Reading a Subcontractor's Financial Statements
A subcontractor has sent you their financial statements as part of prequalification. You now have twelve pages of accounting and about twenty minutes.
Here is the framing that makes the next twenty minutes useful: you are doing a lighter version of what a surety does. Same questions, less depth, one job instead of a whole program.
The full version is in how sureties read your financials — the same analysis a surety runs, including every adjustment and every ratio. This page is the subset a GC needs to decide whether to award one scope to one sub.
What to ask for, and what you will actually get
Ask for three things and you will get some of them.
| What to ask for | Why | What it tells you |
|---|---|---|
| Last two fiscal year-end statements | Two years shows direction, one year shows a moment | Trend, which matters more than any single number |
| Current interim statement | Year-end can be nine months stale | Where they are now |
| Current work-in-progress schedule | Backlog and margin performance live here | The most useful single document on the list |
The WIP schedule is the one to fight for. A balance sheet tells you what they had; the WIP tells you what they have promised and whether their estimates hold.
What the level of preparation means
Two identical sets of numbers are not worth the same. How the statements were prepared decides how much weight you can put on them.
| What you receive | What the CPA did | What you can conclude |
|---|---|---|
| Audit | Tested the numbers, confirmed balances, examined evidence, issued an opinion | Nearly everything. Rare below roughly $20M revenue |
| Review | Analytical procedures and inquiry, limited assurance | Ratios are usable. This is the practical minimum for a real analysis |
| Compilation | Put the contractor's numbers into statement format, no assurance | Structure and classification are probably right. The numbers are unverified |
| Internally prepared | The bookkeeper produced it | Directionally useful for interims, not a basis for a large award |
| Tax return | Prepared to minimize tax, not to present financial position | Very little. Deliberately understates profit and equity |
Most small subcontractors will send you a tax return or a compilation. That is not evasion — it is what they have.
A tax return understates profit and equity by design, and often uses completed contract or cash basis rather than percentage of completion. Do not read a thin tax return as a weak company, and do not read a healthy one as verified. It answers "are they real and roughly what size" and very little else.
Check the basis of accounting as well. Percentage-of-completion accrual is what you need; completed contract says nothing about jobs in progress, which is exactly where the risk is.
The five numbers that matter, in order
If you do nothing else, get these five. They are in priority order — if you only have time for the first three, the first three are the right three.
1. Working capital
Current assets minus current liabilities.
This is the money available to fund payroll and materials before your payment arrives. Subcontractors fail from a lack of working capital far more often than from a lack of profit.
2. Backlog, measured as cost to complete
Backlog means cost to complete — the remaining costs on signed contracts, not the remaining contract value and not the total contract value.
This is the same definition the surety guide uses, and using the wrong one will make every ratio below look far better than it is. Pull it from the WIP schedule: total estimated cost minus cost to date, summed across open jobs.
3. The ratio between them
Working capital to backlog.
This is the capacity test, and it is the number that decides whether the company can finance what it has already sold. Everything else is context.
| Ratio | Formula | Target |
|---|---|---|
| Working capital to backlog | Working capital ÷ cost to complete backlog | over 10% for a subcontractor (over 5% for a general contractor) |
| Net worth to backlog | Net worth ÷ cost to complete backlog | over 7% |
Stated the other way round, working capital to backlog above 10% is the same statement as backlog below 10× working capital. That is where the familiar multiple comes from.
Subs are held to the tighter of the two thresholds on purpose: they sit lower in the payment chain, wait longer to get paid, and control less of the schedule.
4. Current ratio
Current assets ÷ current liabilities. Target over 1.2; many sureties prefer over 1.3.
Below 1.0 means current liabilities exceed current assets, and something has to be sold, borrowed or collected to meet obligations already due.
5. Profitability trend
Not the margin. The direction of the margin, across the years you have.
| Ratio | Formula | Target |
|---|---|---|
| Operating income to revenue | Operating income ÷ revenue | over 3% |
| G&A to revenue | G&A expense ÷ revenue | under 10% |
A sub at 4% and rising is a better bet than one at 7% and falling. Averaging years hides exactly the pattern you are looking for — look at the most recent year, the direction, and the rate of change.
The single most useful test: your contract against their size
If you take one thing from this page, take this one. It catches more defaults than every ratio above combined, and you can run it on the back of an envelope.
Compare your contract value to two of their numbers:
| Test | Rule of thumb | What it is telling you |
|---|---|---|
| Your scope ÷ their annual revenue | Generally should not exceed roughly 10% | Whether one job can sink the company |
| Their total backlog ÷ their working capital | Generally should not exceed roughly 10× | Whether they can finance what they have already sold |
Both are rules of thumb, both vary by trade, by payment terms and by how capital-intensive the work is, and both are the kind of thing a surety would apply with more nuance than you will. Use them as a trigger for a conversation, not as a pass/fail gate.
Why the revenue test matters so much
A sub taking a job that is 40% of their annual revenue is the classic setup for a default, and they can be perfectly profitable while it happens.
The mechanics are simple. That job doubles or triples their monthly working capital requirement, because they are funding labour and material weeks ahead of your payment. Their existing jobs still need funding at the same time. Their credit lines and supplier terms were sized for the old volume.
So they mobilize, cash goes out faster than it comes in, they slow-pay suppliers to bridge it, credit tightens, deliveries stop, and the job that was going to be their best year becomes the reason they close.
A single award above roughly 10% of a sub's annual revenue deserves a deliberate conversation about how they will fund it, and above roughly 25% deserves either a bond, a funding plan you have seen, or a smaller scope. These thresholds vary by trade — a labour-only trade with weekly billing carries a very different profile from one buying long-lead equipment.
Worked example
A drywall sub with $6M of annual revenue and $220,000 of working capital, bidding a $1.9M scope on your job. They have $4.2M of cost-to-complete backlog before your award.
| Test | Calculation | Result | Reading |
|---|---|---|---|
| Scope to revenue | $1,900,000 ÷ $6,000,000 | 31.7% | Far above the 10% rule of thumb |
| Backlog to working capital, before award | $4,200,000 ÷ $220,000 | 19.1× | Already about double the 10× guideline |
| Working capital to backlog, before award | $220,000 ÷ $4,200,000 | 5.2% | Half the 10% sub target |
Add your scope and the picture gets worse, not better. This sub may be profitable, well regarded and the low bidder. They are still the wrong sub for this scope at this size unless something changes — a bond, a reduced scope, joint checks, or capital they can show you.
Concentration risk, in both directions
Concentration is the question that turns a decent financial picture into a specific risk, and it runs both ways.
How much of their business are you? If your job is 40% of their revenue, you have become their most important customer and their most dangerous one. A dispute with you, a slow payment cycle from you, or a delay you caused becomes an existential event for them.
How much of your job are they? If they hold 20% of your subcontracted value on a schedule-critical path, their failure is your failure regardless of how their balance sheet looks.
Then look at concentration inside their own numbers:
- Customer concentration — one customer over roughly 25% of their receivables means someone else's payment problem becomes yours
- Job concentration — their largest contract over roughly 30% of backlog means one bad job can take the company down
- Receivable concentration — a large balance from a single owner or GC, especially an aging one, is a single point of failure
The most dangerous combination is a sub who is heavily concentrated in one customer, and that customer is you, on a job that is large relative to their revenue. That is three versions of the same risk stacked, and it is common with a sub who is delighted to have won your work.
The adjustments, in short form
Sureties do not use the balance sheet as presented. They rebuild it, and you should make a lighter version of the same corrections before computing anything above.
The terminology is as given (what the statements say) and as allowed (what survives adjustment). Three adjustments do most of the work at a GC's level of depth.
| Adjustment | What to do | Why |
|---|---|---|
| Related-party receivables | Remove them entirely — amounts due from officers, owners or affiliates | The company cannot make itself pay. This is the most common single adjustment and often the largest |
| Stale AR | Remove or heavily discount receivables over 90 days | If it has not been collected in 90 days, it is disputed, the customer is struggling, or the billing is wrong |
| Underbillings | Discount them, commonly by half | Costs and estimated earnings in excess of billings is an asset created by an estimate, not by an invoice |
Two smaller ones worth a minute if the numbers are close: prepaid expenses and inventory are both weak current assets for a contractor and sureties routinely disallow or heavily haircut them.
And one that goes the other way: formally subordinated officer debt — subordinated in writing, not by understanding — behaves like equity rather than a liability.
Watch underbillings as a percentage of working capital. Above roughly 25–30%, their working capital is mostly an accounting estimate rather than a liquid resource. Treatment varies by surety and the same logic applies to your read.
The full adjustment table, including the worked as-given-versus-as-allowed example, is in the surety version. If a sub is large enough to matter, run the whole thing.
What to look for on the WIP schedule
If you got the WIP, three checks are worth more than the rest of the package.
- Gross profit fade — compare the margin now against the margin at bid on jobs nearing completion. Fade above roughly 2% means reported profit systematically overstates real profit, and every ratio built on it is overstated too
- Any job in a loss position — a foreseeable loss must be recognized in full immediately, so a loss job on the schedule is a cash drain already underway
- Estimated cost to complete that does not move period to period, or jobs open with no cost activity for months
Red flags
Any of these justifies a follow-up question. Several together justifies a bond, a smaller scope, or a decline.
| Red flag | What it usually means |
|---|---|
| Working capital flat or falling while revenue grows | Overtrading — the most common cause of failure among profitable, growing contractors |
| Negative working capital | Current obligations already exceed current resources |
| Related-party receivables appearing or growing | Cash is leaving the company for the owners |
| Growing underbillings, especially from unapproved change orders | Revenue recognized on work nobody has agreed to pay for |
| Fully drawn line of credit | No cushion left. The next problem has nowhere to go |
| Rising days sales outstanding | Collections are slipping. This typically precedes cash trouble by a couple of quarters |
| Distributions exceeding net income | The company is being drained faster than it earns |
| Change of CPA in a weak year | Sometimes routine, often not. Ask |
| Statements more than nine months old | Either the back office cannot execute or the current numbers are worse |
| Level of assurance moved downward | A review that became a compilation is a deliberate choice |
| Gross margin declining year over year | Buying work, or estimating badly. Both end the same way |
| Officer compensation moving sharply in either direction | Either the owners are pulling cash out or they have stopped paying themselves to survive |
When they will not give you financials at all
This is very common, and refusing to award work over it is often the wrong answer.
Plenty of good subcontractors will not send financial statements to a GC. Sometimes it is privacy, sometimes it is a competitor concern, and often it is that a company with a bookkeeper and a tax preparer genuinely does not have statements worth sending.
You have five alternatives, roughly in order of how much comfort they give you.
| Alternative | What it proves | Limits |
|---|---|---|
| A performance and payment bond on their subcontract | A surety underwrote them and is standing behind the scope with its own money | Costs premium, which you pay in their price. Not available to every sub |
| A bonding capacity letter from their surety producer | A third party has underwritten their whole company, seen the statements, and set a single-job and aggregate limit | It is a statement of capacity, not a guarantee for your job. Confirm the date and call the producer |
| Trade and bank references | Whether they pay suppliers on time and whether the bank line is real | Only as good as the references they chose to give you. Call the suppliers they did not list, too |
| A smaller first award | Actual performance data, which beats every document on this list | Slow, and it does not solve today's award |
| Joint checks on their major supplier | That the material gets paid for out of your money | Administrative work, and it does not protect against labour non-payment |
The second one deserves more attention than it usually gets. A capacity letter from a surety producer is frequently better information than the statements themselves, because a professional underwriter has already read those statements, applied every adjustment in the surety guide, and reached a number.
If their single-job capacity is comfortably above your scope, a great deal of your analysis has been done for you by someone with more information than you have.
Your own surety producer can usually tell you, in general terms, what a given capacity letter implies about the company behind it, and whether the surety issuing it is one they know. That is a free phone call.
See bonding capacity for how those numbers are set.
What you owe them
The relationship runs both ways, and how you handle this determines whether good subs keep bidding your work.
Treat the financials as confidential and say so in advance. Tell them who will see the statements, that they will not go to your estimating team or leave your office, and how long you will keep them. Then do that.
Scale the request to the award. Do not ask a $40,000 sub for audited statements. It is not a serious request, it signals that you do not understand their business, and the good ones will simply not bid.
A defensible ladder looks roughly like this, and the breakpoints vary by company and trade:
| Award size | Reasonable request |
|---|---|
| Small | W-9, certificate of insurance, license, references |
| Mid-size | Add a prequalification form, a tax return or compilation, and bank and trade references |
| Large | Add two years of reviewed statements, a current interim, a WIP schedule, and a bonding capacity letter |
| Very large or schedule-critical | Add a bond and an annual requalification cycle |
Give them an answer. If the financials produce a concern, tell them what it is. A sub who learns their working capital is thin relative to your scope can often fix it — a subordination, a collected receivable, a smaller scope, a bond. A sub who just never hears back learns nothing and neither do you.
If you need to award with conditions, do it in writing with the conditional approval letter.
What to do next
Run the two size tests first — your scope against their revenue, and their backlog against their working capital. They take a minute and they carry most of the signal.
Score the whole picture with the subcontractor risk scorecard, then fold the result into prequalification.
Once they are on site, the numbers stop being the leading indicator and behavior takes over. That is warning signs a subcontractor is in trouble.
Related Resources
- Subcontractor Risk Scorecard — score the statements
- How Sureties Read Your Financials — same logic on your own books
- Subcontractor Prequalification — tier requirements and award limits
Not financial or legal advice. Ratio targets, adjustment practices and capacity multiples vary by surety, by trade and by year, and the ones here are typical rather than universal. Work the specifics with your CPA, your surety bond producer and your construction attorney.
Try it: Subcontractor Risk Scorecard.