Are you a contractor who just won a public works project? More than likely, you’re going to need a performance bond and a payment bond. These bonds require certain due diligence by your underwriter. They may ask you some questions about your business and throw some terms around. One of these terms is “Profit Fade.” This may be an unfamiliar term. After all, contractors don’t spend years learning accounting and financial jargon. They spend years learning their craft. Still, profit fade is something that contractors think about and understand, despite not knowing there was a term for it. Let’s help break it down so you can confidently talk to your surety agent.
Have you ever estimated your profit on an uncompleted project? Of course you have. You’ve probably calculated how much your company will bring home when the job is over. You may even have a vacation lined up when the job is done. But after the job’s completion, you find that it wasn’t as profitable as you thought. Your Hawaiian vacation turned into dinner for two at the local Crate and Barrel. Well, this, my friend, is profit fade. But why does anyone care that the project wasn’t as profitable as originally thought?
Contractors need to submit profit and loss statements even if they have pending projects. These pending projects find their way into these statements to determine the strength of a company. If a company claims that they are making a larger profit than what actually happens, that’s not really a good thing. If a contractor consistently claims much higher profits across many projects to inflate their company’s worth, that could border on fraud.
Now we all know, contract work is more art than science. Estimates are not set in stone, and there could be tons of reasons a project didn’t reach its mark. Anyone knows that the steel and wood markets could fluctuate overnight, meaning your original estimate could be way off. They signed a contract three months ago, and now materials may cost as much as the labor. This all eats away at your profit. Surety bond underwriters understand that happens. However, if it keeps happening, they may raise the red flag.
It’s true, underwriters can and will penalize contractors if they consistently overstate their profits. They may even make their own internal adjustments to your own profit estimates. However, conservative estimates and under-selling and over-delivering can easily solve this problem. Contractors who consistently return quality work that builds their company have no problem earning a reputation that still wins them bids. It also helps their surety bond underwriters avoid having to look for profit fade in their account.
