Making Contractors Irresistible to Banks and Bonding Companies

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It can be challenging to get banks and bonding companies to want to work with contractors. What can you do about it? Can you stack the deck in your favor? Can you dress up your financial picture? Find out on this week’s episode.

Topics we cover in this episode include:

  • Why a good year-end financial statement is important to bonding companies and banks
  • Pay back Officer Loans at the end of the year
  • Inject capital at the end of the year
  • Improve your working capital ratio
  • Extend the terms of your line of credit
  • Timing expenses and collections
  • Be aware of bank covenants on your line of credit


Join the conversation on our LinkedIn page:

Wade Carpenter, CPA, CGMA |
Stephen Brown, Bonding Expert |


[00:00:00] Wade Carpenter: It can be challenging to get banks and bonding companies to want to work with contractors. What can you do about it? Can you stack the deck in your favor? Can you dress up your financial picture? Come on in, let’s talk about it.

This is the Contractor Success Forum, and if you’re new here, I’m Wade Carpenter with Carpenter Company CPAs. WIth me is my co host, Stephen Brown, with McDaniel Whitley Bonding and Insurance. Stephen, as we are recording this, we are nearing the end of the year. Any initial thoughts on dressing up financials?

[00:00:32] Stephen Brown: Well, here it is end of November. And my advice is you should have already met with your CPA to go over what your financial statement is going to look like. And so my question to you is, Wade, why? I have my own answers. Why is that important to bonding companies and banks?

Why a good year-end financial statement is important to bonding companies and banks

[00:00:49] Wade Carpenter: Well, we were just talking about this before the show, no contractor likes to pay taxes. But you also want to dress it up for the banks and the bonding companies they don’t have to necessarily be mutually exclusive because a lot of times we’re on a different method of accounting, like you may be on cash basis for tax purposes and you go spending all your money out to knock down your taxes.

But it can wreck your ratios if you run all your cash out and you’ve got negative cash. So we’re going to talk about that. Most of the time, anything we do after the fact, if you’re a December year end, after January 1, it’s too late to do something about a lot of these things.

[00:01:28] Stephen Brown: Yeah. And, I wanted to point out that if your fiscal year end is December 31st, it’s not necessarily December 31st, then at the very latest, now’s the time to be talking to your CPA about how the financial statement’s going to look. And don’t be afraid to bring your bond agent into that meeting, because you’re all pulling with the same set of oars. I’ve always said from a bonding company’s perspective, the financial statement that you have at the year end is the foundation for the next year’s surety credit.

[00:02:00] Wade Carpenter: Absolutely. And it’s usually the one they hang their hat on as well as the banks,

[00:02:04] Stephen Brown: too.


[00:02:05] Wade Carpenter: And, so we’re going to talk about some of the common benchmarks today and, I’d like you to maybe speak from the underwriter criteria from the bonding side.

[00:02:14] Stephen Brown: Sure.

[00:02:15] Wade Carpenter: A lot of times there are industry specific ratios and health indicators like working capital or debt to equity that we talk about all the time on the show.

And another problem that a lot of contractors have had, especially since 2008, the great recession, is getting banks to want to work with them. Getting more capital lines of credit. A lot of people jump out and think they can get a line of credit right off the bat. And typically getting credit for a contractor or any business is like being a teenager. And that teenager has to work into that credit.

So with a construction contractor, typically it’s three years before a bank is really even going to talk to you about getting a line of credit unless you’ve got some serious collateral personally or in the company that they would hang their hats on.

It goes back to a lot of these industry statistics. A lot of the banks pay attention to the RMA annual statement studies is one of the biggest ones that they look at and they actually report and share numbers with.

I know a lot of the numbers I look at from the bonding side come from The Construction Financial Management Association, but Stephen, do you have any places where you really look at–

Five Minute Underwriting

[00:03:29] Stephen Brown: Well, the first thing, we’ll just call it a five minute underwriting when you get that year end statement. You look to see how much cash, working capital, current assets minus current liabilities. You look at the cash position of the company. Then, you look to the income statement to see if they reported an income or not.

 Then you go back to the work in progress report to see if there was any particular jobs that had job fades, and when I say job fades, I say job profits that did not perform according to the original plans. So originally, when we talk to a contractor about different projects, we get a rough idea of what kind of profit they expect to make on that.

And, if the profit’s ridiculously low on a projected job, we need to discuss that so we can discuss that with the bond underwriter, it’s going to come up. You need to discuss it. And, so that financial statement, just for a quick five minute underwriting situation, tells you I can breathe easy or there’s some huge problems.

Then you start digging deeper into that financial statement and you find out a lot more information that you need to know to underwrite bonds. Also last but not least, as you’re going through that statement, if you’re a construction oriented CPA, you cannot have enough notes in your statement to make a bank or a bonding company happy.

The key financial ratios in your financial statement

[00:04:55] Wade Carpenter: That’s great. The key financial ratios that I see are, the first two I think you probably agree with me is working capital ratio and debt to equity. But then there’s other ones like profit margin and looking at that year to date, is it track year over year, net profit margin, you want to be able to show that you have some healthy cash flow and you can pay back a bank if you borrow money.

 We could probably spend a little bit of time talking about things like backlog, or you tell me what do you pay attention to?

[00:05:27] Stephen Brown: Well, that’s so important.

Like you said, the bank wants to know that they’re gonna get paid for anything they’ve lent you. From a financing standpoint, bonding companies don’t give a lot of credit to your equipment being paid down. You would think that’s an asset. That’s something I don’t have to pay for, it comes right off a job cost, but nevertheless, bonding companies don’t give you credit for that. And what banks are looking for is they’re looking for positive cash, communication of the outflow of that cash and the inflow of that cash on contracts in progress.

So we’ve talked a lot about backlog gross profit, and you get that from your work in process statement. You see how much of your backlog of work, how much is your anticipated gross profit? And historically speaking, do I need to discount that number the contractor’s telling me, or is that a conservative estimate?

[00:06:23] Wade Carpenter: Yeah, okay. I think we’ve done some other episodes, and we can maybe, if we have time, drill into some more of that, but what I wanted to spend the time talking about was some of the strategies that I use when thinking about dressing up a financial statement here at the end of the year.

As you said, especially the year end, that’s the one they hang their hat on. So these are my perspective and I’d love you to chime in on each one of them.

[00:06:47] Stephen Brown: Okay.

Pay back Officer Loans at the end of the year

[00:06:48] Wade Carpenter: The first one I wanted to throw out there was officer loans. They’ve been taking money out of the company and they got a big balance at the end of the year. One of the things I tell people a lot is, hey, can you put that money back even if it’s just temporary? Can you temporarily inject cash back into the company for the balance sheet even if it’s just for a few days so that it looks a little better?

But what’s your perspective on things like officer notes and those kind of things?

[00:07:15] Stephen Brown: Well, it’s completely discounted by everyone. It’s not considered a receivable that’s good. Because, even though it’s from you, and that’s no reflection on you or your personality, but when you’re taking money in and out of your company, that makes banks and bonding companies nervous.

So you’re right, Wade, that’s great advice. Show that as little as possible. because it’s not going to help you. And if you can temporarily pay that loan to owner or stockholder back, then it’s going to show up as additional cash, which is going to mean more bonding for you and more bank credit.

Inject capital at the end of the year

[00:07:50] Wade Carpenter: Yeah, and I guess extending that a little further, not just paying back officer notes, but injecting capital at the end of the year can go a long way, and what you were saying is getting the bond agent involved in the year end planning can go a long way. If you need to be able to do higher bonded jobs next year, but you don’t have the capacity, that can help

[00:08:11] Stephen Brown: And, you know, Wade it’s always good if you can put some personal cash back into your company because your bond agent is recommending it, to increase your bonding line for the next year.

Because the bonding company, what they will normally do is they’ll do what’s called a subordination agreement with you as the owner. And you say, I agree not to pay myself back, for the next 18 months or so. And that gives the bonding company comfort that at least for the next year, you won’t be pulling that cash back out. It’ll be there.

[00:08:42] Wade Carpenter: A lot of times the banks won’t get as extensive in trying to get some kind of agreement not to pay it back unless they’re really leveraged, but that can help you get a line of credit in your company.

Put prepaid income taxes toward next year’s taxes

[00:08:56] Wade Carpenter: Moving on, another thing that we talk about with clients is, say you’re a cash basis contractor, the idea is let’s pay all our expenses out, but maybe we prepay some expenses.

And if they’re prepaid, they’re really not going to be deductible. But one of the things that I talk about all the time is, if we prepaid some income taxes. And we have the choice of getting it back, or putting it aside for next year. It may be sound financial planning to go ahead and maybe put that towards next year’s taxes. But getting that income tax receivable and calling it an income tax receivable, my perspective is a lot of times the bank will treat that as working capital versus a prepaid that you’re going to throw out.

Agree or disagree?

[00:09:41] Stephen Brown: So will a bonding company.

Improve your working capital ratio

[00:09:42] Wade Carpenter: Okay. Another thing that I talk about a lot of times is, we trying to balance the cash and paying down, expenses before the end of the year, assuming you’re cash basis, but there are things you can do to improve your working capital ratio. And I’ll give you a quick little example, again, this is where we want to bring the bonding company in and say, do you want a specific amount in cash at the end of the year? I think you probably would agree that you don’t want to see somebody that has a negative bank account.

[00:10:11] Stephen Brown: Of course not.

And remember, it’s a general rule of thumb for bonding. If you want a million dollar job, you need to have $100,000 of working capital. So that’s what they call a 10 percent case, because 10 percent of 100,000 is a million. You multiply that out. So as a general rule of thumb, that’s what you want.

So the more cash, the better, the more equity. I’ve heard numerous underwriters and other bonding agents say that they have seen a lot of contractors go out of business trying to get out of paying taxes.

You say well, I’m playing a tax game here. Can’t you understand that I took money from this job and I put it here so I wouldn’t have to pay taxes here?

[00:10:53] Wade Carpenter: My perspective, yes, you’ve got working capital, but you can have working capital in your accounts receivable, and you can have cash in the bank. And a lot of times what I’ve seen is the bonding company wants to see a certain amount of liquid cash.

 Would you agree?

[00:11:06] Stephen Brown: Absolutely.

That’s why they consider your current assets as your most liquid assets, their cash accounts receivable, some other things.

[00:11:16] Wade Carpenter: Okay. But you can improve your working capital ratio, simply by paying down debt if you have the cash to do it. And let’s just say you had a million dollars in cash, for simple math, and you had $800,000 in accounts payable. Let’s just say that’s all you had. So that would be a working capital ratio of 1.25 times, right?

[00:11:38] Stephen Brown: Right.

[00:11:38] Wade Carpenter: So let’s say we took 500, 000 of that and paid down that $800,000 of accounts payable. You’ve got 500 in current assets, 300 in current liabilities. The ratio jumps to 1.67. It didn’t do a single thing for working capital because you’re still at $200,000 working capital. I hope everybody followed that. You know, it did not improve your working capital, but it did improve your ratio. And sometimes that can mean a lot for a bank if you’ve got certain debt covenants. And we’ll go into that a little more later, but any thoughts on that?

[00:12:15] Stephen Brown: No, that’s a good point. That’s a gray area with the bonding because the bonding wants to see as much cash. And, like I said, it’s so amazing to me that you can literally have a million dollars of net worth in your equipment that you don’t owe versus the fair market value and you don’t get bonding credit for it.

 From a bank standpoint, you do, that’s an asset that doesn’t have any debt on it.

Extend the terms of your line of credit

[00:12:38] Stephen Brown: Maybe this is a good time to bring up the idea of, if you owe a lot prior to the year end on your bank line of credit, that might be a good time to see if you can amortize that debt and spread it out over a number of years because that way it won’t show up as a current liability. Only 12 months worth of that debt will be a current liability.

[00:13:00] Wade Carpenter: Exactly the same thing I was going to say, extending the terms of line of credit. Typically, a line of credit will expire every year, and if you can get that renewed for the next year before you do that financial statement, where we can make it long term, or at least the bonding company will see that, hey, it’s not going to be called for at least a year, then sometimes that can go a long way.

[00:13:22] Stephen Brown: And it’s okay to explain if you’re close to being maxed out on your bank line and it’s because of a job that’s been slow pay that’s coming in, and then you’ve got to explain to the banker and the bonding company, is that debt good?

[00:13:36] Wade Carpenter: Right, and sometimes it’s Catch 22 because a bank wants to see that reviewed financial statement before the end of the year, but we would love to have that in the notes that we’ve extended that. So that is one thing I was going to say is, I have done a draft on multiple occasions, I have to do that, do a draft, give it to the bank where they can see the numbers and then sometimes they’ve been confident enough to go ahead and extend the line of credit beforehand. And if we can, that helps.

[00:14:06] Stephen Brown: That makes sense.

[00:14:07] Wade Carpenter: Some of the other things, like managing the liabilities and extending credit terms, I think you just read my mind this morning, but if you could term out a line of credit or something that is short term to a longer term debt before the end of the year, that can go a long way as well.

[00:14:23] Stephen Brown: Mm hmm.

[00:14:24] Wade Carpenter: And one of the biggest things, the EIDL loans, the disaster loans during COVID, those were pretty much gold for contractors if they didn’t waste the funds because you got a long term 30 year payback on it at 3.75%, which you can’t even get as we’re recording this now. So it was gold if you treated it properly. But a lot of these contractors right now, if they get in a cash flow crunch, they do these pay by the week loans that are, they bury the interest rate, but it is exorbitant amount of interest, so if you could refinance that, that goes a long way, especially if you can make more of it long term.

[00:15:01] Stephen Brown: Makes sense to me. the interest rates are really horrific on your line of credit. When you’ve negotiated prime plus 1% or 2%, just depending on the bank’s terms.

[00:15:14] Wade Carpenter: Right.

[00:15:14] Stephen Brown: Another thing is you may have a piece of equipment that you’re not using. Maybe it’s too late at year end, but if you can sell that equipment and use those proceeds to pay down on that line of credit, you’re just going to be helping yourself from every standpoint.

[00:15:30] Wade Carpenter: Good point. Yeah, I guess on a similar note, most contractors don’t have inventory. Let’s just say it. But if you do have inventory. A lot of people think about Hey, let’s buy something for the end of the year, and they were thinking about pricing or something like that. Especially if you’re buying inventory, even if you’re on the cash basis, that is an asset and you’re not going to be able to deduct it from a tax picture. A bonding company, my experience is if you’ve got inventory, at best, they’re going to give you half credit.

At worst, they may give you no credit.

[00:16:01] Stephen Brown: Bonding companies generally 25 percent unless you have an audit that shows that all the inventory has been audited.

[00:16:09] Wade Carpenter: Yeah.

[00:16:10] Stephen Brown: So if you’re a plumber, electrician with a lot of inventory, that might be a good idea.

[00:16:15] Wade Carpenter: And I have seen other situations like a pipeline contractor that bought a whole bunch of pipe that, you’ve got a ton of money in those and that you’ve got the jobs set up to pay them out, I’ve seen them give a little better, credit on that.

[00:16:27] Stephen Brown: And that can be posted to job costs too. So from a bonding company, you’re going to get credit for a pipe. If you have a specific job that calls for that pipe, of course. If it’s just excess inventory, you’re not going to get much credit. Okay.

[00:16:41] Wade Carpenter: Right. we won’t go into it, but there’s a difference between stored materials and an inventory. Where stored materials, you should be able to at least recognize the cost of that material if it is for a specific job.

[00:16:53] Stephen Brown: Exactly.

Timing expenses and collections

[00:16:54] Wade Carpenter: Again, at the end of the year, one of the biggest things with tax strategies is timing expenses and timing collections, especially if you’re on a cash basis, collecting that money before the end of the year, you’re going to pick it up as income. If you spend it out, it’s going to be an expense for that year. Now, let’s say you’re on the accrual basis and you go ahead and bill it before the end of the year, that’s going to count. I caution people that if you’re doing full financial statements and you’re doing a WIP schedule and you don’t bill it before the end of the year, you’re going to show an underbilling. So you should be picking up the asset, but not necessarily picking up the billing.

Where you get in trouble with that is, if you’re too far underbilled, the bonding company is going to start saying why, and is it a cashflow problem?

Thoughts on that?

[00:17:42] Stephen Brown: Absolutely. Why are you underbilled? Well, there’s a specific reason we’re showing underbilling. There is an answer to that. And, from a tax standpoint, possibly some of that can be explained.

[00:17:56] Wade Carpenter: Right,

[00:17:57] Stephen Brown: From a bonding standpoint, big swings of overbillings and underbillings are a big red flag.

And that’s going to cause underwriters to look directly at that work in progress report and try to analyze exactly what jobs were overbilled and underbilled and why.

[00:18:13] Wade Carpenter: And I’ve said it multiple times on this podcast that, doing year-end planning for a contractor really needs to be at least a two pronged approach. Balance the picture between minimizing your taxes, maximizing your financial statement. While third prong is let’s not screw up your cashflow in January, February, because we didn’t bill something.

So, there’s factors we’ve got to take into account. And too often contractors worry so much about the tax picture that, they end up wrecking this whole picture, or CPAs that my only job is to knock out your taxes. And if you don’t understand the relationship, that can really hurt you.

[00:18:51] Stephen Brown: Well, you’re either a contractor or a tax expert, and not many that I’ve met are both. And a lot of folks, they’ll get ideas that they think is a great way to get around tax, saying, well you need to do this, you need to do that, from your friends, but eventually things work out and they catch up with you.

So my recommendation is just go ahead and try to do it the right way. Then you don’t have a lot of explanations to bond underwriters and bankers and other people you depend on for credit. Also you’re not putting the cart before the horse and worrying in the future whether your profits are going to hold up to pay those taxes when they come.

[00:19:29] Wade Carpenter: Okay. one more thing coming back to the cash thing, but we were talking about overdrawing cash. And a lot of times I’ll see people go ahead and spit out all the cash or hold all their billings and not put cash in until January 2nd, and I’ve talked about some horror stories where people have put 2 million in the bank on January IRS comes back and says, no, that’s not going to work.

But if you are showing an overdraft in your bank account, that can actually show a negative picture, at least the perception of it, and sometimes maybe you should either reclassify some of those back to payables or show an overdraft in the bank as a liability as opposed to in the cash account. Sometimes we will reclassify that to a liability, or maybe you overdrew your operating account, but the rest of the cash is positive. We may leave the positive amount in the current asset.

[00:20:22] Stephen Brown: Sure. Yeah.

[00:20:24] Wade Carpenter: Sometimes it’s perception.

[00:20:25] Stephen Brown: Well, it certainly is. Yes.

Be aware of bank covenants on your line of credit

[00:20:27] Wade Carpenter: Okay. Another consideration, whether you’re thinking about it, Stephen, from when you’re advising a client, if a company has bank covenants on their line of credit or their other loans, this is the time to know what they are, number one, and, do something about it.

Because if you’re not going to meet those bank covenants, they can call those loans depending on the terms of it. And too often I see contractors not understand what those covenants are or be aware of them and they come back to bite them.

[00:21:02] Stephen Brown: Sure.. And, and, think this is a great time for me to at least remind contractors that’s always good to spend some time with your bonding folks and your bank folks.

Always, throughout the year. But

just keep them updated on what you’re doing. If you’ve run interim financials, provide those to them, discuss it, review it.

That just builds confidence and that just helps you down the road. I can’t tell you how many people need, bank credit and bond credit that have just because they’ve just been hiding something for too long. And, I can explain, look, this is what’s going on here. Okay, fine, but what I’m hearing as a banker or a bonding company is what you’re telling us is you’re dead to us because you put yourself in a situation that does not make sense. There goes your credibility as a business person, and you’ve also, come to that bank or the bonding company in an emergency situation.

[00:21:58] Wade Carpenter: Right,

[00:21:59] Stephen Brown: So, those are two strikes against you.

[00:22:02] Wade Carpenter: Yeah, and just to comment back on that,, a lot of contractors don’t know what they’ve done to themselves if they’re not getting proper help, or they don’t know these things that dress up the financial statements.

[00:22:14] Stephen Brown: That’s right, I don’t mean to be overly hard on the contractors. They may have been getting bad advice all along, or no advice from their banker or their bonding agent.

[00:22:23] Wade Carpenter: Okay.

Building trust and effective communications with your banker and your bonding company

[00:22:24] Wade Carpenter: The last real point that I wanted to make, you’ve already alluded to earlier in the show was talking about building trust and effective communications with both your banker and your bonding company.

Don’t wait till you need that bond before you give a bonding company a heads up or you need it the next day, which I know that happens all the time, but again, realizing how much your bonding credit is and addressing problems. You’ve already said it. if there’s a problem on your financial statements or you got a problem job, then let them know about it and then communicate what’s going on and what you’re doing to fix it.

[00:23:03] Stephen Brown: Sure. And it’s gonna take a longer time that you anticipate to get a bank line of credit in place.

[00:23:09] Wade Carpenter: Oh, yeah, absolutely.

[00:23:10] Stephen Brown: so you think, I got to meet payroll in two weeks and I’m, I’ve got a cash flow crunch. the bank line is the way to go. And all I can say is just start thinking about it now. And, polish that apple, as my old boss used to say all the time.

[00:23:26] Wade Carpenter: Don’t wait till you need that line of credit, don’t wait till you need that bond, go make those relationships.

[00:23:31] Stephen Brown: Absolutely.

[00:23:32] Wade Carpenter: Well, thank you all for listening to the Contractor Success Forum. Check out the show notes at ContractorsSuccessForum. com or on CarpentersCPAs. com YouTube channel for more information. Consider subscribing and follow us every week as we post a new episode. We will look forward to seeing you on the next show.

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