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When it comes to Bid and Performance Bonds, you may have heard that Working Capital is a deciding factor. If the calculated amount on the applicant’s financial statement is insufficient, the surety underwriter will decline the bond.
So what is Net Worth (NW) and how important is it for bonding purposes? Let’s start with a brief description of what this is and where you find it in the financial reporting. Funny thing about net worth: It is a measure of the company’s financial strength, but it is listed among the company’s debts! Hmmm…
Where Do You Find It?
NW aka “Stockholders Equity” is listed on the company Balance Sheet, which is divided into assets and liabilities (debts).
The assets include cash in the bank, accounts receivable, buildings, equipment, etc. The liabilities are accounts payable, bank and other loans, other debts, and (in a corporation) the Stockholders Equity. The NW or Stockholders Equity section appears at the bottom of the Liabilities column, below “Total Liabilities.”
What Is It?
Stockholders Equity shows the funds put in (loaned to) the firm by the stockholders such as Capital Stock, plus the portion of all past profits allowed to accumulate in the company (called Retained Earnings). These comprise the corporation’s NW.
Why is it a liability? NW is a liability because it is owned by the stockholders, not the corporation itself. If the company shuts down and is liquidated, the NW goes the stockholders and the corp reverts to its original financial position: $0.
Think of NW as a piggy bank that holds the company’s long-term, ultimate financial reserves.
Now let’s discuss what this has to do with surety bonds. Bond underwriters always evaluate the Working Capital amount. And many place equal importance on the NW. While it is true that a company can show good Working Capital but have no NW, is a lack of NW really a concern?
You may assume that it is difficult for a company to get a bank loan if they have no NW, and the absence of both makes it harder to get bonds.
Surety underwriters are concerned about a company’s staying power if they don’t have financial reserves to help survive tough times. When companies fail, there are bond claims – exactly what the underwriters don’t want!
Analysts will wonder “Why is there no NW in this company?” especially if it is not a new entity. Has there been a lack of profitability, a failure of management, and therefore no profits to accumulate?
Our “Secrets” articles are usually inspired by the file activity we enjoy each week with our colleague brokers. Such was the case this week. Here is the actual info from a financial statement that was the seed for this article: “( )” indicates a negative number.
STATEMENT OF EQUITY, September 30, 2015
Balance at January 1, 2015 $ 0
Plus: Member’s contributions 33,616
Less: Net loss (50,597)
Less Member’s distributions (131,060)
Balance at September 30, 2015 $(148,041)
This report is describing the changes in one part of the NW. They started with nothing, put in $33 thousand, lost $50 thousand this year, and on top of that, took out everything they put in and more! What are they thinking?!
Q. If you are the bond underwriter contemplating the likelihood that this company’s survival, what might you conclude?
- Company management is weak?
- Their ability to continue may be doubtful?
- Instead of bolstering the company with additional funds, the owners are stripping it of assets – maybe with the intention of declaring bankruptcy?
A. All of the above!
Our conclusion is that Net Worth IS important. In bonding, the company is the applicant. Its financial position indicates if management has achieved profitability and accumulated a war chest of funds to provide a strong foundation. Without it, future credit may be unavailable, and the company may falter when facing difficulties.
NW is one of the critical factors underwriters, and all credit analysts, review. It should be nurtured, protected and preserved.
The experts at Bonding Pros can help Insurance Agents and Contractors when tough bonding situations arise. We have the markets and the know-how to succeed even when others have failed.
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