6 steps to understand construction bond limits

If you have worked on public projects before, or have been researching how to work on one, you may have heard the phrase “construction bond line” or “construction bond limit” being thrown around. This is something you should be well aware of, as you can get into real trouble if you're not.

Basically, a construction bond line sets a limit to the dollar amount of the projects you can work on as a contractor being bonded by a surety company. Sometimes, you may find that these limits are too low and prevent you from growing. While this is a common complaint, there are steps you can take to deal with it. Here’s what you need to know to better understand construction bond limits, and how they can be increased.

1. Understanding the two limits

If you already have an account with a surety, you may have noticed that you are given two limits—a single limit and an aggregate limit. The single limit value pertains to the maximum dollar amount per project that you can bid on, while the aggregate limit is the maximum amount of work you can do at any one time. For instance, if you have a single limit of $250,000 and an aggregate limit of $500,000. This means you cannot bid on a contract that is more than $250,000, and at one time, you cannot work on more than two projects valued at $250,000 each, or five projects valued at $100,000 each, and so on.

2. How a construction bond limit is calculated


 

To better understand construction bond limits, you might want to review what is a surety bond first. For smaller projects (generally $350,000 or less), construction bond lines are largely determined by your credit score. Your credit score is a way for the bonding company to determine your likelihood of triggering a claim or defaulting on a project. Therefore, a compromised credit score or credit history will be a red flag for the surety, resulting in lower limits. Fortunately, you can talk to your surety agent and ask how other factors can help to increase your limits.

3. Provide your financial statements

Aside from the obvious option of increasing your credit score, which is not always possible, there are other steps you can take that will allow you to work on higher-priced projects. The most effective among these is to submit strong financial statements, and that includes both your business and personal statements, as well as those of all partners in your business. It’s only logical that strong liquidity will show the surety that you have the capacity to finish the projects you've started, so that they will be willing to increase your construction bond line

4. Choose the right CPA

Strong financial statements are fine, but normally, sureties will only accept them if they are signed by an external CPA. Most sureties will only accept statements written in-house for the smallest accounts. It’s best to choose a CPA who specializes in construction, as they will know the specifics of the industry better and be able to help you choose an accounting method—which should be your next step.

5. Deciding on your accounting method

There are four types of accounting methods you can choose from. The cash method is the simplest one, but using it typically limits you to smaller projects. You may choose between the accrual method, or the percentage of completion method, with the latter allowing for much larger increases in bond limits, as long as your company is in good financial health. The final method, called the completed contract method, is only appropriate for smaller construction companies.

6. Picking financial statement formats

A good CPA is also important because statement formats are just as important as accounting methods in determining your bond lines. You can work with your CPA to determine the level of detail required in your statement, based on your specific needs. There are three levels of detail you can provide in a financial statement—a compilation, a review and an audit, with a compilation being the least detailed and an audit being the most detailed. It’s best to discuss with both your CPA and your surety agent which combination of financial statement format and accounting method will lead to the best results for you.

 

Combined, all of these strategies can do wonders for your construction bond lines. However, remember that understanding contract bonds is just as important, so be sure to review the basics along with the different types of contract bonds you may need for a project. The easiest way is to follow this contractors' bond guide to get your questions answered.