A general contractor with $12 million in revenue and a profitable year on the books can still get a letter from the surety asking why the bond program should go up. The answer is almost always one number: working capital, as the surety computes it, not as the balance sheet shows it. The two are rarely the same, and the difference between them is where bid capacity lives.
This article defines working capital the way a surety underwriter and a bank credit analyst define it, walks through the ratios they test, gives you a method for computing a target for your own company, and lists the levers that move the number before the next bond request. Every dollar figure below is illustrative. Your surety's appetite and your bank's covenants are the numbers that govern, and your agent and banker will tell you what they are if you ask.
What working capital means for a contractor
The textbook definition is current assets minus current liabilities. For a contractor, that definition gets adjusted before anyone underwrites it. A surety analyst starts with your balance sheet and then removes the current assets it does not trust to become cash within the operating cycle: receivables older than 90 days, retainage on disputed jobs, receivables from affiliates and employees, prepaid expenses, inventory not assigned to a contract, and the cash value of life insurance. What remains is adjusted working capital, sometimes called allowed or analyzed working capital.
The liability side gets the opposite treatment. Billings in excess of costs and estimated earnings stays a current liability. Current maturities of long-term debt stay. The line of credit balance stays, even though the bank calls it revolving. A shareholder loan may be treated as equity if the surety has a signed subordination agreement on file, which is a document you will not want to be negotiating the week before a bid is due.
So the number that matters is not the one your accounting software computes. It is the number left after an outsider removes everything they cannot count on. A contractor who understands this computes both numbers every month and manages to the smaller one. A contractor who does not learns the difference from a letter.
What the surety looks at
A surety prices risk on the probability that you will finish the work you have bonded. Working capital is its first proxy because it measures whether you can absorb a bad job without missing payroll or a supplier payment. Three tests carry most of the weight, and the same three show up, with different names, in a bank's credit memo.
Working capital to backlog
The underwriter divides adjusted working capital by total backlog, or by the uncompleted portion of the bonded program, to see how much cushion you carry per dollar of remaining obligation. Each surety sets its own appetite for this ratio, and the number moves with your history, your industry, and the type of work. For the method in this article, suppose your surety wants adjusted working capital equal to at least 10 percent of the program it is willing to support. That figure is illustrative. Ask your agent for the one your underwriter uses, because it is the single most useful number you can carry into a planning meeting.
Debt to equity
Total liabilities divided by adjusted net worth. The underwriter removes the same soft assets from equity that it removed from working capital, so a balance sheet with goodwill, affiliate receivables, or an owner's airplane will show a higher ratio than you expect. A rising ratio means the company is financing growth with vendors and the bank rather than with retained earnings, which a surety reads as a contractor one bad job away from a claim. A falling ratio is the cheapest bond capacity you will ever buy.
The other tests
Underwriters also look at the current ratio, the trend in underbillings, the age of receivables and retainage, gross profit fade from original estimate to closeout, and whether the work-in-progress schedule ties to the financial statements. A clean, tied-out WIP schedule does more for your bond line than any single ratio, because it tells the surety that you know where each job stands. A WIP schedule that changes every time the surety asks a question tells them the opposite, and they will remember it longer than you will.
How to compute a target
Start with the program you want, not the one you have. If you plan to carry $18 million of backlog next year and your surety wants 10 percent of that in adjusted working capital, your target is $1.8 million. Then compare that target with what the surety will actually credit from your current balance sheet. The steps are the same every month, and they take about an hour once the schedules are in order.
- Pull the balance sheet as of month-end, along with the aged receivables, the retainage ledger, and the WIP schedule as of the same date.
- Compute book working capital: current assets minus current liabilities.
- Subtract disallowed assets: receivables over 90 days, retainage on disputed jobs, affiliate and employee receivables, prepaids, non-contract inventory, and any other current asset you could not turn into cash in 60 days.
- Add back any shareholder debt the surety has formally subordinated, if your surety treats it that way.
- Divide the result by planned backlog and compare it with the percentage your surety has told you it wants.
- The gap between the target and the adjusted number is the amount you need to generate, retain, or contribute before the next bond request.
Repeat the computation using the bank's covenant definitions, which are usually simpler but never identical. Banks tend to test current ratio, debt service coverage, and tangible net worth rather than working capital to backlog. The contractor who manages to the tighter of the two definitions never gets a surprise letter from either party, which is the entire point of the exercise.
A worked example
The table below is illustrative. It follows a general contractor with roughly $15 million in annual revenue that wants to carry $18 million of backlog next year. The surety in this example has said it wants adjusted working capital of at least 10 percent of backlog. The owner believes the company is in good shape, and by the book, it is.
| Line item | Amount | Surety treatment |
|---|---|---|
| Cash | $850,000 | Allowed |
| Contract receivables, under 90 days | $2,400,000 | Allowed |
| Contract receivables, over 90 days | $310,000 | Disallowed |
| Retainage receivable | $620,000 | $140,000 disallowed (disputed job) |
| Costs and estimated earnings in excess of billings | $390,000 | Allowed, questioned if it keeps growing |
| Prepaid expenses | $95,000 | Disallowed |
| Receivable from owner's other company | $210,000 | Disallowed |
| Total current assets (book) | $4,875,000 | |
| Accounts payable and accrued expenses | $1,950,000 | Current liability |
| Billings in excess of costs and estimated earnings | $540,000 | Current liability |
| Line of credit | $400,000 | Current liability |
| Current portion of equipment notes | $185,000 | Current liability |
| Total current liabilities | $3,075,000 | |
| Book working capital | $1,800,000 | Current assets minus current liabilities |
| Less disallowed assets | ($755,000) | $310,000 + $140,000 + $95,000 + $210,000 |
| Adjusted working capital | $1,045,000 | What the surety credits |
| Target at 10 percent of $18 million backlog | $1,800,000 | |
| Shortfall | ($755,000) |
The owner in this example believes the company has $1.8 million of working capital, and the balance sheet agrees. The surety credits $1,045,000 and will likely support a program closer to $10 million than $18 million. Every dollar of the $755,000 gap is a dollar the owner can recover without writing a check: collect the old receivables, resolve the disputed retainage, collect from the affiliate, and stop paying the annual insurance premium in one lump when the carrier offers monthly installments.
The book number and the surety's number are both correct. Only one of them decides how much work you can bid.
Levers to improve working capital
Working capital rises for two reasons: the company earns and retains profit, or the company converts assets the surety disallows into assets it allows. The second is faster. The list below is ranked roughly by how quickly each lever moves the number.
- Collect receivables over 90 days. Each dollar collected moves directly from disallowed to allowed. Assign one person to call on day 31, and give that person a printed list every Monday morning.
- Bill on time and bill fully. A pay application that misses the owner's cutoff slides cash by a full cycle. Underbilling leaves earned revenue sitting in the WIP schedule as an asset the underwriter discounts.
- Resolve disputed retainage. A signed change order or a settlement turns a disallowed asset into an allowed one, even at a discount, and closes a job the surety is watching.
- Clear affiliate and shareholder receivables. Either collect them or convert them, with counsel's help, into a formal note the surety can evaluate. Do not leave them as current receivables.
- Term out equipment purchases. Equipment bought on the line of credit sits in current liabilities. The same equipment on a five-year note moves most of the balance to long-term debt and improves the ratio the day the loan funds.
- Subordinate shareholder loans. With counsel and the surety, a subordinated note may count toward equity rather than against working capital. Ask the surety how it treats them before you rely on it.
- Set a distribution policy tied to the target. Distributions above what the owner needs for taxes come straight out of the number. A written policy that ties distributions to the surety's target is the most durable lever on this list.
- Manage overbillings deliberately. Billings in excess is a liability, but the cash it brought in is an asset, and the net effect on working capital is zero. A front-loaded schedule of values that the owner and architect accept is legitimate cash management. One that the WIP schedule cannot support is a different conversation, and a shorter one.
The lever that does not work is optimism. A bigger backlog with the same balance sheet lowers the ratio, which is why the year a contractor lands its largest job is often the year the surety gets nervous. Growth in bonded work has to be matched by growth in retained earnings, and the only way to make that happen on purpose is to compute the number every month and plan distributions, equipment, and bids around it.
Where a fractional construction CFO fits
Most contractors between $3 million and $50 million do not have anyone whose job is to compute the surety's number every month and manage to it. The controller closes the books. The estimator builds backlog. The owner reads the bond letter and calls the agent. A fractional or interim construction CFO closes that gap with a monthly adjusted working capital computation using both the surety's and the bank's definitions, a WIP schedule that ties to the general ledger, a collections cadence with names attached, and a 13-week cash forecast that shows when the number will move and by how much.
The output is not a report. It is a bond program that goes up when you ask, a bank that renews without a new covenant, and a distribution the owner can take without a phone call from the agent the following spring. Those are the things a growing contractor's balance sheet is for, and they are easier to arrange in March than in the week a bid is due.