How to Increase Bonding Capacity for Construction

For many Denver and Colorado construction companies, bonding capacity is critical. Companies looking to bid on larger projects need appropriate bonding levels. A high bonding capacity indicates financial stability and a proven track record of project success to project owners.

The higher the bonding capacity, the larger the project a construction company can bid on. Bonding capacity can be the difference between winning a major contract or missing out on significant opportunities. For those interested in increasing bonding capacity, there are several steps to take.

Understanding what is bonding capacity in construction is essential for business growth. Companies must know how to determine how many bonds they can handle. This knowledge drives competitive advantage.

This guide covers cash flow management, financial health, and strategies different types of projects require. WhippleWood CPAs has provided key details below to help construction companies improve their aggregate bonding capacity.

What is Bonding Capacity?

Bonding capacity refers to the maximum amount of surety bonds a construction company can obtain. These bonds act as a financial guarantee. They assure project owners that a contractor will complete a project according to contract terms.

What is bonding capacity meaning in practice? It’s a measure of financial health and project capability. This is common practice in both public and private sectors. It helps minimize risk to project owners and ensures construction projects proceed smoothly.

Sureties determine bonding capacity by evaluating a company’s financial health, project history, and risk management. They assess the bonding capacity of oxygen – meaning the company’s ability to “breathe” financially under pressure. Bonding limits are typically expressed in two ways:

• Single project bonding capacity: The maximum bond amount for an individual project
• Aggregate bonding capacity: The total bonded work a company can take on at one time

A contractor’s bonding capacity can increase, or decrease based on business performance. For example, a growing construction company wanted to bid on larger projects. The bonding limit wasn’t keeping pace with growth. The surety flagged concerns about working capital, which remained flat despite rising revenue.

By retaining more earnings and tightening cash flow management, the contractor improved financial stability. After a financial review, the surety increased the bond limit. This allowed the company to take on bigger construction projects and improve project success rates.

Key Financial Metrics for Bonding Capacity

Sureties conduct a detailed financial review before determining bonding limits. Understanding construction bonding capacity explained through key metrics helps companies prepare. Three key financial metrics play a major role:

Working capital

Working capital is the difference between current assets (cash, receivables, inventory) and current liabilities (short-term debt, payables). It measures the positive cash flow available for day-to-day operations.

A construction company with strong working capital can cover expenses and absorb unexpected costs. Sureties look at the working capital ratio along with other measurements of financial health. Strong cash flow forecasting helps maintain adequate working capital.

Net worth

Net worth equals total assets minus liabilities. A higher net worth reassures sureties that a contractor has financial stability. This financial cushion helps withstand economic downturns, supply chain disruptions, or unexpected project costs.

Building net worth demonstrates long-term financial health. It shows the construction company can handle different types of projects without financial strain.

Cash flow

Cash flow measures how money moves in and out of the business. Cash flow management is critical for construction companies. Even profitable companies struggle if cash flow is inconsistent.

Many contractors report delayed payments, creating negative cash flow situations. Sureties examine whether a contractor has enough operating cash flow to cover payroll, material costs, and other expenses.

A strong cash flow statement and regular cash flow forecasting improve bonding capacity. Contractors can improve cash flow by strengthening accounts receivable (AR) processes. They should monitor payment terms closely.

Managing the line of credit effectively also helps maintain healthy cash flow. Understanding the period of time between project milestones and payment helps with cash planning.

How to Increase Bonding Capacity

Finances are key, but sureties also evaluate operational efficiency, risk management, and project history. The following strategies help contractors secure higher bond limits and determine the bonding capacity of a construction company:

Strengthen Financials

Contractors start by reviewing key financial ratios with a professional. Sureties favor companies with CPA-prepared financial statements, healthy working capital, and manageable debt.

Retain earnings in the business instead of taking large distributions. Pay down short-term debt. Reduce overhead costs. These actions help reduce risk and improve credit scores.

Manage Backlog

Taking on too many projects overwhelms resources. This leads to cost overruns and delays. A steady backlog with reasonable profit margins attracts sureties more than rapid, unsustainable expansion.

Managing cash effectively across different types of projects demonstrates strong financial planning. Project owners value contractors who maintain quality across their entire portfolio.

Build a Strong Credit Profile

A solid credit history reassures sureties that a contractor can meet financial obligations. Credit card management, timely bill payments, and reduced outstanding debt matter.

Monitor both business and personal credit scores. Strong credit scores improve bonding capacity and access to flow forecasts for future projects.

Improve Risk Management

Sureties want robust internal controls. This includes WIP reports, budgeting, cash flow forecasting, compliance programs, and safety protocols.

Risk management practices show that a construction company can manage projects effectively. Financial obligations are met, and informed decisions protect project success. Strong management strategy reduces exposure to negative cash flow.

Demonstrate a Strong Track Record

A history of successful project completion matters. Minimal disputes and strong relationships with clients and suppliers increase bonding limits. It’s important to maintain accurate records of completed projects to strengthen the case.

Diversify Project Experience

Expanding into different types of projects reduces financial risk. Contractors can branch into municipal, commercial, or infrastructure work.

This demonstrates adaptability and shows the ability to handle varying payment terms and operating cash flow requirements. Working with a credit card for smaller expenses and a line of credit for larger needs shows financial sophistication.

Plan Ahead

How to determine how many bonds your company can handle takes time. Increasing bonding capacity isn’t overnight. Contractors expecting to bid on larger projects in the next 12-18 months should start preparing now.

Work with your CPA to improve your cash flow statement and financial review processes. Planning during this period of time ensures you’re ready when opportunities arise.

Action Steps

Here are key steps contractors can take to improve financial standing and qualify for larger bonds:

• Review financials with a CPA to ensure statements accurately highlight working capital and financial health.
• Retain earnings in the business instead of taking large distributions to improve liquidity and positive cash flow.
• Reduce short-term debt and avoid unnecessary financial obligations that strain the cash flow statement.
• Improve job costing and cash flow forecasting to demonstrate strong financial oversight.
• Track and document project success to show a history of on-time, on-budget completions.
• Communicate with stakeholders including the project owner, surety, and lenders to align expected bonding capacity with business growth goals.

Contact Us

A higher bonding capacity makes a significant difference in the long-term success of a construction company. It opens doors to larger, more profitable construction projects. Understanding what is bonding capacity in construction and taking proactive steps improves your aggregate bonding capacity.

Questions about increasing your bonding capacity? Need help with tax or accounting issues? WhippleWood CPAs is here for you.

For additional information call 303-989-7600. We look forward to speaking with you soon.