How Bonding Capacity Works (and Why It Matters) (2024)

How Bonding Capacity Works (and Why It Matters) (1)

Bonded projects help protect owners and contractors from defaults and payment issues. If you want to work on these bonded construction projects, you have to be able to get a bond, which means you have to have bonding capacity.

The companies that provide bonds use this capacity as a measurement for how confident they are in your ability to do the work properly and pay your suppliers and subcontractors. Knowing how bonding capacity is determined can help you position your company to work on larger projects.

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How construction bonds work

A construction bond is similar to an insurance policy — it protects the parties to the bond in case the work isn’t completed, payments aren’t made, or repairs aren’t made during the warranty period. There are three parties involved in each bond — the obligee, principal, and the surety company. The obligee is the one that’s being protected by the bond, the principal is the party that purchases the bond, and the surety company is the one who pays if a claim is made and proven.

Bonds can cover many different facets of performance on a construction project. Some protect suppliers from non-payment, others protect owners during the warranty period. The types of bonds that may be required on a project will depend on the type of work being done, who it’s being done for, and jurisdictional requirements.

If there’s a dispute on a bonded project, the obligee can file a claim with the surety company, seeking reimbursem*nt for damages they’ve suffered.The surety company investigates the claim, and if it finds that it’s legitimate, it will pay out funds to cover the claim.

After the claim is settled, the surety will then collect the funds it paid out from the principal who purchased the bond. It’s in the principal’s best interest to avoid issues that may lead to a bond claim, as they will have to pay the costs, and claims damage their reputation.

Surety companies ensure contractors will meet their responsibilities on projects, whether it’s completing the work, honoring their warranty, or paying their suppliers and subcontractors. The surety spends a lot of time assessing the risk of bonding a company.

By getting to know the company and its officers or owners, the surety determines how much risk it’s willing to take. The limit of this risk is called bonding capacity.

What is bonding capacity?

Bonding capacity is the maximum amount of coverage a surety will provide to a company. Through investigating the financial standing, experience, and business practices of the company and its owners, the surety decides how much it’s willing to support them.

There are two limits that are spoken about when it comes to bonding — single-job and aggregate.

The single job bonding limit is the maximum amount the surety will guarantee on one project. The aggregate limit is the total amount of bonded work that the surety will back at one time.

For example, a contractor may have a $1 million single-job limit, with up to $5 million aggregate. This means the contractor can have five $1 million bonds or ten $500,000 bonds active at one time. Depending on the type of bond and its terms, a bond is considered closed when the work is complete or the warranty timeline has expired.

Why does bonding capacity matter?

Like most things, a higher bonding capacity is good. Contractors should be striving to increase their bonding capacity, as it shows that their business is stable, that they complete their work, and are able to avoid bond claims.

A higher bonding capacity shows that a contractor has experience completing projects. Contractors can’t apply for bonds when they’re just starting out. They have to develop a portfolio of projects that they’ve completed, along with good references.

Even if a project isn’t going to be bonded, bonding capacity may come into play when qualifying to bid a project. Owners often use bonding capacity as a way to prequalify contractors for a project. They let the surety companies investigate the contractors, and then rely on their judgment to help make the decision.

Owners may make contract decisions based on the bonding capacity of bidding contractors. If one contractor has a higher limit, the owner may feel more confidence in going to contract with them than a contractor with a lower limit.

A higher bonding capacity also means that you can bid on larger projects, helping your company grow. It’s a good practice to go after projects slightly outside your bonding capacity. You’ll need to provide additional information to the surety company, but as long as the project isn’t outside your capabilities you should be approved. Stretching the limits is a way to grow your bonding capacity.

Factors that determine bonding capacity

Sureties look at several factors when reviewing a company’s bonding capacity. They include accounting practices, financial stability, and experience.

If you’re still running your business out of a shoebox with receipts stuffed inside, it’s going to be difficult to qualify for bonding. Surety companies are looking for companies that are organized, with organized records, job costing reports, and accurate financial statements. You’ll also need to hire a construction CPA to review and audit your financial records.

Underwriters look at several factors when determining a contractor’s bonding capacity. One important factor is the contractor’s financial performance. The surety measures this by looking at some key accounting ratios, as well as gauging the level of equity, liquidity, and debt that your company is carrying. They consider the type of work your company does, so equipment-heavy companies with a lot of bank loans won’t be penalized.

They are also likely to look at the amount of jobs you have in your pipeline, to see how well you’re managing the backlog of work. If a contractor is stretched too thin, or the surety doesn’t believe they have the ability to complete the promised work, they may reduce the bonding capacity.

Surety companies are also looking to see how much experience your company has completing jobs successfully. They want to see that you’ve completed several projects and have happy customers. To help them out, keep your surety informed about positive reviews and project and employee awards.

How to increase your company’s bonding capacity

There are four primary ways for contractors to boost their bonding capacity.

1. Provide proper financial statements and reports

Work with a construction CPA so you know which reports the surety will be looking at, and make sure they are presented professionally.

2. Improve your personal finances

Sureties look at your personal credit report when reviewing your bonding capacity. Work on lowering debts and cleaning up credit issues.

3. Build a portfolio of successful projects

You don’t want to jump into $100 million high-rises out of the gate. Start with smaller projects and build your skills and your crews. A steady increase is better than taking a giant leap.

4. Choose a good surety agency

Look for a surety agency, instead of a single surety company. An agent will shop around and find the best surety for your business and get you the best rate. The agent can also coach you on any areas that need improvement.

Don’t forget to protect your bonding capacity

Working to increase your bonding capacity is a good way to get on larger projects and grow your company. By concentrating on your financial statements and position, getting good reviews from customers, and developing a good working relationship with a surety agency, you can steadily improve your bonding capacity.

As your bonding capacity grows, set up processes that protect your bottom line. Your office manager or credit team will need the right tools to track lien deadlines, manage waivers, and ensure you are getting paid on time for the extra work you’re taking on.

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How Bonding Capacity Works (and Why It Matters) (2024)

FAQs

Why is bonding capacity important? ›

Having a higher bonding capacity allows general contractors to bid on larger—often public—projects. Even for non-bonded projects, owners sometimes prequalify bidders by looking at their bonding capacity.

What is the bonding capacity? ›

Bonding capacity is the maximum amount of surety credit a surety company will provide to a contractor. It is generally expressed in terms of the largest single project the surety would be willing to issue and the maximum amount of contract backlog a contractor can hold.

What is an example of a bonding capacity? ›

For example, a principal who is qualified for a bonding capacity of $5 million single/$20 million aggregate can be assured that the surety agency will readily approve for a bond of up to $5 million on a particular project, as long as they are within the aggregate limits of $20 million or less in other bonded work or ...

How do you determine a company's bonding capacity? ›

Bonding capacity as calculated by a surety is usually done in one of two ways: by working capital or by net worth. If by working capital, then the working capital is calculated and then multiplied by a number, like 10 or 20.

What is bonding and why is it important? ›

In one sentence bonding means building a child's emotional engagement with parents and should continue throughout the life. For new parents, this bond is evident and strong.

What are the main purposes of bonding? ›

Bonding is used to reduce the risk of electric shocks to anyone who may touch two separate metal parts when there is a fault somewhere in the supply of electrical installation. By connecting bonding conductors between particular parts, it reduces the voltage there might have been.

What are three items that affect bonding capacity? ›

Primary Factors Affecting Contractor Bonding Capacity
  • Profitability.
  • Net worth.
  • Cash flow.
  • Work-in-Process.
  • Under-billing and over-billing.
Apr 26, 2019

How to increase bonding capacity? ›

To improve bonding capacity, contractors should:
  1. Maintain accurate and up-to-date financial records.
  2. Focus on increasing profitability by reducing overhead expenses and improving cost management.
  3. Maintain healthy cash flow and ensure access to working capital.
  4. Maintain a line of credit but keep debt levels manageable.
Dec 20, 2023

What are 3 main types of bonding? ›

There are three primary types of bonding: ionic, covalent, and metallic. Definition: An ionic bond is formed when valence electrons are transferred from one atom to the other to complete the outer electron shell.

What employees should be bonded? ›

Individuals who typically must be bonded include union officers (both elected and non-elected), employees such as business agents, trustees, key administrative and professional staff, and clerical personnel. Liquid assets, for purposes of this formula, are those assets that are quickly and easily negotiable.

How is bonding determined? ›

The type of bonding is determined by how the outermost electrons of an atom, the so called valence electrons of one atom interact with neighboring atoms. In ionic materials electrons are fully transferred. Covalent materials share electrons with neighboring atoms and metals share electrons over a wide region.

How is bonding calculated? ›

The bond valuation formula is presented here: Price = ( Coupon × 1 − ( 1 + r ) − n r ) + Par Value ( 1 + r ) n , where: Coupon is the cash flow received for each intermediate payment before the par value.

Why is bond strength important? ›

Bonds are an important part of a wide range of products, from EV batteries to aerospace components. To ensure the products' safety and long-term quality, these bonds must be reliable and durable. Especially when they are exposed to stresses, loads, and high levels of energy. To achieve this, strong bonds are needed.

What is the importance of being bonded? ›

Without the right bonds you may not get business from certain people. And without insurance you'll end up paying for liability claims and property damage out of your own pocket.

Why bond strength is important to living things? ›

Both strong and weak bonds play key roles in the chemistry of our cells and bodies. For instance, strong covalent bonds hold together the chemical building blocks that make up a strand of DNA. However, weaker hydrogen bonds hold together the two strands of the DNA double helix.

Why is it important to know how molecules are bonded? ›

These bonds are interactions between two atoms that hold the atoms together. It is important to understand the various types of bonds because they help determine how different molecules function within an organism.

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