Secrets of Bonding146: Financial Statement Sniff Test

Secrets of Bonding146 Financial Statement Sniff Test

Here’s a list of accounting and business courses I took in college

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As an Education Major (teaching), I did not receive any financial statements “FSs” training. As a trainee in surety bond underwriting, I quickly realized I didn’t know what a balance sheet was. But I learned.

We will correct your initial reaction to an FS if it is “Duh!” Continue reading! This view will be from 30,000 feet—the big picture.

Every financial statement must contain at least the following information in order to be considered complete:

1) Balance Sheet

2) Statement of Profit and Loss

The Balance Sheet

This document shows a quick snapshot of the assets and liabilities in the company. Because every dollar in the company can be seen from two perspectives: the Asset side, and the Liability side, it is equal to “balance”.

We can start by reviewing three critical parts of the Balance Sheet. Let’s look at their functionality.

Current Assets: The line item located near the middle in the Asset column is called a subtotal. It is the asset that can be converted to cash in the next fiscal year, such as Accounts Receivable.

Current Liabilities (located near the middle column of the Liabilities column) are debts that must be paid during the next fiscal year (such as Accounts Payable).

Total Stockholders Equity, also known as Net Worth, is usually the last section near the end in the Liabilities column. This would be the Net Worth of the company if everything was liquidated or shut down.

The Profit and Loss Statement

This historical summary shows all money is taken (aka Revenues) and spent (Expenses) during the previous period. It is usually one year. The column’s bottom line shows the Net Profit. This is the amount of money that the company made for the year after it has paid all taxes and bills.

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What can we do with the strategic numbers you have gathered from any FS?

Calculate your Working Capital

All analysts use this primary measure to determine financial strength, including banks and sureties. This is calculated by subtracting the Current Assets from the Current Liabilities. It indicates the expected cash flow for the following year.

The Sniff Test

This is a simplified, quick test that you can use to evaluate a bid or performance bond. The expected contract amount (not the bond) is used to assess the bidder. This gives an immediate indication of the financial strength of the project.

Part 1 – The Working Capital target amount equals 15% of the contract amount. If the contract amount is $1,000,000, then sureties would like to have at least $150,000 in Working Capital.

Part 2 – The net worth target amount is 20% of the contract amount of approximately $200,000 in our case.

There is much more to surety sub writing than this simple analysis. This method will give you a quick indication of the strength or weakness of the bond’s financial statements. Negative numbers are apparent signs that your comment is not good. These numbers can be found in parenthesis in financial reports.

Keep in mind that applicants who do not meet these criteria might still be eligible for bonds based upon other factors. There are many factors that go into surety underwriting. This article will provide a simplified overview of the process, but it’s still valid for a quick review. This will allow you to quickly do a financial assessment and then relate it to the surety exposure.

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Summary

Although this article does not make you a bond underwriter, it will help you to get a new FS. You can now say, “Let’s analyze this!”

A quick analysis and the Sniff Test will give you an indication of the probability of getting surety support. Although you learned a lot in just three minutes, if your bond fails the Sniff Test, our market access and expertise will help you. Contact us today!

Steve Golia has extensive experience providing bid and performance bonds to contractors. He has been solving bond problems for contractors for over 30 years and helping them succeed when others have failed.

Bonding Pros has the market access and underwriting talent you need. All this is complemented by exceptional service and easy access.

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