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THE BOTTOM LINE

Atlantic Coverage Corp.

EXCELLENCE IN SURETY BONDS

4th Quarter 2003 Volume 5, Issue 4

Bid Price Escalations And Bid Bonds “Famous Quotes” “Dollars do better if they are accompanied by sense.” Earl Riney “There are two fools in every market; one asks too little, one asks too much.” Russian Proverb “Forget about the sales you hope to make and concentrate on the service you want to render.” Harry Bullis “All good sales managers have teeth-marks in their tongues.” Jack Falvey “I’m living so far beyond my income that we may almost be said to be living apart.” e.e. cummings “Inflation makes balloons larger and candy bars smaller.” David L. Kurtz           Why is it important to notify the bonding company of a bid escalation (that is, when the actual bid amount exceeds the amount indicated when the bid bond was requested)? Bonding companies typically understand that the anticipated bid amount on a project is just an estimate and that it might fluctuate up or down from the time the bid bond is ordered to the time of the actual bid. They typically feel that any increase up to 10% more than the requested amount does not require their re-approval. Beyond that 10% threshold, they want to be notified for re-approval of the request.           There are some exceptions to this “10%” rule, such as when a large bid bond request is approved. In this case, the surety may indicate that their approval is not to exceed a certain dollar amount, not 10% above that number.           Why do they require this? Bonding companies are making financial decisions based on information that a contractor provides. They want to know that this information is accurate. Even if the bid bond request is relatively small in relation to a contractor’s bonding program, providing conservative information goes a long way in the bonding relationship.           They use the information that a contractor provides them to better understand the contractor’s potential backlog, and, in some cases, they have a maximum level above which they will not support an account.           Providing accurate information is, also, useful in cases when multiple bids occur within a very short time frame.           One area that even we have difficulty with is when a construction firm routinely bids let’s say $10,000,000 projects. In this example, they have a request for a bid bond for a $1,000,000 project. Technically, they need to notify the bonding company once the amount exceeds $1,100,000. It sounds crazy that this amount would need to be re-approved, but that is technically what the bonding company would expect of its client.           This is just part of the relationship with the bonding company. There are many aspects to this relationship and this is one of them. Like many other things, this aspect must be managed and not necessarily taken for granted. When they see a construction firm constantly bidding more than 10% of their initial estimate, they need to wonder what the actual number will be when that very large request comes along.           Included in notifying the surety of a bid escalation is indicating why the estimate increased from the original amount contemplated. For example, maybe an equipment supplier provided an estimate well in excess of what was originally contemplated. Or maybe there is no specific reason other than the architect’s estimate was used when the bid bond was requested and that the numbers just do not support that estimate.           In most cases, the bonding companies allow us, the bonding broker, to type in the bid bond percentage without limitations. For example, the bid bond might read “10 percent of the amount bid”. While it is done frequently, when one thinks about it, it is quite a leap of faith on the bonding company’s part. Let’s say for example that a contractor requests a 10% bid bond on a $300,000 project. That bid bond has a value of $30,000. But, let’s say that there was a communication error at the construction firm. Maybe, it was really a $3,000,000 bid. Now this bid bond has a value of $300,000. When something like this occurs, the bonding company might insist on limitations being placed on the bid bond itself. For instance, the bid bond might read “10% of the amount bid not to exceed $30,000”. In this case, if a contractor’s bid exceeded $300,000, the bid bond would not provide sufficient bid security and the bid may be rejected for that reason.           This is not meant to imply that exact bid prices should be provided to the bonding company. There is really no need to provide exact numbers. However, sometimes it is important to give an accurate estimate since a particular request may be at the high end of what a bonding company may support on either a single project or on an aggregate basis.           So, what should a construction firm do? We know it sounds simplistic, but start by requesting an amount that is already increased by at least 10% and then stay in constant communication with your broker as to potential increases and the reasons why.

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THE BOTTOM LINE

“It’s no trick to be a successful salesman if you have what the people want. You never hear the bootleggers complain about hard times.” Robert C. Edwards “There are more fools among the buyers than among sellers.” French Proverb “I don’t want to be a millionaire, I just want to live like one.” Bernard Shor “Cutting the price is usually insanity if the competition can go as low as you can.” Michael E. Porter “I am the world’s worst salesman; therefore, I must make it easy for people to buy.” Frank W. Woolworth “Only a fool holds out for the top dollar.” Joseph P. Kennedy “The lack of money is the root of all evil.” George Bernard Shaw “People want economy, and they’ll pay any price to get it..” Lee Iacocca “A bashful beggar has an empty purse.” Hungarian proverb Year End Planning To Maximize Bonding            A contractor’s aggregate bond limit is largely determined by their firm’s working capital, net worth and leverage positions as reflected in financial statements, especially its fiscal year-end financial statement. The year-end statement is the one primarily used to establish a bonding program with an interim statement, typically six months from the year-end, used to support the same or possibly an even greater level.           Since many of our clients have calendar year-ends, the timing of this topic is critical. It is close enough for us to be concerned about it, yet it gives us enough time to meet with any of our clients that wish to discuss their particular situation in detail. You must plan in advance to be sure that the numbers and ratios are strong enough to support the credit that you need. Keep in mind that this statement will be the basis for your bonding credit for a year. Also, you will live with this statement for three to five years since banks and bonding companies typically look for three to five years of statements prior to making a credit decision.           The ‘aggregate’ limit is that level that a surety feels comfortable supporting a contractor for all of its work ( not just one particular project). This includes both bonded and unbonded work. It is not the accumulation of the contract prices, but rather the evaluation of the costs that need to be incurred from the current date to complete the contracts in progress. Since the aggregate level is largely determined by a firm’s financial statement, it is critical that these financial statements look as good as they can.           Much of what follows amounts to just window dressing, but let’s be honest about human nature— first impressions are hard to break. We want that first impression of the financial statement to be a favorable, long-lasting one. Of course, there are a number of issues that need to be addressed in this process. First, of course, is tax-planning. Second is the firm’s true financial position. It is easier to make your firm look good when your firm is truly enjoying a good financial position. If the firm is on the brink of bankruptcy, very little window dressing will hide this.            The balance sheet is simply a snapshot of a firm’s financial position at a particular point in time. Cash could be zero on December 31st and $1,000,000 on January 2nd. The firm has not changed except that a $1,000,000 account receivable came in. Still, aesthetically it looks better to have $1,000,000 in cash versus zero. Of course, if your firm recognizes revenue on the cash basis for tax purposes, tax planning may dictate bringing the cash balance as low as possible.           As long as it is not contrary to tax planning, as of a financial statement date: Cash should be maximized. Cash is king, no doubt about it. Nothing is more important to a bonding company than liquidity. Yes, it is true than when you do this at the end of the year your accounts payable will be higher than if you used your cash to pay them. The working capital number does not change, but cosmetically, its looks better to have more cash. Receivables, especially those over 90 days, should be collected. Work very hard in the last month or so to collect as much money as possible. Projects should be billed as much as possible. It is preferable to be overbilled on each project rather than underbilling, especially if your cash balances are very strong. Underbillings often raise concerns about a project’s profitability. Inter-company transactions should be eliminated as of the date of the Financial Statement. Again, our goal is to keep the balance sheet of the constructio company as clean as possible. Loans to shareholders and employees should be cleaned up by the end of the year. The bonding company will not allow these amounts in their analysis. This could have a serious impact on the credit granted. Bank debt should be reduced as low as possible, preferably to zero. This implies that you are not too dependant on the bank. Defer equipment purchases for all cash or purchases that require significant down payments. Equipment is a “long-term” asset which does not contribute to your working capital calculation. What you are doing then is replacing a current asset, cash, with a long-term asset, negatively affecting working capital. Also, whenever possible, consider using long-term financing. Try to keep stockholder distributions to a minimum. If you are an “S” Corp., try to take distributions only in an amount sufficient enough to cover any tax obligations. It is your money, but it is important to keep enough in the company to support the credit you need to operate and grow your business. These ideas are designed to present your company in as favorable a light as possible. If you are interested in maximizing your bonding program, please give us a call to set up a meeting.

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THE BOTTOM LINE

“Famous Quotes” “It is hard to believe that a man is telling the truth when you know that you would lie if you were in his place.” H. L. Mencken “Nothing is as irritating as the fellow that chats pleasantly while he’s overcharging you.” Frank McKinney Hubbard “The salesman knows nothing of what he is selling save that he is charging a great deal too much for it..” Oscar Wilde “The sale merely consummates the courtship. Then the marriage begins. How good the marriage is depends on how well the relationship is managed by the seller.” Theodore Levitt “In an era of relationship marketing, sales excellence is demonstrated by the number of customers who make a second purchase.” Louis E. Boone “If you can’t convince ‘em, confuse ‘em.” Harry S. Truman Meeting Your Bonding Company           The contractor surety relationship is not just about financial information. Communication and understanding each other are just as important. Most Surety Companies, especially the ones writing larger single risks, like to meet with their contractor clients on an annual basis. Meetings allow the surety underwriter to learn about the personality of the principal(s) of the firm and its key people. It also provides an excellent opportunity to learn about a contractors business operations first hand and discuss current projects in progress and what might be on the agenda in the near future. A firm that is serious about its Surety Bond program should want to meet with its surety or a potential new surety.           When meeting with a Surety company it is important to show that you are in complete control of your organization. Financial numbers are very important to the surety, but your character and ability to demonstrate that you are capable of running a business is just as important. It is also beneficial to establish a relationship where the surety underwriters become confident in your abilities as a contractor and businessperson. Sureties have learned that good contractors are capable of performing the project work, successful contractors are good at running the entire business of construction. Meeting with a contractor is an opportune time for the Surety to evaluate its clients’ abilities as a businessman.           Here are a few items to keep in mind that will help you make a positive impression when meeting with your Surety.           The contractor asked the agent to place him with another bond company. Make sure you review all existing projects on hand and can answer questions related to these projects. Surety companies like to see that the principals (key people) are on top of all projects from what has been paid to what materials are on site. Let them know you are completely aware of what’s going on at the jobsite(s). If you indicate that you are unfamiliar with what is going on with your projects it is a RED FLAG to the Surety. Demonstrate your estimating and job costing procedures. Bond companies love to see how contractors estimate and track projects. If you have a system that shows you can track your projects from its original estimate to its completion show it off. Abilities such as this make a positive impression with bond companies. How does your office and yard look? Are you neat? Sureties relate neat with organization. If you have a well maintained office and yard it indicates some organizational skill. If your meeting is at a project site this becomes even more important. Neat translates into organized and an organized contractor is usually more efficient. Office staff / employees. It doesn’t matter if you have one employee or one hundred. Are they efficient? When you ask for something can it be provided in a timely manner? Is the work accurate? Bookkeeping and project supervisors are probably most important. Collecting your money and sending out invoices are how you get paid. Organizing the project, getting along with the owners & addressing any unforeseen situations successfully are key to managing the most profitable projects. You should be familiar with your financial and banking situation. When asked about your finances or banking capabilities you should be able to address the basic questions. If you refer to a bookkeeper or office staff member for the most basic questions (like how much money have you collected from Project A?)it sends a message to the surety that you are not paying attention to the basics of your business.           Provide details about what it takes for you to be successful in bidding. Don’t be shy about what you need to have for success. As long as it makes business sense, you should explain to a surety what market conditions are like and why you have adopted the bidding patterns you use. Discuss who your good competitors are and why, and same for competitors you hate to see bid against you. Give the bond underwriter an idea of what projects you like and why. What are your advantages when considering certain types of projects? Start to give the bond company a feel about your specific firm and the strengths you have.           Do not compare yourself to others when talking to the bond company. Explain what formula has made you successful and what you believe it will take to continue being a success. Bond companies have met many successful contractors with different approaches but similar results. It is the contractors that have always paid attention to their own business that they feel are the most successful. Underwriting is about risk. It is the Surety Underwriter’s job to measure if taking on the risk of writing bonds for you is worth the reward. It is your job as Principal of the firm to provide as much comfort to the underwriter that you are capable of running your business successfully at the credit levels you are requesting. Meeting the surety and making a positive impression at the meeting is a big step in moving in the right direction. Update Your Bonding File           By now your interim financials should be in the hands of your bonding company. Make sure you send a work-in-progress schedule and the accounts receivable aging report along with any financial statements. A work-in-progress schedule should be submitted quarterly, so if it’s been 3 months since the last one, go ahead and do another. In addition, send over anything that has renewed recently, such as a bank line of credit or your certificate of insurance. Contractors should also begin thinking about their Year End Financial Statement planning with their CPA -not just tax planning. Don’t forget to keep the bonding experts in the loop for their input. They are there to help!

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