The Kentucky CPA Journal

Feature

Strategic Financing: Protecting Bonding Capacity Through Equipment and Vehicle Loans

Issue 1
March 10, 2025

By Collin Temple, CPA

For contractors, preserving bonding capacity is essential for securing new opportunities and growing their businesses. While using cash reserves for major purchases like vehicles and equipment may seem practical, it can reduce liquidity and weaken bonding capacity. Strategic financing provides a method to maintain financial stability while meeting operational and bonding requirements.

Understanding surety bonding and financial requirements

Surety providers evaluate a contractor's financial health based on key documents: the balance sheet, income statement, work-in-progress (WIP) report, and financial statement notes.

• The role of the balance sheet
  Sureties assess liquidity—the difference between current assets and current liabilities—to evaluate bonding capacity. Large cash expenditures can reduce working capital, directly impacting bonding eligibility.
• Insights from the income statement
  Income statements summarize revenues and expenses over a defined period, providing insights into gross profit margins and operational efficiency.
• WIP reporting
  Accurate WIP reports demonstrate effective project management and financial accountability by detailing project progress, profitability, and billing status.
• Significance of financial statement notes
  Notes explain asset valuations, loan terms, and accounting methods, helping sureties assess the reliability of financial reporting.

Sureties may adjust financial data to reflect operational realities, including:

• Related-party loans: Reclassified as non-current assets if not readily available for operations.
• Retainage receivables: Often reclassified as long-term assets if tied to project completion conditions.
• Inventory: Obsolete or slow-moving inventory may be excluded from liquidity calculations.

Sureties also exclude intangible assets, like goodwill, focusing on tangible financial strength. Transparent reporting minimizes adjustments and builds confidence with underwriters.

When reviewed or audited financial statements are required

The assurance level of financial statements depends on the bonding capacity:

• Reviewed financial statements: Required for bonding capacities under $10 million.
• Audited financial statements: Required for capacities above $10 million, offering the highest assurance through in-depth verification of financial data.

Audited statements may also be necessary for high-risk, multi-year, or public sector projects, even for lower bonding amounts.

Why financing supports bonding capacity

1. Liquidity management
   Financing preserves cash reserves, maintaining working capital and strengthening the balance sheet.
2. Tax benefits
   Depreciation deductions, including Section 179, optimize tax savings without reducing cash flow.
3. Operational agility
   Financing keeps cash available for other needs, providing flexibility during market fluctuations.

Best practices for making financing decisions

1. Collaborate with sureties
   Engage with surety providers early to align financing strategies with bonding requirements.
2. Optimize loan terms
   Negotiate low-interest loans with repayment schedules matching the lifespan of financed assets.
3. Maintain accurate reporting
   Update WIP reports regularly to reflect project statuses and avoid financial discrepancies.
4. Leverage tax advantages
   Maximize depreciation benefits and integrate financing into broader financial strategies.
5. Track financial metrics
   Monitor liquidity and debt ratios to present a strong financial profile to sureties.
6. Enhance contract schedules
   Provide detailed schedules separating bonded and non-bonded projects for transparency.
7. Adapt to accounting standards
   Review lease agreements to comply with updated rules and reduce debt ratio impacts.

Year-end financial strategies

Year-end financial statements are vital for bonding assessments. Contractors can strengthen their financial position by:

• Financing large purchases to maintain liquidity.
• Ensuring GAAP compliance for accurate financial representation.
• Highlighting WIP data to demonstrate project profitability.
• Reducing overdue receivables and resolving unapproved change orders.
• Using percentage-of-completion accounting for reliable revenue recognition.

Conclusion

Strategic financing allows contractors to safeguard bonding capacity while maintaining operational flexibility. By preserving liquidity, meeting financial reporting standards, and leveraging expert guidance, contractors can position themselves for long-term success. In Kentucky, where infrastructure investments are booming, aligning financial strategies with local market conditions is crucial for remaining competitive.

About the author: Collin Temple, CPA, CCIFP with more than is an audit manager at Monroe Shine & Co., Inc. in New Albany, Indiana. Temple serves on the Society’s Accounting and Auditing Committee.