Unless you’ve been buried underneath a pile of bidding documents or work in process reports, you’ve likely taken notice of the volatility in the stock market over the last few weeks. A correction, as I’m told.
The volatility of the stock market is likely going to have an impact on all of us, especially contractors. From the price of oil impacting the cost of transportation, maintenance, and materials, to insurance companies’ portfolios performance affecting insurance and surety rates and risk appetites, to your own brokerage accounts’ activity increasing or decreasing your balance sheet and bottom line - there are many moving parts that only add to the long list of challenges contractors face.
But have you considered that the securities or brokerage account sitting on your balance sheet, if you have them, may not be helping your surety capacity as much as you think it should? Whether you realize it or not, your surety company is likely giving your investment balance a haircut. You should take some time to understand how sureties handle working capital in order to make sure you and your surety agent are telling the right story and getting credit where credit is deserved.
Surety Companies And Your Balance Sheet
When it comes to working capital, sureties do not just accept current assets and current liabilities as presented in your CPA financial statement. Rather, the sureties compute an “adjusted” or “analyzed” working capital number.
While generally accepted accounting principles (as a recovering CPA, I had to find a way to work GAAP into a blog!) classify as current those assets that are available for use in the coming 12 months or liabilities due within the coming 12 months, sureties are a bit more precise. Sureties typically accept current liabilities per GAAP, but there are additions and subtractions to GAAP current assets. Sureties focus on assets that can be readily converted to cash in order to satisfy liabilities.
The usual suspects for adjustment are investments, prepaid expenses, old receivables, related party receivables, and cash surrender value (CSV) of life insurance.
Investments, although these are usually recorded at the market value at the balance sheet date, are still viewed by sureties to need to be reduced. Their position is that if these were to be liquidated, there is likely going to be some cost to do so, some tax consequences, etc. The sureties typically reduce the value carried on the balance sheet by 20-25%.
Prepaid expenses are most certainly assets, but they usually cannot be converted to cash – cash was already expended and now the accounting function of burning off an accrual will occur over time.
Old receivables (except retainage, anything over 90 days) are viewed by the sureties with suspicion – will you really be able to collect these items? The same is true with related parties receivables – when will they be paid and where will the cash come from? The standard position being that a distribution from the company will need to be made in order to fund the repayment.
All of the above are the typical reductions. Fortunately, there is at least one typical add back. Whole-life insurance policies carrying a CSV are recorded under GAAP as a long-term asset because it is associated with a long-term insurance policy. From a surety perspective, however, the surety will give credit for CSV as a current asset rather than long-term when computing analyzed working capital. The theory is that the cash value of the insurance can typically be obtained if it were needed – via either loan or by cashing in the policy.
What Can You Do?
Educating yourself about what impacts your surety capacity is key. As is aligning with a surety agent and team that can help navigate both the GAAP world and the surety world.
Ensure that your surety agent is working for you. Left to their own devices, surety underwriters are conservative and will not go out of their way to increase working capital, and thus surety capacity. Look closely at the composition of your balance sheet and see what might need explanation to the surety, or what might even need to be reconsidered from a strategic perspective.