The lifeline of any contractor, particularly in the public works arena, is the surety program. Over the last several years, tough economic conditions have challenged even the best-managed contractors to remain profitable. Historically, however, losses in the surety industry begin to show up in the recovery period as opposed to the down cycle. This is primarily driven by the fact that when work is taken on following a downturn, contractors’ still-recovering balance sheets are stretched to the breaking point.
Since we are beginning to see signs of a long-awaited recovery following one of the deepest downturns the market has experienced in a long time, surety companies are underwriting as diligently as ever to protect their balance sheets from default exposure. This being the case, now is a critical time to make sure your surety program is managed properly.
Choosing Your Partners
As a contractor, your partners can have a significant impact on your surety relationship. Every CPA, attorney, banker and surety broker you work with should possess a deep understanding of the construction process and how each member of the team impacts your surety program. For example, having a CPA that fully understands construction accounting and can provide complete financial documents will go a long way to build an underwriter’s confidence in the information being provided. This will improve your ability to expand capacity to take on projects as the market improves.
Open communication is crucial to managing your surety relationship. There is nothing that builds trust more than communication, no matter what the message is. An example of maintaining such communication is notifying your surety when a large capital expenditure takes place or when a debt restructuring plan has been developed. There is nothing worse than surprises—particularly negative surprises—when it comes to managing your surety relationship. It is important that you treat your surety company as a true partner in your business.
If you encounter a problem in your backlog, the earlier the problem is disclosed and addressed, the better your chances of minimizing and surviving the effects of that problem will be. In many instances, the surety carrier can help resolve the issue, as it is likely that they have seen or dealt with such a situation in the past. If you let a problem sit without acknowledging it, you are going to be less able to manage the issue, and you will strain your relationship with your surety carrier. In order to maintain an open line of communication with your surety, it is important to meet regularly with your underwriter (at minimum, once a year) to share your expectations for the current period’s results and your business strategy for managing those expectations.
Timely and Accurate Information
Providing timely and accurate information to your surety is also critical. In an underwriter’s eyes, if there is a significant delay in receipt of information, it is indicative of a negative outcome. Even if the news is negative, it is always better to share the news early and explain why the loss occurred and how the company plans to proceed than to withhold the information.
Sureties typically like to see internal financials on at least a quarterly basis. If you have the ability to provide a balance sheet and income statement coupled with a work-in-process schedule and an aging of receivables tying to the same period, it will go a long way to building their confidence in your company. If you can get in the habit of sending the information regularly without waiting on requests for the information, your surety’s trust and support will become even stronger.
Proper management and regular review of job costs is also important. While the ability to forecast costs accurately is beneficial in demonstrating the strength of your internal financial controls, your surety will also gain confidence in your company if you demonstrate that you know your costs and are able to make accurate adjustments to your financial information to reflect cost-related changes that occur.
Focus on Business Basics
Solid fundamental business practices, aside from regularity in reporting and openness in communicating, are crucial in maintaining surety credit in the current market. It is important to concentrate on construction activity where the company has demonstrated profitable results. Too often the trend during economic downturns has been to “chase the money.” Doing so can lead to significant problems due to unfamiliar construction environments.
Manage overhead within a realistic revenue projection. Focus on managing cash conservatively and minimizing debt. This is particularly critical for equipment-intensive businesses. Too often, offers of low interest rates and tax advantages entice contractors to assume unnecessary debt, which leads to problems in the future. Proper management of overhead will also assist in improving accuracy on future bid activity.
Managing your surety relationship is like managing any partnership. The contractor has to realize that all parties have a vested interest in the company’s success. At the core of this relationship lies open communication and timely and accurate information. If properly managed, it will assist in maximizing the competitiveness and efficiency of your surety program while ensuring minimal interruptions in service.