Secrets of Bonding146: Financial Statement Sniff Test

Secrets of Bonding146: Financial Statement Sniff Test




Here is a list of my business and accounting courses in college:

1.

2.

3.

I was an Education Major (teaching), so I didn’t get anything on financial statements “FSs”. When I started as a surety bond underwriting trainee, I realized that I had no idea what a Balance Sheet was – but I learned.

If your first reaction when you look a FS is “Duh,” we will fix that right now. Keep reading! This will be a view from 30,000 feet. Big picture.

To be complete, every financial statement must include at the minimum:

1) Balance Sheet

2) Profit and Loss Statement

The Balance Sheet

This document is a one-day break shot of the funds in the company (Assets) and who owns them (limitations). The assets and limitations are equal “balance” because every dollar in the company is shown from two points of view: the Asset side and who owns it, the Liability side.

The Balance Sheet has three important parts we can review initially. Let’s clarify them based on their functionality.

Current Assets: This line item is a subtotal found near the middle of the Asset column. It represents those assets freely convertible to cash within the coming fiscal year (such as Accounts Receivable).

Current limitations: Found near the middle of the limitations column, these are debts to be paid in the coming fiscal year (such as Accounts Payable).

Total Stockholders Equity, aka Net Worth: Usually the last subsection near the end of the limitations column. This is the company’s Net Worth that would keep if they shut down and liquidated everything.

The Profit and Loss Statement

This is a historical summary of all the money taken in (Sales aka Revenues) and money spent (Expenses) during the preceding period, usually one year. At the bottom of the column is the Net Profit, which is the money the company “made” for the year after paying all the related bills and taxes.

Now that you can pick out a associate of strategic numbers on any FS, what shall we do with them?

Calculate Working Capital

This is a dominant measure of financial strength used by all analysts, including sureties, edges and other credit grantors. It is found by subtracting the Current limitations from the Current Assets. It is an indicator of expected cash flow in the coming year.

The Sniff Test

Here is a quick, simplified test to use when considering a particular bid or performance bond. The evaluation is made based on the expected contract (not bond) amount. This is an moment indication of the adequacy of the finances in regard to the upcoming project.

Part One – The Working Capital target amount is 15% of the contract amount. For example, if the contract amount is $1,000,000, sureties hope to see Working Capital of at the minimum $150,000.

Part Two – The Net Worth target amount is 20% of the contract amount or about $200,000 in our example.

Certainly there is more to surety underwriting than this simple examination. However, by using this method, you can get a quick idea of whether the financial statement easily supports the bond, or may be a stretch. If your examination discloses negative numbers, which are shown in parenthesis on financial reports, that’s clearly a bad sign.

Also keep in mind, applicants that do not meet these criteria may nevertheless qualify for bonds based on other factors – and the reverse is also true. Surety underwriting takes many factors into consideration. In this article we are offering a very simplified version of the time of action although it is valid as a quick review. This procedure will permit you to make a fast financial evaluation, and relate it to the upcoming surety exposure.

Summary

This article doesn’t make you a bond underwriter, but now when you get a new FS instead of “Duh!” you can say “Let me analyze this!”

Running a quick examination plus the Sniff Test will indicate the likelihood of obtaining surety sustain. You learned a lot in three minutes, but when you have a bond that fails the Sniff Test, that’s where our skill and market access come in. Call us!




leave your comment

Search

Top