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What is bonding capacity?
Why is bonding capacity important for contractors?
What factors influence bonding capacity?
What are some ways to increase bonding capacity?
How can BOSS Bonds help contractors boost their bonding capacity?
As a contractor, surety bonds are your ticket to tackling exciting private and public construction projects. They give project owners and regulatory agencies peace of mind that you’ll deliver on your promises.
Your bonding capacity determines the size and amount of surety bonds you can obtain. By boosting your bonding capacity, you can unlock opportunities to bid on larger projects and amplify your earning potential.
So, how can you boost your bonding capacity? Below, we’ll define bond capacity and explain its key components. After that, we’ll offer ten steps to increase your bonding capacity over time.
What is Bonding Capacity?
Bonding capacity is the amount of credit your surety company will extend to you. Having a higher bonding capacity allows you to bid on larger projects. In contrast, a low bonding capacity can limit the number and scale of projects you undertake.
There are two categories of bonding capacity you may want to increase:
- Individual bonding capacity refers to the size of the surety bond you can get for a single project.
- Aggregate bonding capacity is the total bonding capacity you have for all of your ongoing projects.
In many ways, bonding capacity works like a credit card’s credit limit. Your surety company can adjust your bonding capacity as their confidence in your overall performance increases. Additionally, you can request a boost after updating your financial information and demonstrating strong project management skills.
How Do Surety Companies Determine Your Bonding Capacity?
Surety companies consider the three C’s when setting contractors’ bonding capacity: capital, capacity, and character. Let’s explore each of these components in greater detail:
Capital
Capital refers to the cash or cash equivalents you have to meet your immediate financial obligations. Surety companies want to see that you have enough liquidity to manage your ongoing expenses and any unexpected costs that may arise during project execution.
As a result, your surety company will carefully assess your:
- Financial statements, including balance sheets, income statements, accounts receivable, and cash flow projections.
- Work in progress (WIP), which represents the value of your ongoing projects that are not yet completed.
- Net worth, which is calculated by taking the total value of your company and your personal assets and subtracting any liabilities or debts.
Capacity
Capacity refers to your ability to complete projects effectively and manage their associated risks. Surety bonds evaluate this component using the following factors:
- Experience – A strong track record of completing projects on time can demonstrate that you have what it takes to manage new projects with confidence.
- Workload management – While having ample experience is a good thing, surety companies want to make sure you’re not overextending yourself at any given time.
- Resource allocation – Surety companies want to see that you have the necessary labor, equipment, and materials available to complete projects on time and within budget.
- Credit – Having a good credit score and a robust line of credit can show that you’re equipped to take on larger financial commitments.
Character
Lastly, surety companies consider your character as a contractor when setting your bonding capacity. Along with having a proven history of completing projects successfully, you also want to provide evidence that you operate with integrity and overcome challenges without cutting corners.
10 Steps to Increase Your Bonding Capacity
Now that we’ve clarified what bonding capacity is and how it’s determined, here are ten practical steps to help you increase yours over time.
Step 1: Strengthen Your Financial Standing
Since your financial stability is such a crucial factor in determining your bonding capacity, it’s important to maintain detailed documentation of your business finances. Most surety companies require three to five years of third-party-vetted financial statements to assess your bonding capacity.
If your financial documents have room for improvement, you can enhance your financial standing by:
- Prioritizing your profitability – You can increase your profits by streamlining your overhead expenses and expanding your business initiatives. Start by identifying areas where you can reduce costs without compromising quality.
- Improving your cash flow – It’s important to keep close tabs on your cash flow and optimize it as needed. This may involve updating your clients’ payment terms, incentivizing faster payments, or managing your accounts receivable more effectively.
- Retaining more earnings in your company – While you may be tempted to use your business profits for personal expenses, putting that money back into your business is better for your bonding capacity. That’s because investing in new growth initiatives can increase your revenues and strengthen your financial standing.
Step 2: Evaluate Your Backlog
Surety companies carefully review your backlog before increasing your bonding capacity. Your backlog includes any projects you have under contract that haven’t been completed yet.
Generally speaking, surety companies want to see that you have capital equal to 10% of your existing work backlog. This means if you currently have $1 million of projects in your backlog, you would need $100,000 of liquid assets to satisfy these capital requirements.
Step 3: Increase Your Access to Credit
Did you know that more contractors struggle financially during economic expansions than recessions? That’s because it’s easy to run out of cash when you have a bloated backlog.
By securing ample lines of credit, such as a business line of credit or home equity line of credit, you can ensure you have the cash you need to pay for unexpected project expenses.
Step 4: Demonstrate Strong Project Management Skills
While your finances are crucial, they’re ultimately a byproduct of the quality of your work. Thus, it’s equally important to prioritize your project management. You can do so by:
- Consistently completing projects on time and within budget
- Showcasing excellent workmanship
- Adhering to strict quality control and safety protocols
- Establishing a reliable project management team
- Maintaining strong client relationships
- Fortifying your risk mitigation
Step 5: Carefully Vet Your Subcontractors and Suppliers
Speaking of risk, your subcontractors and suppliers’ performance can impact your project outcomes. Their mistakes can lead to delays, jeopardizing your deadlines and budget. To mitigate these risks, ensure you thoroughly evaluate subcontractors and suppliers, choosing only those who are bonded, insured, and trustworthy.
Step 6: Document Your Successful Projects
After a job well done, make sure to ask your clients for reviews, testimonials, or references. This social proof can improve your reputation with your surety company and help you acquire more business.
Step 7: Build Relationships with Other Industry Professionals
Another way to enhance your reputation is to network with other respected contractors. For example, you can attend industry events, such as trade shows, conferences, and workshops, or join professional associations. Additionally, you can propose strategic collaborations with other contractors from time to time.
Step 8: Select the Right Surety Company
Not all surety companies are created equal. Some may be more willing to extend higher bonding limits than others. By doing your research and shopping around, you can find a surety company that aligns with your goals and understands your needs. After that, make sure you establish a positive relationship with their underwriter from the start.
Step 9: Increase Your Bonding Capacity Incrementally
Surety companies typically won’t grant you a high bonding capacity right away. Even if you have an excellent rapport with your surety company, you can’t expect to jump from $500,000 of bonding capacity to $50 million overnight. Instead, you must stretch your bonding capacity gradually by showcasing steady improvements in your financial stability and performance.
Step 10: Request Bonding Capacity Increases In Advance
Bonding capacity is a vital aspect of your business, so it should always be a top priority. To ensure you have the necessary capacity when needed, request increases well in advance rather than waiting until the last minute.
Additionally, it’s a good idea to provide your surety company with regular financial updates. Doing so can help you obtain more frequent bonding capacity increases.
Boost Your Bonding Capacity with BOSS Bonds
While increasing your bonding capacity takes time, it can significantly improve your earning potential and profitability down the line. If you have any more questions about this process, don’t hesitate to reach out to the surety bond experts at BOSS Bonds.
Our team can guide you on your path toward higher bonding capacity, providing expert guidance and responsive support every step of the way. With decades of experience under our belt, you can trust that we have the expertise to navigate any challenge.
Ready to start boosting your bonding capacity? Contact a BOSS Bonds specialist today.
Sources:
Surety.org. Contract Surety Bonds: Protecting Taxpayer Dollars.
https://surety.org/wp-content/uploads/2021/11/Contract-Surety-Bonds.pdf
