For litigation bonds, our underwriters may ask to see a principal’s financial statement as part of the application process. This is especially true if the principal is a business, organization, or corporation. Acceptable financial statements prepared by a Certified Public Accountant (CPA) include the following elements: a balance sheet, income statement, statement of retained earnings, statement of cash flows, opinion statement, and other notes and information.
The surety must look at financial statements before approving the bond to evaluate several factors. Principals with very strong financial backgrounds may not have to post full – or any – collateral for a litigation bond. The surety evaluates the financial statements to ensure the principal has enough liquid funds to pay the full bond penalty in the event of a claim or final judgment. Liquidity is the most important factor for underwriters making these decisions. Liquidity is often determined by the principal’s working capital, which is the difference between current assets and current liabilities.
Principals willing to supply as much financial information as possible have better odds of securing a bond by building their relationship with the underwriter.
To determine whether or not a principal has the funds, underwriters can rely on a simple question: “Can you pay the bond penalty today, if you had to?” If the answer is “No,” the principal needs to find an alternative solution to securing the bond. Several alternative options are available and will be discussed in future blog posts.