Surety companies commonly want their contractors to obtain a line of credit from their bank to support their bonding program. These lines of credit can act as a form of “financial insurance” from the surety’s perspective to ensure the contractor has adequate access to cash if they hit a bump in the road with a bad project or disputed receivables. And as the saying goes, “Banks will lend to you when you don’t need it, not when you do”, so it’s generally best to get these in place prior to an issue.
A common rule of thumb sureties use for determining the size of the line of credit a contractor might need is taking 5% to 10% of annual revenue. As with all rules of thumb, there are exceptions and other considerations.
Recommended Reading: 4 Factors Your Surety Company Considers When Bonding Larger Projects
Specific Considerations
Beyond using the formula outlined above, there are other factors that contractors should take into account when thinking about how much of a line of credit they want for their business.
The type of work the contractor performs can greatly influence their line of credit needs. A general contractor has much lower cash flow requirements given how little work they self-perform than a subcontractor with heavy labor who has to fund payroll weekly.
Performing work as a prime versus a subcontractor can also make a big difference. Being closer to the source of funds usually results in getting paid faster. Whereas subcontractors may have to wait for 90 to 120 days to receive payment.
The timing of payments can also be addressed by the contractor vetting the particular owners or general contractors that they choose to work for. Some simply pay faster than others.
All that to say, if you work primarily as a subcontractor for owners that routinely pay slowly, you may want to have a larger line of credit than the general contractor working directly for quick paying owners.
Worst Case Scenario
Another way to think about how much of a line of credit you might need is to consider what a worst-case scenario in your business looks like. For example, what would happen to your cash balances if you performed $1 million of change order work that the owner ended up disputing? What if this project was delayed, and that same owner was claiming LD’s withholding $500,000 of your retention? Do you have the excess cash to continue operating without any hiccups?
You can adjust the scenario and numbers to whatever may be appropriate for your particular business. For example, try imaging you have a large job with a 20% loss or that you have two jobs with problems. Consider what that would do to your business and whether your typical cash balances plus your available line of credit would be sufficient to cash flow your operations through those issues.
Self-Insurance
Not every contractor needs a line of credit. Much like insurance, it is possible to “self-insure” by carrying substantially large cash balances either corporately or personally. We have some clients that will personally loan the money to their company as needed as their source of cash flow, because they don’t like to rely on a bank for a line of credit.
Conclusion
Determining the right size line of credit isn’t about hitting a single “correct” number – it’s about understanding your business’ cash requirements. While the 5%–10% of revenue guideline is a helpful starting point, contractors should layer in real-world factors like payment timing, job size concentration, disputed change orders, and worst-case scenarios.
For some, a well-structured bank line provides critical flexibility and reassurance to their surety. For others with very strong balance sheets, self-insurance through existing cash reserves may be sufficient.
Ultimately, the goal is the same: ensuring you have reliable access to liquidity when you need it most, before a problem arises, not after. Thinking through these issues proactively alongside your surety agent puts you in a stronger position with both your surety and your bank and helps keep short-term cash flow issues from turning into long-term business problems.
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