To many contractors, accounting is a foreign language and a necessary evil that they would rather spend as little time as possible involved with. What isn’t often considered is how having quality internal financials can help increase your bonding capacity and grow your business through properly set up procedures and an accounting system.
Surety companies use financial information in a few important ways to determine bonding capacity of a contractor. One way is to evaluate whether you have the ability to cash flow your work. Another way sureties use financial information is to gauge your track record of success on past projects and running your company profitably. After all, past success is a great indicator of your future capabilities. To make those assessments, sureties need accurate financial information.
Before we discuss how investing in quality internal financials works, it is best to begin with the types of construction accounting and define what makes your internal financials be of good quality.
The Types of Construction Accounting
Some readers may already be aware of the three primary types of construction accounting, but for those who don’t or are newer businesses, it’s a helpful starting place:
The Cash Accounting Method
The cash method is the most simple as it amounts to counting income when you receive payment and deducting expenses when they’re paid. Sureties consider this is the least reliable method of accounting and typically require at least financial statements prepared on an accrual basis for bonding. If you currently prepare your financials on the cash method the first step you will want to take is switch over to the accrual method of accounting.
The Accrual Accounting Method
This method of construction accounting recognizes revenue when you bill for it and expenses when you are billed by your suppliers or subcontractors. So you can see the timing of when you bill something or when you are billed by vendors plays a big part in the timing of when you account for revenue and costs.
The Percentage-of-Completion Accounting Method
To figure out how much income to report using this method, you would divide your project costs incurred to date by the total estimated cost to complete the entire job. For example, let’s say you have a $1 million project that is expected to cost $800,000 to complete, which means you will have a gross profit margin of $200,000. If you have incurred a cost of $400,000 out of the $800,000 estimate, you would be considered 50% complete. According to this method of accounting, you would recognize 50% of the revenue or $500,000 and 50% of the gross profit or $100,000. This method is especially important to understand as many sureties require contracts to use the percentage-of-completion way of accounting once you start to need larger bonds.
What are Quality Internal Financials?
Now that you’ve read an overview of the different types of accounting used in the construction business, what does it mean to have quality internal financials? Due to the unique circumstances accounting faces in a contractor’s company, it’s much more than having accurate books. To have quality internal financials means:
- The job costs are set up and expensed correctly to the appropriate projects
- Revenue and costs are posted in the same month they are incurred
- You have the ability to generate a work-in-progress schedule
- You can tie the work-in-progress schedule into your balance sheet and income statement
Construction isn’t like other businesses where the accounting is fairly predictable, it fluctuates based on the project. Also, due to needing surety bonds to successfully bid on projects, accounting becomes all the more important. Bonding companies base a lot of their decision-making on financial information, so having more accurate financial information gives a surety confidence in issuing bigger bonds. This is how having quality internal financials leads to increasing your bond capacity, and therefore good accounting can actually help you grow your business.
How to Invest in Internal Financials
No matter the state of your internal financials now, there are several things you can do to invest in having them be of better quality:
- Take the time to properly set up your accounting procedures and system.
- Have quality staff that knows the unique accounting of the construction business.
- Ensure that the type of system you’re using is relevant to your business, meaning make sure it’s built for contractor accounting.
- Have access to outside resources to ensure your internal financials continue to be of good quality, such as a surety specialist.
Investing in your internal financials isn’t about having fancy computer software or hiring an extensive team of accountants, it’s making sure you have a system in place with sensible procedures that can accurately reflect your business’s income and expenses on a valid timeline. This is an area many contractors, especially newer ones, overlook and it can cost you bonding opportunities as well as income.
CSBA and Financial Resources
If you’re unsure how to begin taking steps to better the quality of your internal financials, then you can seek outside help from an expert in construction accounting, like a surety agent. A surety agent can help you evaluate your needs and lay out the steps you can take from the position you’re currently in. A surety specialist has access to the resources to make those necessary changes and can guide you on the path to having quality internal financials while growing your bond capacity.
We at Commercial Surety Bond Agency are experts in the unique accounting of the contractor business and have the resources to guide you. We have internal underwriters on staff that used to work in surety companies and are familiar with what a surety looks for in financial records before issuing a bond. Working with CSBA means having access to that knowledge as well as bookkeepers, controllers, and CPAs that specialize in contractors.
Don’t neglect the accounting aspects of your business, it costs much more than money to not invest in that area. Reach out to CSBA and begin building quality internal financials and growing your bond capacity.