If you’re a contractor that needs bid, performance, and payment bonds, you are probably familiar with what a work-in-progress construction schedule is. What you may not know is what surety companies look for when evaluating work in progress.
Work in Progress Overview
For contractors that are less familiar with work in progress construction schedules, they are essentially a list of your projects that details the contract amount that includes change orders, total estimated cost, and gross profit for each job, along with the progress to date. To calculate work in progress in construction on each project, the WIP compares the cost you’ve incurred by the total estimated cost. For example, a $1.5 million contract with an estimated cost of $1 million where $500,000 of costs have been incurred to date would be considered 50% complete ($500,000/$1,000,000).
The percentage completely drives everything else on the schedule. Using the same $1.5 million job example above, at 50% complete you would recognize half of the contract value as revenue and half of the gross profit.
Revenue: $1,500,000 x 50% = $750,000
Gross Profit: $500,000 x 50% = $250,000
Finally, the schedule will show whether you are overbilled or underbilled compared to the revenue earned. Let’s say you billed $800,000. Since $800,000 is greater than the revenue earned of $750,000 above, you are considered to be overbilled by $50,000. Conversely, if you’ve only billed $400,000, you would be underbilled by $350,000.
When reviewing work in progress construction schedules, sureties look for three main things:
- Job profit trends
- The cost to complete the backlog
- Under and overbilling
Let’s take a look at each in more detail.
Job Profit Trends
Surety companies track jobs over time to see how they perform from beginning to end. When a contractor can finish projects consistently for close to the same profit they bid it for, it demonstrates their ability to estimate properly, anticipate challenges, and run projects well in the field. The more consistency there is, the more a surety company can rely on the work in progress to forecast projections for revenue and profit of the contractor, which ultimately helps when approving bid, performance, and payment bonds.
Construction being what it is, there is typically some deviation from the original estimate to the final profit. Having a single bad job showing a declining profit or loss isn’t the end of the world. Where surety companies do get concerned is when there is a trend of multiple job profits declining, the job that has a profit fade or loss is very large, or when the contractor can’t explain why the losses are occurring.
Cost to Complete
As explained above, the cost to complete is simply the total estimated cost to complete a job minus the cost incurred to date. Sureties base total bonding capacity, otherwise known as aggregate bonding capacity, on the total cost to complete for all projects. So, if a contractor had 10 of the $1.5 million jobs mentioned above, that would be $15 million in combined contract value. That means they would have a total cost of $10 million, and if each of those jobs were 50% complete, the cost to complete would be $5 million.
Total Estimated Cost for Backlog $10 million x 50% Complete = $5 million Cost to Complete
So, if this contractor has a total aggregate bonding capacity of $10 million, they still have $5 million of capacity available. In addition, each month that goes by, the contractor works off additional work freeing up more bonding capacity. It’s an important distinction to realize that bonding capacity is not based on total contract value and that it is constantly adjusted for work that is burned off and additional contracts that are added.
Underbillings and Overbillings
Bond companies primarily focus on underbillings. Again, based on the way a work-in-progress construction schedule is structured, this means the contractor has billed for less than they have earned using the formulas outlined above. Sometimes underbillings are simply due to the timing of a billing date or not being allowed to bill for a particular item that is not on the job site yet. Those situations generally work themselves out fairly quickly, and the billings catch up to the revenue earned. What is more concerning to a surety company is when an underbilling on a project is consistent, especially in the later stages of the job. This often signals change orders that have not been approved by the owner that can’t be billed for yet. This creates a level of uncertainty, and it is important to discuss these with your surety agent so they can properly communicate the circumstances to the bond company.
As you can see, it’s important for contractors to understand the work-in-progress construction schedule, so you can properly communicate with your surety company about what is happening in your business and what your bonding capacity needs are. Effective communication can literally mean the difference between getting approval or declination for a bid bond or performance and payment bond. With a little bit of effort and some guidance from your surety agent, you can make sure you are in the best position possible to get the surety bonds you need.
At CSBA, we work hand-in-hand with our contractors on their work-in-progress construction schedules, so we can understand their business and advocate to surety companies on their behalf to maximize the bonding capacity they have available.