Bonds: When Receivables Are Not Recevable

Surety bond underwriting involves many elements, and
financial analysis is always one of them. In this newsletter,
let's look at a single element, an important one, and how
you can influence the effect it has on bonding decisions.

Accounts Receivable "A/R" are the funds owed by outside
parties to the company for work it has performed. This is a
Current Asset and is part of Net Worth. Active contractors
always have such money due them.
The number can be
significant for firms in a growth mode. Problem: Sometimes
bond underwriters discount, or disallow part of this figure,
thus reducing the applicants recognized financial strength
and bond worthiness. Why does this happen and how can
you influence the outcome?

One reason for such assets to be disallowed is the age of
the individual receivable on the fiscal year-end (FYE)
financial statement date. In order to be conservative, A/Rs
that are 90 days old or more "over 90" are assumed to be
uncollectable, and therefore are disallowed. (Key word:
Assumed)

Same with receivables arising from change orders that are
unapproved or in dispute. Projects with performance
problems may have all payments held up by the owner, and
therefore related A/Rs may be disallowed. In fact,
receivables may be discounted if there is a dramatic
increase over historic levels, even if there is no apparent
reason to doubt the collectability of the funds.

When A/Rs are disallowed the Working Capital calculation
suffers as well as the ratio analysis.

This can reduce or eliminate the contractors bonding line.

Here are some possible cures.

Retainages - A/Rs over 90 days old may be acceptable if
they are actually Retainage which is slightly different from a
true "trade receivable." Identify if any of the A/Rs are
actually Retainages. They should be separated from the A/R
analysis and "allowed."

Over 90s - Older A/Rs are allowable if they were
subsequently collected (no matter how old they became.)
Ask the client or accountant for an update regarding the
collection of year-end receivables. All collected items are
included in the financial strength analysis. The underwriter
should be updated if they are eventually collected at a
future date. The client will be penalized for a disallowed A/
Rs for 12-15 months after the fiscal date. Updating the file
when funds come in could help achieve a bond approval
any time during this period.

Change Orders - The same concept applies to COs no
longer in dispute or project issues that are resolved. All A/
Rs that are ultimately collected are allowed, regardless of
how late they occur.
Payment Bond - If our client is a subcontractor, there may
be a Payment Bond "above them" available for claim. An
over 90 A/R might be allowed based on the existence of this
safety net.

Caution: If an aged schedule of year-end A/Rs is produced
at a subsequent date, items that were not over 90 at FYE
(but remain open) may now may be old and therefore
disallowed! It works both ways.

Conclusion

The financial analysis associated with surety bond
underwriting is primarily focused on the fiscal year-end
financial condition of the company. These numbers drive
the bond line until the next FS is issued - normally about 15
months.

The receivable collection is an ongoing process that
warrants interpretation and monitoring because of its
changing nature.