Maintaining availability on a line of credit facility is crucial for contractors, and Enhancing Credit Availability with Strategic Surety Solutions is a key approach to achieving this. Project demands, delayed payments, and unforeseen expenses are just three of the many cash flow challenges contractors face. Having readily available credit ensures that contractors can quickly adapt to the circumstances without disrupting their operations or having to pass on new opportunities.
This article will start by giving a brief understanding of a line of credit facility borrowing base and common deductions to that borrowing base and then conclude with some often-overlooked deductions that can be eliminated with the use of commercial bonds.
To better understand how Enhancing Credit Availability with Strategic Surety Solutions can be beneficial, let’s delve into the specifics of a line of credit facility’s borrowing base and common deductions. Understanding how to increase availability of borrowings on a line of credit requires understanding what common deductions reduce the borrowing base or base of assets the creditor is lending against. The primary asset base being lent against in a line of credit facility is receivables, so it can be inferred that common reductions would include those receivables that have a perceived higher risk of collection, including those that may be aged, concentrated, or contingent upon another event such as retainage contingent on completing the project. There are often other components to a borrowing base, such as contract assets from work in process, inventory, and sometimes equipment, each typically with their own respectable percentages that are allowed for inclusion in the borrowing base.
Outside the scope of this article, the two starting points for impacting a borrowing base are improving a collection cycle and negotiating the calculation of the borrowing base by adjusting reduction percentages of certain categories of assets with your lender.
However, the focus of this article is on other available options… Often, but not always, a common deduction in a borrowing base includes letters of credit that a company has issued. Recognizing common deductions that reduce the borrowing base is a step towards Enhancing Credit Availability with Strategic Surety Solutions. Letters of credit are commonly issued to a beneficiary to protect the beneficiary by ensuring the ability to collect funds from a company. These letters of credit can add up to a significant amount and therefore a significant reduction in available borrowings on a line of credit facility.
Letters of credit are commonly issued when a mechanic’s lien is not an available remedy for the subcontractor or supplier. This begs the question of, “Can I avoid using a letter of credit or replace a letter of credit?” Yes. Commercial bonds can be used in lieu of letters of credit and would act as the financial guarantee of payment. While commercial bonds can replace a letter of credit, you would typically want to wait until renewal of the letter of credit to avoid duplicating the fees for these facilities. A significant aspect of Enhancing Credit Availability with Strategic Surety Solutions involves reevaluating the use of letters of credit in favor of commercial bonds.
The process for being issued this type of bond would include underwriting of your company by the surety and include looking at financials and credit history among other things, a process contractors are familiar with if they require contract bonds. The next step is for the beneficiary to accept the payment bond in lieu of a letter of credit. The bond provides the same financial guarantee as a letter of credit and should not be a hurdle.
Aside from eliminating reductions in your borrowing base, there are other benefits to seeking a bond versus letter of credit, including: bonds having no negative impact to a contractor’s credit or borrowing capacity, no additional collateral requirements, bond duration can complement the duration needed for a vendor (a letter of credit may require renewal and additional fee), and a surety will investigate claims to ensure it is not fraudulent (letters of credit often provide open draw opportunity for the vendor).
Each of these financial guarantees provided by a letter of credit or bond has an associated fee. In both cases, this fee is not a standard rate and is typically determined through the underwriting process and thus impacted by the financial strength of the underlying company.
Exploring options beyond traditional methods like the strategic use of commercial bonds in place of letters of credit is one option that can enhance financial flexibility of a business. Optimizing your business operation is critical to maintaining a competitive edge and seizing new opportunities. Enhancing Credit Availability with Strategic Surety Solutions is at the core of what we do at DSP. We know construction and we use our experience to be a trusted advisor and partner to your company. DSP is ready to work through a strategic approach to surety and risk management custom to your company’s unique needs
