Bank Credit Underwriting for Commercial Contractors
Bank Credit Underwriting for Commercial Contractors
Contractors, take note – the commercial contracting sector is considered one of the riskiest industries by banks. Yet, it also represents a significant portion of many banks’ Commercial & Industrial (C&I) loan portfolios—especially at community and regional banks. Why? Because when credit is properly underwritten and the banking relationship is well managed and monitored, contractors can be a highly profitable client segment.
Understanding the key credit underwriting criteria that banks use when evaluating contractors can help you secure financing for your operations, project pipeline, equipment needs and working capital. It can also improve your standing with bonding companies and other financial partners.
Business and Industry Risk Assessment
1. Experience & Management
Track Record: The bank evaluates the contractor’s history of completed projects, assessing whether they were finished on time, within budget, and met quality standards.
Review any history of disputes, Mechanics’ Liens, litigation, or stalled jobs.
Management Team: Owners and leadership must be reputable and of high integrity.
Strong financial management capabilities, including job costing and budgeting, are essential.
Demonstrated ability to manage complex or large-scale projects.
Credit History: Both business and personal credit of principals are reviewed.
Bonding and Insurance:
Adequate bonding capacity (payment and performance bonds) is critical.
Sufficient general liability and workers’ compensation insurance coverage are also required to mitigate risk.
2. Industry Conditions
Market Demand & Competitive Landscape: Banks assess how well-positioned your firm is within the industry, its bidding success rate, and ability to adapt to economic cycles.
Sector-Specific Risks: Union labor, regulatory compliance, or geographic constraints are considered.
Seasonality & Cash Flow Volatility: Contractors must demonstrate their ability to manage cash flows during off-seasons or delays.
Project Pipeline & Backlog: Banks review contracts in progress, committed future work, and market outlook.
Financial Analysis
Contractor financials are often more complex than those of other industries. The business model involves longer operating cycles, reliance on progress payments, and varying cash flow patterns. Lenders focus on three key areas:
1. Working Capital
Strong working capital is essential to keep projects on track and avoid costly disruptions. The standard measure of working capital is the Current Ratio, calculated as Current Assets divided by Current Liabilities. While banks generally prefer to see a ratio of at least 1.5x, they also place significant emphasis on the quality of current assets and the composition of current liabilities—especially for contractors, given the complexity of their operations and financial reporting.
Receivables Turnover: Measures how quickly the firm collects payments for completed work.
Bad Debt Expense: Excessive write-offs or prolonged disputes can drain cash reserves.
Progress Billing: Structured milestone-based payments affect liquidity and project cash flow.
Payables Management: Consistently slow vendor/subcontractor payments may raise concerns about financial stability.
Cash: Are adequate cash reserves generated and maintained or are they “leveraged” from overbillings and stretching accounts payable?
2. Leverage
Debt-to-Equity Ratio: Indicates how much of the company’s assets are funded by external debt versus owner equity. Lower ratios are preferable.
Funded Debt-to-EBITDA* Ratio: Measures the company’s ability to repay debt using operating earnings. A lower ratio signals better debt management capacity.
*Earnings Before Interest, Taxes, Depreciation and Amortization
3. Cash Flow
Debt Service Coverage Ratio (DSCR): EBITDA divided by annual debt obligations. A minimum DSCR of 1.25x is often required, though higher ratios are favored for companies with higher leverage.
From my experience, higher leverage requires stronger DSCR as a compensating factor.
Revenue and Profit Trends: Banks assess historical and projected performance, with attention to volatility and its impact on cash flow.
Consider for example, a firm with increasing revenues and decreased earnings. These trends can be a red flag for a number of issues and should be addressed.
Financial Reporting & Accounting Methods
High-quality financial reporting is a foundation of any strong banking relationship.
Accrual Accounting with Percentage of Completion (POC): This method is preferred over cash or completed contract methods for credit evaluation.
It offers a real-time, accurate view of revenues, expenses, and profitability for long-term projects.
Work-in-Progress (WIP) Reports: Required alongside POC financials to track:
Percent of project completion
Incurred costs
Remaining costs to complete
Billed/unbilled revenues
Gross profit margins
Tip: If you’re a growing contractor, speak with your accountant about switching to POC accounting, even if your tax filings still use cash or completed contract methods. This change can significantly improve your financial visibility and credibility with lenders, as well as providing you with more effective financial management tools that can support your operations and business strategies.
Advantages of POC Accounting
Accurate Financial Reporting: Captures real-time revenue and profitability.
Improved Cash Flow Management: Aligns revenue with expense timing.
GAAP Compliance: Meets Generally Accepted Accounting Principles and lender expectations.
What Bank Underwriters Look for in POC Financial Statements
Revenue Recognition & Trends
Gross Profit Margins: Should align with industry benchmarks and historical company performance.
Revenue Overstatement Risk: Revenue recognized should correspond to actual costs incurred.
Accounts Receivable & Retainage:
Aging analysis helps identify collection issues.
Retainage receivables should be tracked for timely collection.
WIP Schedule: A critical companion to financials.
Costs in Excess of Billings = Underbilling (Asset)
Billings in Excess of Costs = Overbilling (Liability)
Job Costing Accuracy: Compare historical estimates to actual costs and evaluate the credibility of cost-to-complete projections.
Potential Red Flags During Underwriting
Some warning signs banks will look for include:
Ø FFinancial Statement Issues
· Unusually High Costs in Excess of Billings (Underbillings) – May indicate poor project management, billing practices or unapproved cost overruns.
· Billings in Excess of Costs (Overbillings) Without Associated Cash Reserves – Could be sign of covering cash flow gaps.
· Declining Gross Profit Margins – Could be indication of rising labor/material/subcontractor costs disproportionate to job bidding.
· Frequent Cost Revisions – (Can be spotted on WIP reports) – Could signal poor cost estimates and/or project oversight.
Ø Cash Flow & Liquidity Concerns
· High Retainage Receivables
· Slow Accounts Receivable Collections
· Heavy dependence on a Few Clients – concentration risk.
· Projects not progressing or completed to schedule.
· Excessive Change Orders
Concluding Thoughts
Commercial contractors who understand what banks look for during credit underwriting are far better positioned to secure financing, support sustainable growth, and build long-term financial strength. Financial transparency, sound accounting practices, and disciplined cash flow and operational management are essential to earning—and maintaining—your bank’s trust.
For example, most contractors maintain a line of credit with their bank to support working capital needs related to long operating cycles, seasonal cash flow fluctuations, and bonding requirements. In addition, contractors frequently utilize bank financing for equipment and machinery purchases, real estate acquisitions, facility expansions, and capital improvements.
The quality and timeliness of your financial reporting reflect the effectiveness of your internal financial controls. It's critical to demonstrate to your lender that you are actively managing the common risks and challenges inherent to contracting, particularly:
Estimates & Adjustments: Your ability to accurately forecast costs and revenues, starting with job costing and bidding, speaks directly to financial reliability.
Project Delays & Cost Overruns: These are common in the industry. How effectively your team addresses these issues will determine your ability to avoid earnings restatements and maintain credibility.
Ultimately, a strong, transparent relationship between the contractor and their bank benefits both parties—and often leads to more profitable outcomes on both sides of the table.
