financial statements

Secrets of Bonding #47: Compilation, Review, Audit?

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Secrets of Bonding is brought to you by Bonding Pros

Need a bond?  Talk to the Pros!  856-304-7348  www.BondingPros.com

Brokers protected.  Contractors welcomed.

When it comes to Bid and Performance Bonds everyone knows that financial statement numbers are important.  But before surety underwriters get to them, they evaluate the method of financial presentation, its quality and credibility.

  • Is a CPA needed or can a PA or Tax Preparer be used?
  • Audits are expensive.  Can contractors avoid the cost?
  • Are there times when you can’t you use the same accounting method for tax and financial reporting?

There are a number of variables to consider.  Let’s go over what to use and when.

Accounting Professionals

A CPA is a Certified Public Accountant. These people are the premiere accounting professionals.  Bonding companies expect contractors to have a CPA prepared fiscal year-end (FYE) financial statement if individual bonds will be in the range of $1 million or more.

Below a CPA is a PA, Public Accountant, and then there are bookkeepers and tax preparers. Accounting professionals with lower credentials should only be used by contractors with small bond needs.

Accounting Methods

There are four accounting methods.  Any can be used for tax purposes, but banks and bonding companies are more selective.

  1. Accrual Method – probably the most common for construction companies.  May be acceptable for all bonding situations.
  2. Percentage of Completion – more sophisticated than Accrual.  Often used by larger contractors.
  3. Completed Contract – used by contractors that have multi-year projects such as road and bridge builders.
  4. Cash Method – acceptable for tax purposes, but not for financial reporting to banks or sureties.

Financial Presentation

The presentation can vary greatly. This too, is an important element. Surety underwriters expect to make a number of financial evaluations.  If the presentation is inadequate, they will not have info they need (schedules, notes and other elements).you-decide

Audit – the accountant’s cover letter states an “unqualified opinion” meaning they vouch for the accuracy of the report without reservation.  This is the most expensive presentation and is required when bonds and bank credit are in high amounts ($2 – 5 million and above).

Review – This report includes some “review” and verification by the preparer, but less than an Audit. Review reports are required by bonding companies starting with projects around $1 million.

Compilation – This is merely a typing job by the accounting firm, using the numbers provided by the client.  They make no verifications with outsiders and may not even double check the arithmetic. Normally this is acceptable for clients needing bonds below $1 million.

QuickBooks – Financial Statements produced from the client’s computer may be adequate for small bonding lines, or to provide a mid-year update.  “Internal” financial statements are not used as primary underwriting info for sizable obligations.

Learn a little more about accounting methods: http://www.inc.com/encyclopedia/accounting-methods.html

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.

Give us a call today!  856-304-7348

Not available in all states including Idaho.

Secrets of Bonding #45: Backpedaling and How to Avoid It

Sureties commonly rely on a variety of elements when deciding if they will provide bid and performance bonds for contractors. Because Sureties are required to fully back their bonds with a dedicated asset, their underwriting process may be the most thorough. When a Surety issues a bid or performance bond on a federal or private project, all relevant underwriting factors are considered, including the applicant’s financial condition.

In most bonding scenarios, the applicant for the bonds is a construction company – typically a corporation or LLC. An important element of the financial evaluation is the company’s financial statement.

Why so much emphasis on this one document? The financial statement is considered a report card on the quality of management. It shows a range of important indicators. To name a few:

  1. How strong a financial commitment the owners made to the company (capitalization)
  2. The amount of revenues management has acquired in the previous operating cycle
  3. The extent to which construction contracts were realistically estimated and successfully managed
  4. The management and efficient use of overhead dollars
  5. Tax planning
  6. Adequacy of cash flow
  7. Liquidity
  8. Profitability
  9. Reliance on banks and other creditors to finance operations
  10. Collectability of receivables

The analyst’s favorite financial statement date is the company’s fiscal year-end (FYE), which is “tax day.” They prefer this date for two reasons.

  • Underwriters need to make a periodic review to monitor the applicant’s financial status, so an annual review on the FYE is perfect.
  • The tax day numbers will be realistic and conservatively presented – to minimize the tax exposure. This conservative approach is ideal for the bond underwriters who hope to make a realistic analysis of the applicant.  For most companies tax day is December 31st.

So where does the backpedaling come in?

Company managers will rely on their Certified Public Accountant for financial advice, especially tax planning. Limiting taxes is a popular goal, but at what price? Lower taxes may be the result of lower pre-tax profits. Lower profits mean less financial growth and possibly an inadequate net worth. (See Secret #3: Taxes)Why should stockholders continue to support a company that fails in its primary mission: Producing a profit?

Obviously these issues are a great concern to surety underwriters, who want successful, well-managed companies as clients. If tax avoidance is aggressively pursued, it is not unlikely that bonding capacity will be compromised. The surety may limit their support or even terminate the relationship if financial performance is weak. Once the financial document is carved in stone, company management may face an entire year of backpedaling  “We showed poor results because…” until the next FYE report can show better numbers.

The problem is not uncommon, and the solution is simple if executed properly. Avoid backpedaling by having a draft financial statement initially produced by the CPA. The document will be marked “For Discussion Purposes” and discussion is exactly what’s needed. A review by the underwriter will determine if any elements of the report are detrimental for bonding purposes. Plans for the coming year can be discussed and bonding capacity evaluated.

If the financial statement does not support the desired amount of surety capacity, now is the time to make adjustments before the final version is produced. Backpedaling is avoided!

With some planning and open dialogue agents can help their contractors avoid the missteps that prevent companies from realizing their full bonding and financial potential.

Agents, for your clients with a 12/31 year-end, NOW is the time to act.


A special note from the author: Steve Golia

I am an Independent Broker and Surety Bond Specialist. If you wish to co-broker bond business, together we will deliver the best in bonding expertise for your clients.  I have a broad range of markets available and often can solve problems even when others have failed.

Call me now (856-304-7348) or email: Steven.Golia@gmail.com

 

Secrets of Bonding #14: Financial Statements – Timing

Brought to you by…

Secrets of Bonding is brought to you by Bonding Pros

Need a bond?  Talk to the Pros!  856-304-7348  www.BondingPros.com

Brokers protected.  Contractors welcomed.

When it comes to financial statements, no news is bad news.  Let’s talk about the timely delivery of annual financial statements.

Many construction companies have a 12/31 fiscal year-end (FYE).  This means their most important Financial Statement (FS) are based on this date each year.

By the end of March, bond underwriters and bankers are expecting to see the financial statements for the FYE.  90 days after the date is normally the time allowed for this info.  Beginning on April 1st (or 90 after the FYE, whenever that is), the contractor enters the tap dancing zone.

Q. “When will we see the 12/31 FS?”

A. “There is a slight delay due to…” (choose one)

  • My CPA was ill and got a late start
  • Our software crashed and it delayed the accounting process
  • The dog ate it

While it’s true there are outside or uncontrollable factors, sometimes contractors intentionally hold back the info.  One example we’re seen involves loan covenants.  The company may have fallen out of compliance with their lender and now is attempting to obtain a waiver from the bank.  Having such a waiver will enable the CPA to comment that the FYE non-compliance has been resolved.  That sounds a lot better!

Here is the downside: We have seen construction clients hold back the FS for 10 months in some cases.  Obviously the delay itself can become an even bigger problem.  At some point underwriters say to themselves “If the FS was good, the contractor would want us to see it…”

So the point is that timely financial reporting is beneficial to bonds and banking.  It shows that the company is well organized and professional.  There is no hiding from the financials.  If there are issues, prepare an intelligent explanation,  describe the corrective actions management is taking and provide projections for the current year.

Producing financial info on time is as important as the numbers themselves!

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.

Give us a call today!  856-304-7348

Not available in all states including Idaho.