Surety Bond underwriters DEMAND it. Contractors maneuver to maximize it. Bond agents pray for it... What is Working Capital, and what is the awful truth
that everyone ignores?
Define the term
When contractors apply for bonding, the company financial statement is analyzed by the surety underwriters. They always calculate the Working Capital As Allowed (WCAA) on the Balance Sheet, which is simply:
Current Assets minus Current Liabilities
This number is also subject to interpretation by the analyst. For example, they may disallow assets they feel are overstated or of questionable value - thus the title "As Allowed."
The working capital figure is then compared to the size bonds and aggregate (overall) program the contractor desires. Here is the important part:
For many bonding companies, if the WCAA is deemed insufficient, there is an immediate declination.
It's true that "everything is important" in surety underwriting. But it is also true that this is a life or death issue for many decision-makers. Specifically, the fiscal year-end Working Capital As Allowed must be adequate for the capacity requested. That isn't the awful part...
Underwriters focus their decision-making on the fiscal year-end (FYE) of the company, tax day. For many contractors, this day is 12/31 each year. This is a natural and convenient annual milestone that is presumed to be realistic and conservative. Underwriters don't want puffed up numbers designed to impress them. That makes good sense.
Awful Truth #1
The FYE WCAA is only correct for ONE DAY. If the company spends cash on January 1st, bills a contract, incurs an invoice, the WC is immediately different.
Awful Truth #2
The WC calculation is always based on obsolete info. When does the 12/31 statement get produced? Maybe February, but more likely March, April or later. This GUARANTEES that the WC calculation is outdated.
Awful Truth #3
Considering the great emphasis placed on the importance of fiscal year-end info, interim financial statements (produced on other days in the year), are largely ignored by underwriters. This means if the company has a good event occur, it may be overlooked - however a downturn is always taken into consideration!
Like an elusive pot of gold, the WCAA underwriters depend on may never materialize as actual cash flow. But another "truth" is that underwriters must base their decisions on something, and historically this has been a relevant indicator of future success. Despite the often overlooked flaws we cited, Working Capital analysis will remain part of surety underwriting.
We recommend that underwriters keep the relative value of this indicator in perspective, and remember that interim statements and other underwriting elements should also play an important role.
About the Author:
Steve Golia is an experienced provider of bid and performance bonds for contractors. For more than 30 years he has specialized in solving bond problems for contractors, and helping them when others failed.
The experts at Bonding Pros have the underwriting talent and market access you need. This is coupled with spectacular service and great accessibility.
Contact us today and discuss how you start a new bonding relationship for your company, or increase your current bonding capacity. Call 856-304-7348.
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