Year-End Planning for Working Capital

November 3, 2020

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This article was written by TSIB’s Andrew Waterbury and is published in the ABC Southern California Monthly Newsletter, The AGGREGATE, November Edition. Andrew is the Director of Surety at TSIB’s Santa Ana, CA, office servicing Orange County, Lost Angeles County, and Riverside County.

The fiscal year-end for many companies is just around the corner. Subsequently, now is a good time to begin tax planning while keeping in mind how your year-end financials will look when presented to your banks and Surety companies. Banks utilize year-end financial statements to underwrite your credit facilities as well as Surety carriers to establish your bond program throughout the year.   

 

For most, year-end planning is focused around minimizing your tax exposure by paying down debts, payables, purchasing equipment, etc., but for those that are looking to increase their bonding capacity and/or credit facilities, it is important to be conscious of how some decisions may affect your Working Capital.

The bond company will review a Contractor's financial statements throughout the year to evaluate their Working Capital, but the year-end financial statement is typically the foundation for the bonding limits set for the year ahead.

 

Understanding Working Capital

Working Capital, as it relates to a surety program, is the primary financial indicator that dictates the total amount of work that a bond company is willing to support, referred to as your Aggregate Bonding Limit. The Working Capital is used to measure a company’s short-term financial health by evaluating the amount of Current Assets it has to cover its Current Liabilities:

 

Working Capital = Current Assets - Current Liabilities

As a general rule of thumb, a bond company will issue an aggregate bond program by a multiple of 10 times the company's Working Capital amount. So if your Working Capital is equal to $1,500,000, then you would have an aggregate bond program of $15,000,000. There are other factors that may impact this rule of thumb, such as personal net worth, use of the SBA bond program, or whether you are a Trade or General Contractor. Key items when looking at the Current Assets are:

As important as knowing one’s primary Current Assets, knowing which current assets may be excluded or disallowed from a surety company’s underwriting is also crucial—some of which are outlined below:

  • Accounts Receivable over 90 days
  • Loans to Shareholders or Related Entities
  • Inventory, typically only 50% for current assets and 50% goes to long term assets
  • Employee Advances
  • Prepaid Assets (Ex. Deposits, Prepaid Insurance)

Accounts Receivable over 90 days (does refer to retention), when disallowed, can often have the biggest impact on Working Capital. This is an area to always keep an eye on. However, as you approach your year-end and mid-year financial reporting, it is critical to tighten up collections to avoid having this discounted from your Working Capital.

Should you collect on any of the over-90-day receivables subsequent to the date of the financial statements, you should ask your CPA to make a note in the financials stating how much has been collected at the date the financials are published.  This should assist in having the Surety include the collected over-90-day receivables in your Working Capital calculation.

 

Understanding Current Liabilities

When it comes to the liabilities that make up your Current Liabilities, the bond company does not typically disallow any of them unless you have a subordination agreement for those liabilities. Outlined are some of the key current liabilities to be aware of:

  • Line of Credit
  • Current Portion of Long-Term Debt
  • Accounts Payable
  • Overbillings

When year-end planning, it is worthwhile to consider paying down your bank line of credit where possible. While it does not increase your working capital, banks and bond companies like to see that a contractor has the ability to get out of the bank line and this should also lower your interest-bearing debt ratio.

If you carry additional bank debt, you should discuss with your CPA and Surety broker if it makes sense to pay any of it down further, since it would require you to use available cash, which may reduce your Working Capital.

Purchasing property and/or equipment, depending on how you structure the purchase, can also impact your Working Capital. To put it simply, when a company purchases property and/or equipment with cash (a current asset) and buys property and/or equipment (a long-term asset), it reduces your Working Capital and overall equity by replacing the cash with a depreciating asset. Work with your CPA and Surety broker to determine the best way to structure a purchase of property or equipment based on your company’s Working Capital needs.

Each company is unique with its own individual financial goals. Work with your trusted advisors on your year-end and future planning to ensure you are positioning yourself for the opportunities that lie ahead. 

If you have questions about your year-end planning, reach out to TSIB today and speak with one of our Surety Brokers. You may click below to download our How Your Surety Broker Helps You Thrive piece for additional insights.

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TSIB is a full-service brokerage that specializes in controlled insurance programs, traditional property and casualty placements, and surety for construction-related industries. Our Surety Brokers are currently servicing the following locations:

East Coast

  • New York City, NY,
  • Bergen County, NJ,
  • Philadelphia, PA

Texas: Austin, San Antonio, Houston, Dallas

California: Orange County, Los Angeles County, Riverside County, San Bernardino County, San Diego County

Topics: Surety Bonding

Written by The TSIB Team

All Authors and TSIB