How to Strengthen Financial Ratios for Construction Contractors
Sureties and banks use a handful of financial ratios to judge a contractor's financial strength. Stronger ratios usually mean better bond limits and loan terms. Below are the ratios they check most often, what each one means, and how to improve it.
The Financial Ratios Sureties Watch
Current Ratio
How it is calculated: Current assets divided by current liabilities
What it tells a surety: Whether you can pay your short-term bills
How to improve it: Retain earnings, collect receivables, and term out short-term debt
Working Capital
How it is calculated: Current assets minus current liabilities
What it tells a surety: Your cushion for running jobs
How to improve it: Same as above, plus limit owner distributions
Debt to Equity
How it is calculated: Total liabilities divided by net worth
What it tells a surety: How leveraged the company is
How to improve it: Pay down debt and retain earnings
Days in Receivables
How it is calculated: Receivables divided by revenue, times 365
What it tells a surety: How fast you collect
How to improve it: Bill monthly, chase retainage, and follow up on past-due invoices
Underbillings to Net Worth
How it is calculated: Underbillings divided by net worth
What it tells a surety: Risk of unbilled work or cost overruns
How to improve it: Bill on time and update cost estimates every month
Gross Profit Fade
How it is calculated: Estimated job margin compared with final job margin
What it tells a surety: Whether your estimates hold up
How to improve it: Run a monthly WIP, tighten estimating, and control change orders
Backlog to Working Capital
How it is calculated: Backlog divided by working capital
What it tells a surety: Whether you can support the work you have
How to improve it: Grow working capital before taking on more work
Target levels vary by surety, trade, and company size. Ask your surety agent what your underwriter expects.
Three Habits That Improve Every Ratio
Close the books monthly and on time.
Prepare a WIP schedule every month that ties to the books.
Review ratios each quarter, not just at year end.
Working capital is the ratio most contractors can move fastest. See How to Improve Working Capital for Construction Contractors.
How SuretyCFO Helps
SuretyCFO tracks these ratios monthly for commercial contractors with $5M to $50M in revenue and builds a plan to strengthen them before your next surety review. We are based in Old Bethpage, New York, and work virtually with contractors nationwide.
Comments