In the bonding industry, there seem to be mixed messages regarding surety credit. One, surety underwriters seem to be worried about the client’s balance sheets and suggest they look for other surety credit options. There are also surety companies that can take over struggling businesses if the company is well managed, has stabilized and has a lot of work left.
Sureties who are willing to take on more risky clients have the upside of gaining a client that wouldn’t have moved in a boom market. The company’s Work in Process report (WIP), is a key determinant in determining whether a company can obtain surety credit in boom or bust markets.
A contractor’s WIP report is the most critical report it needs to monitor the profitability of jobs in its backlog. On a job-by-job basis, surety underwriters want to see the original contract amount and revised contract amount (takes account of any approved change orders), the original estimated cost for a project and the original gross profit.
When estimating gross profit, job costs must include direct materials and equipment, labor, subcontract labor, and indirect labor costs. Payroll taxes, group insurance vacation & holiday pays, retirement contribution, equipment expense shop supplies & small tool safety supplies and training maintenance and warranty pre-employment physicals depreciation are just a few examples of indirect charges. To calculate a realistic gross profit, it is important to include all costs. Estimates are estimates and the final job rarely hits exact estimates.
These two lines, the cost incurred to date, and the revised estimated cost to complete, on a WIP Report, are critical to project management and, sometimes, even receiving surety credit. Both the contractor and the surety need to know what the ACTUAL project costs are for a given project. Not what was estimated. The true cost of completing a project can be calculated once the actual costs have been determined. The total cost to complete includes all direct and indirect costs relating to bonded and unbonded jobs.
These columns are crucial because they show the profit loss or gain for a project. Are profits margins growing or is the job moving ahead of the estimate? What can you do right now to fix the ship if the project is losing money? This difference will be measured by sureties. This can be an indication that there is a problem in estimating, or with being able generate the profit margins necessary to cover overhead.
Overhead can quickly reduce profits due to the competitive environment in today’s construction market. This is classified as general and administrative expenses in a company’s income statement. To be included in the year-end financial statements, sureties must have a completed contract schedule. To determine how close the project’s estimated gross profits were to actual profits, sureties tie WIP Schedules to completed contracts.
Certain sureties will emphasize the WIP when a bond is being issued even though the balance sheet may not be sufficient to justify credit. This applies if the WIP contains all the above elements and has a profitable backlog. A company might have a backlog that extends into July but doesn’t have the ability to cover overhead. If overhead is 15% of sales, gross profits numbers must be in the 15% range to cover expenses. This does not include profit. A company’s current backlog must be conservatively sufficient to cover its expenses. This argument can be used to support obtaining surety credit for a job.
A WIP program is essential for sureties. It’s also important for companies. This tool provides a functional tool that allows them to evaluate the profitability of projects, establish trends and manage their daily operations. A WIP program that is adhered to with diligence will allow a company to be able to respond and adjust to achieve the projected profit margin in both stable or challenging economies.