillings also represent future performance obligations.

A surety may ask:

• How much work remains?

• How much future cost remains?

• Is cash being preserved?

• Are projects still profitable?

• Is the contractor using one project's overbilling to finance another?

The context matters.

Underbillings Can Raise Questions

Underbillings occur when earned revenue exceeds billings.

Large or aging underbillings may indicate:

• billing delays;

• pending change orders;

• customer disputes;

• documentation problems;

• weak project administration;

• collectability risk;

• or inaccurate WIP.

They can also consume working capital.

Related Resource: What Is Overbilling vs. Underbilling in Construction? →

Backlog Matters

Backlog represents future contracted work that has not yet been completed.

A strong backlog can provide visibility into future activity.

But more backlog is not automatically better.

The surety may consider:

• total backlog;

• expected gross profit;

• project timing;

• project size;

• customer concentration;

• geographic concentration;

• type of work;

• and management capacity.

A $100 million backlog can be a strength for one contractor and an operational risk for another.

Backlog Needs Financial Capacity Behind It

Future work requires resources.

That may include:

• labor;

• project managers;

• materials;

• equipment;

• subcontractors;

• cash;

• and working capital.

If backlog grows significantly faster than financial capacity, the contractor can become strained even while revenue grows.

Project Concentration Can Matter

A contractor may have a healthy total backlog but still carry substantial concentration risk.

For example:

One project represents 45% of total backlog.

Or one customer represents 60% of expected revenue.

The surety may want to understand the financial and operational impact if that project:

• is delayed;

• experiences a dispute;

• loses margin;

• or requires significant additional working capital.

Cash Flow Matters Alongside Profit

A profitable contractor can still run short of cash.

Sureties may therefore consider:

• cash generated from operations;

• billing cycles;

• collection patterns;

• retainage;

• underbillings;

• capital expenditures;

• debt service;

• owner distributions;

• and projected cash needs.

Profitability is important.

Liquidity keeps projects moving.

Lines of Credit Can Provide Additional Capacity

A bank line of credit may provide liquidity during:

• rapid growth;

• billing delays;

• seasonal fluctuations;

• or short-term working-capital needs.

The surety may consider:

• total availability;

• outstanding balance;

• covenant compliance;

• maturity;

• and the contractor's overall bank relationship.

A fully drawn line may tell a different story than an unused facility.

Debt Service Matters

Debt creates recurring cash obligations.

Sureties may review:

• equipment loans;

• term debt;

• lines of credit;

• shareholder debt;

• leases;

• and other financing arrangements.

The question is not necessarily whether debt exists.

It is whether the company's earnings and cash flow can comfortably support it.

Profitability Still Matters

Sureties do care about profitability.

They may review:

• gross margin;

• operating income;

• net income;

• trends over multiple years;

• profitability by job;

• and profitability relative to revenue.

Stable earnings can help a contractor build:

• equity;

• working capital;

• liquidity;

• and capacity for future work.

Revenue Growth Needs Context

Rapid growth may look positive.

But sureties may ask whether the company's financial and operational infrastructure has kept pace.

For example:

Revenue increased from $20 million to $35 million.

Questions might include:

• Did working capital increase too?

• Did equity grow?

• Did cash improve?

• Are margins stable?

• Is the accounting team keeping up?

• Are project managers overloaded?

• Has debt increased materially?

Growth without infrastructure can create risk.

Completed Jobs Can Validate the WIP Forecast

The surety may compare historical WIP estimates with final project results.

If projects consistently finish close to management's forecast, that can support confidence in the WIP process.

If jobs repeatedly finish materially below forecasted margin, management's estimates may be viewed as less reliable.

Completed-job performance creates a feedback loop for evaluating estimating quality.

Financial Statement Quality Matters

Financial reporting itself can communicate something about management.

Statements that are:

• timely;

• reconciled;

• consistent;

• professionally prepared;

• and supported by reliable schedules

can demonstrate financial discipline.

Statements that require recurring corrections or contain unexplained balances may raise additional questions.

The Level of CPA Assurance May Matter

Depending on the bonding program, the surety may request:

• internally prepared statements;

• a CPA compilation;

• a CPA review;

• or an audit.

The appropriate level depends on the specific surety and contractor.

A review provides limited assurance.

An audit provides reasonable assurance.

Related Resource: What Financial Statements Do Bonding Companies Require From Contractors? →

Management Capability Goes Beyond the Financial Statements

Surety underwriting is not purely mathematical.

The surety may also evaluate management's ability to:

• estimate work;

• execute projects;

• manage risk;

• control growth;

• maintain accounting systems;

• understand financial results;

• and respond when a project goes wrong.

Strong financial reporting can support that evaluation because it demonstrates whether leadership understands its business.

Management Should Be Able to Explain the Numbers

For example, management should be prepared to explain:

• Why did gross margin decline?

• Why is this project underbilled?

• Why did working capital decrease?

• Why did debt increase?

• Why is cash down despite strong profit?

• Why did a major project's estimated margin change?

• Why is backlog growing rapidly?

• What is management doing about a troubled job?

A credible explanation can be as important as the number itself.

Personal Financial Strength May Also Be Considered

Depending on the bonding relationship and company structure, a surety may also request information about owners.

That could include:

• personal financial statements;

• guarantees;

• liquidity;

• investments;

• real estate;

• and other financial resources.

Requirements vary significantly by surety and contractor.

What Can Contractors Do to Strengthen Their Financial Position?

There is no single formula for increasing bonding capacity.

But contractors can generally strengthen financial management by focusing on:

• timely monthly closes;

• accurate WIP;

• realistic cost-to-complete estimates;

• job-cost discipline;

• billing and collections;

• working-capital management;

• cash forecasting;

• debt management;

• thoughtful owner distributions;

• and consistent financial reporting.

The objective is to build the financial infrastructure behind the growth.

Start Before You Need the Bond

A contractor should not wait until a large bid opportunity appears to ask:

“What will the surety need?”

Ideally, bonding strategy is discussed alongside:

• growth planning;

• annual financial reporting;

• banking;

• working capital;

• backlog;

• and cash flow.

That gives management time to strengthen weak areas before they constrain an opportunity.

Questions Contractors Should Ask Their Surety

Useful questions include:

• What level of financial statements do you require?

• How frequently do you need interim reporting?

• What WIP information should we provide?

• How do you evaluate working capital?

• What financial factors currently limit our bonding capacity?

• How would a larger backlog affect our program?

• Are there financial ratios you monitor closely?

• How do owner distributions affect underwriting?

• What should we improve before pursuing larger projects?

The answers can help turn the surety relationship into a more proactive planning process.

A Simple Surety Financial Review

A contractor preparing for a bonding conversation could review:

Balance Sheet

• Cash

• Receivables

• Retainage

• Underbillings

• Payables

• Overbillings

• Debt

• Working capital

• Equity

Income Statement

• Revenue

• Gross profit

• Gross margin

• Operating income

• Net income

WIP

• Backlog

• Margin gains/fades

• Underbillings

• Overbillings

• Large or troubled jobs

Cash Flow

• Operating cash generation

• Debt service

• Capital expenditures

• Owner distributions

• Forecasted liquidity

The reports should be reviewed together.

Common Financial Issues That May Draw Attention

Depending on severity and context, items that may generate questions include:

• declining working capital;

• persistent losses;

• recurring margin fade;

• significant aging underbillings;

• slow receivables;

• high leverage;

• rapid growth;

• large distributions;

• customer concentration;

• project concentration;

• inconsistent WIP;

• large related-party balances;

• or unexplained financial statement changes.

None of these automatically means a contractor cannot obtain bonding.

They are issues management should understand and be prepared to explain.

The Bottom Line

Sureties generally look beyond revenue and net income.

They want to understand whether the contractor has the financial and operational capacity to successfully complete its work.

That can include evaluating:

working capital

net worth

liquidity

leverage

WIP

backlog

margin consistency

overbillings and underbillings

cash flow

debt

and

management capability.

Strong financial reporting helps the surety see not simply how the contractor performed last year—but whether the business is financially prepared for the work it wants to take on next.

How Bilotta & Company Can Help

Bilotta & Company, CPAs, LLC works with construction contractors on financial statement audits, reviews, compilations, WIP reporting, job costing, accounting, tax, cash-flow forecasting, and financial leadership.

We help contractors connect financial reporting with:

bonding

banking

working capital

backlog

growth

and

financial strategy.

Through our Contractor Compass® Financial Stewardship program, we also help contractors build the monthly processes that support stronger financial reporting throughout the year.

That includes:

Close → Analyze → Forecast → Decide.

Because a strong year-end financial statement usually begins with strong financial management every month.

Related Resource: What Financial Statements Do Bonding Companies Require From Contractors? →

Related Resource: What Is a Construction WIP Schedule? →

Related Resource: What Is Overbilling vs. Underbilling in Construction? →

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This article is provided for general educational purposes and should not be considered accounting, tax, legal, bonding, lending, or financial advice for a specific contractor. Surety underwriting criteria and financial requirements vary by carrier, contractor, project, and bonding program.