Why Financial Statements Are Important for Surety Bonds
Many different types of businesses and professionals are required to purchase surety bonds in order to secure contracts or obtain the licenses they need to work in their industries. Surety bond approval is not automatically granted. Instead, surety companies want to ensure that the businesses and individuals that apply for surety bonds pose minimal risk of claims.
When you apply for a surety bond, you will be required to submit a number of documents so that the surety company can evaluate your application and the risks involved with issuing a surety bond to you. One of the key documents that you will have to provide as a supporting document with your application is a financial statement for both your business and for you. Here is some information about surety bonds and the importance of financial statements in the underwriting process.
Understanding Surety Bonds
Surety bonds are legally enforceable, binding contracts through which the surety company guarantees that the principal will perform its contractual obligations and comply with the relevant laws and regulations. A surety bond is not insurance. It does not protect the bondholder from liability if claims are filed. Instead, the surety company will only step in and pay claims when the principal fails to do so. The surety company can pursue reimbursement for any unpaid claims by seizing the principal’s collateral or filing a legal action. While surety bonds do not work like insurance, they do serve as guarantees of performance and are required for many businesses before they can secure licenses or enter into contracts.
Financial Statements When Applying for a Surety Bond
When you apply for a Florida surety bond with a surety company, you will have to submit a number of documents to support your application. The approval process works similarly to the way in which the credit approval process works for businesses when they apply for credit. The surety company will complete an underwriting process to determine its risk if it issues a surety bond to you. Some of the types of documents you might be required to submit include the following:
• Resumes of all key personnel
• Organizational chart
• Financial statement for your business
• Personal financial statements for major shareholders
• References
• Bank letter
• Bank statements
• Tax returns
What Is Included in a Financial Statement?
At a minimum, your financial statement should include a balance sheet showing your available working capital, your assets, and your liabilities. These three components help the surety company to understand what your company owns and its outstanding debts. You should list your assets in order of how easily they can be converted to cash and divided into current assets and long-term assets. Current assets include those that can be converted into cash within one year. Similarly, liabilities should also be divided into current liabilities that must be paid within one year and long-term liabilities that must be paid after a year or longer.
The financial statement should also include an income statement. This demonstrates how the company has performed over time. Your income statement will include information about your business’s net profit or loss during an accounting period instead of being a snapshot in time.
Using a CPA Audit to Prepare a Financial Statement
One of the best ways to prepare a financial statement for surety purposes is to retain a certified professional accountant to audit your company’s financial statement and provide a professional opinion about its accuracy. An audit can help the surety company to be sure that your statement does not include misstatements or errors so that it can feel more confident in the information you have reported.
Metrics Surety Companies Look for in Financial Statements
Some of the important metrics that surety companies glean from financial statements include the following:
• Debt to equity ratio
• Available working capital
• Company’s and owner’s net worth
• Available assets that might secure the surety bond
• Your ability to meet the contractual obligations
• Work that you have not yet completed
The Surety Underwriting Process
Surety companies consider multiple factors during the underwriting process to determine whether or not to approve an application for a surety bond. Several of these factors are derived from your financial statements, making it important that your statement is thorough and well-prepared. A surety company will want to see that you have sufficient working capital to cover your obligations and to perform your contracts. It will also want to see that you have established a good credit record and that you and your business have good reputations. If you have poor credit, little experience handling projects of the proposed size, have little working capital, or have a problematic history, the surety company could deny your application.
The surety underwriting process also helps to determine the fee that you will have to pay upfront to get the surety bond if you are approved. Businesses with great credit, substantial experience, excellent reputations, and substantial working capital enjoy the lowest fees. If your business meets these types of criteria, your upfront fee might be as little as 1% of the maximum amount of your surety bond. If you are approved but have less experience, a lower credit score, or marks on your record, the premium you might be charged will likely be much higher.
Getting a surety bond is a necessary evil for many different types of businesses. Depending on your industry, you might be required to be bonded just to get a license so that you can legally operate. Making sure that your finances are in order and that you have established a good business reputation will make it likelier that you will be approved. Once you have a surety bond, it is important to operate your business ethically and fulfill your contractual obligations on time to avoid claims against your surety.
