Why Does Financial Capacity Matter in Surety?

The short answer

Financial capacity matters because a bond rests on the expectation that the obligation will be fulfilled. The Surety may pay the Obligee if the Principal defaults and, depending on the applicable indemnity agreement, bond terms, circumstances and law, may have rights of recovery against the Principal and/or applicable indemnitors. Financial capacity is also a proxy for whether the applicant can actually carry out the obligation — most defaults on bonded work trace back to running out of money before running out of scope.

What financial capacity is being read for

An insurer may consider financial information for what it suggests about three things:

• Ability to perform. Whether the applicant can fund mobilisation, materials, payroll and overheads through to completion, including through delayed payments.
• Ability to reimburse. Whether there is substance behind the indemnity if the Surety ever pays.
• Proportion. Whether the size of the obligation is reasonable in relation to the applicant's resources and existing commitments.

What is commonly submitted

Audited financial statements, income tax returns, and supporting schedules or bank records are commonly requested; what is required in a given case is determined by the insurer. Beyond the totals, insurers often pay attention to liquidity and working capital, net worth, the level and structure of borrowings, receivables and their ageing, and whether results are consistent from period to period.

Currency matters as much as content. Statements that are out of date, unsigned, unaudited where audit is expected, or inconsistent with the registration documents and tax filings tend to generate more questions than the figures themselves.

Capacity is not the same as one bond amount

An insurer looks at total exposure, not just the bond in front of it. Bonds already outstanding, work in progress and pending applications all form part of the picture, which is why a business may be comfortable with one bond of a given size and be asked for more information on the third one that period.

Common friction points

• Financial statements that are not current, or that differ from the tax returns filed.
• Related-party receivables or advances that are large relative to net worth and unexplained.
• Growth in bonded work that outpaces working capital.
• A bond amount that is large relative to the applicant's own resources, without security or explanation.

None of these is automatically disqualifying. They are the points most likely to be raised, and each is easier to address if it is explained at submission rather than after a query.

What helps

Keep the books current and reconciled, submit consistent documents, be able to explain a weak period, and where you know the obligation is large relative to your size, be ready to discuss what security or arrangements you can offer. If the terms of any bond are indicated to you, they come from the insurer.