Depending on how long the contractor has been in business, the surety will request fiscal year-end statements for at least the past three years and may require a financial statement audited by a certified public accountant (CPA). Financial statements typically include the following:

• Accountant's opinion page - discloses whether the statements were prepared according to audit, review, or compilation standards.
• Balance sheet - shows the assets, liabilities, and net worth of the business as of the date of the statement. This helps the surety company evaluate the working capital and overall financial condition of the company.
• Income statement - measures how well the business performed. The surety analyzes each item, including gross profit on contracts, operating profit, and net profit before and after tax provisions.
• Statement of cash flow - discloses the cash movements from operating, investing, and financing activities.
• Accounts receivable and payable schedules - should reflect aging.
• Schedules of contracts in progress and contracts completed - show the financial performance of each contract and provide insight into the potential for future earnings from contracts in progress. This should tie into the balance sheet.
• Schedule of general and administrative expenses - may reveal how well overhead expenses are controlled and managed.
• Explanatory footnotes - qualifications made by the accountant.
• Management letter - conveys the CPA's findings, observations, and recommendations about the contractor's business. Not all CPAs provide management letters.

Quality of Financial Statements

Financial statements are only as good as the accountant preparing them. That is why it is important to select a CPA who is knowledgeable of construction accounting and the American Institute of Certified Public Accountants' Audit Guide for Construction Contractors. Sureties prefer, and at certain levels require, audited fiscal year-end statements, but there are occasions when a surety may accept a review or compilation statement.

An audit verifies relevant items in the financial statement with internal and external investigations of their accuracy. The accountant certifies that the financial statement is presented in accordance with generally accepted accounting principles.

A review statement, which does not require the outside verification present in an audit, consists principally of a thorough review of the contractor's financial records and the application of certain analytical procedures to the financial data. Although narrower in scope than a full audit, the review does provide some limited assurance about the financial statements.

A compilation, however, provides little or no assurance of the credibility of the figures presented and would typically be accepted only for interim statements.

In general, statements prepared by the contractor's staff are not acceptable to sureties because they are difficult to verify and lack the approval of an independent auditor. While sureties may offer modest programs based on review or compilation statements, audited financial statements are most often required, especially for larger work programs.

Next: Commitment