Cash Surety Bonds in Construction: Accounting Tips for Contractors

Cash surety bonds are a specific tool in the construction industry that can protect owners and obligees while creating accounting and cash management considerations for contractors. Understanding how these bonds operate, when they are required, and how to treat them in the books helps prevent surprises during audits, project execution, or tax season. The following sections explain the mechanics, financial impact, and practical accounting approaches contractors should follow when a cash-backed bond is involved.

Construction contracts frequently require some form of guarantee that obligations will be met. Many contractors are familiar with performance and payment bonds, but less familiar with situations where cash is used as the form of collateral. Cash surety bonds convert what is usually an insurer-backed guarantee into a cash-backed obligation. While they guarantee the same outcomes for owners, they carry different accounting, collateral, and liquidity consequences for contractors.

For contractors operating on thin margins or multiple overlapping projects, a cash bond can shift the financial dynamics of a job. This article provides an overview of what cash surety bonds are, why they may be required, how they differ from other bonds, and, crucially, how to treat them from an accounting and cash management perspective. Practical suggestions for minimizing disruption and handling tax implications are included to help contractors maintain healthy operations.

What Is a Cash Surety Bond in Construction?

A cash surety bond is a guarantee in which the principal (the contractor) provides cash or a cash-equivalent deposit to the obligee (the owner or agency) or to the surety as collateral. Unlike a traditional surety bond, which is issued by an insurance company based on underwriting and credit assessment, a cash surety bond means the surety or owner has immediate access to funds if a claim is made. The cash may be held in escrow, a restricted bank account, or directly with the surety or owner, depending on contract terms.

These bonds are typically used when the surety company or the owner perceives higher risk—whether due to the contractor’s credit history, the size or complexity of the project, or the nature of the jurisdictions involved. The cash functions as a security deposit that can be drawn upon to cover default, defects, or unpaid subcontractor claims. Because the cash sits outside the operating cash available for routine activities, it behaves more like a restricted asset than ordinary cash.

Define cash surety bond vs. traditional surety bond.

A traditional surety bond involves three parties: the obligee (owner), the principal (contractor), and the surety company. The surety underwrites risk and guarantees performance without requiring cash collateral in many cases. If a claim is made, the surety investigates and may pay on behalf of the contractor, then pursue recovery from the contractor through indemnification agreements.

In contrast, a cash surety bond replaces or supplements the surety’s underwriting with actual cash collateral from the contractor. Instead of the surety fronting funds under a credit agreement, the cash sits as a guarantee. That cash may be released at project completion if there are no valid claims, or partially forfeited if the contractor fails to meet obligations. The main practical differences are liquidity impact for the contractor and the immediate availability of funds for the obligee or surety in the event of a claim.

When contractors might need a cash surety bond (e.g., high-risk projects, poor credit situations).

Certain circumstances commonly lead owners or sureties to require cash-backed bonds. Projects that are politically sensitive, located in jurisdictions with weak legal protections, funded by unfamiliar lenders, or that involve critical infrastructure often prompt owners to demand higher certainty. Contractors bidding on such projects may be asked to provide cash collateral to secure a bond.

Contractors with weak credit profiles, limited operating history, or recent claims on prior projects are also more likely to be asked for cash bonds. From a surety’s perspective, cash offsets underwriting risk. Similarly, joint ventures, subsidiaries, or contractors operating in new markets may need to provide cash until a track record is established or creditworthiness improves. Understanding when cash collateral is likely helps contractors plan and negotiate better terms.

Differences from secured/unsecured bonds.

Secured bonds and cash surety bonds are related concepts but not identical. A secured bond typically means the surety has recourse to specific assets or collateral if a claim arises—this could include liens on equipment, assignments of receivables, or letters of credit. A cash surety bond is the most direct form of secured bond: cash is the collateral. Unsecured bonds, often issued to contractors with strong credit and relationship history, rely primarily on the surety’s underwriting without immediate collateral.

Compared with secured non-cash arrangements, cash collateral is simpler to value and liquidate, which explains its attractiveness to owners and sureties. However, it imposes a heavier operational and accounting burden on contractors because it reduces immediately available cash and must be tracked separately. Letters of credit and escrow arrangements can function similarly but may have different fees, renewal terms, and accounting treatments.

Why Contractors Choose Cash Surety Bonds

Although cash surety bonds can be burdensome, contractors may choose them in several situations. Offering cash collateral can win competitive bids that might otherwise be lost, especially on projects where owners prioritize certainty and speed of recovery over cost. For some contractors, providing cash is an affordable way to get bonded access to large projects when lack of credit or high premiums would otherwise block participation.

Cash bonds can also be a strategic decision to maintain relationships with a surety that prefers cash in certain markets, or to avoid long underwriting delays. In short, cash surety bonds can be a pragmatic tool to bridge capability gaps, secure desirable contracts, and demonstrate commitment to owners—albeit at the cost of reduced liquidity.

Accounting Challenges with Cash Surety Bonds

Cash surety bonds create accounting complexities that extend beyond a simple cash withdrawal. Questions arise about classification, presentation, and disclosure—especially in interim financial statements and project reporting. Properly reflecting restricted funds, potential liabilities, and contingent exposures is crucial to present an accurate picture of financial health.

Additionally, managing multiple cash bonds across projects can complicate job costing and project profitability analysis. If restricted cash is not correctly tied to the associated project or contract in accounting systems, it becomes difficult to assess the true working capital available to execute other contracts. Misclassification can lead to misstated liquidity ratios and misinformed management decisions.

How cash surety bonds affect working capital and project budgets.

When cash is locked into a bond, working capital decreases by the same amount, reducing the contractor’s ability to fund payroll, materials, or other projects without additional financing. This shrinkage can be particularly acute for small and mid-sized contractors that rely on limited operating cash.

Project budgets often need adjustment to account for the opportunity cost of locked cash. For example, if a bond requires a three-month cash hold, the contractor must forecast additional short-term financing or defer other investments. Incorporating bond collateral into budget scenarios ensures project bids and subsequent cash flow plans remain realistic and resilient to sudden liquidity needs.

Impact on Balance Sheet: Classifying as restricted cash or security deposit.

Accounting standards generally require that cash held as collateral be presented separately from unrestricted cash. Common classifications include "restricted cash" or "cash held as security deposit." Placement on the balance sheet depends on contract terms—whether the funds are held by a third-party escrow agent, the surety, or the obligee—and on expected timing of release.

Restricted cash should be clearly disclosed in notes to the financial statements, identifying the amount, purpose, and anticipated release conditions. If the cash is deemed a performance security subject to potential forfeiture, additional disclosure about contingencies and possible liabilities may be necessary. Proper classification helps stakeholders evaluate liquidity and solvency with greater accuracy.

Cash flow strain and potential delays in other projects.

Locking cash into bonds can force contractors to draw on lines of credit earlier or seek alternative financing, often at higher cost. The diversion of cash to a single project can delay supplier payments, slow down procurement, or necessitate deferred hiring. In turn, this may cause slack in project schedules and risk escalating costs or penalty exposure.

Proactive cash flow modeling that includes scheduled releases and potential forfeiture scenarios reduces surprises. When a contractor recognizes the strain early, options such as staged bond releases, negotiated partial releases upon milestone completion, or bank lines specific to bonded projects can be pursued to avoid domino effects across the portfolio.

Accounting Best Practices for Contractors

Adopting consistent accounting practices for cash surety bonds reduces audit friction and improves management visibility. First, establish a policy that outlines how cash bonds will be recorded, who has approval authority, and how releases will be tracked. Standardized procedures help teams handle bonds consistently across projects and over time.

Second, integrate bond tracking into the project accounting system. Each cash bond should be linked to the related contract, with fields for amount, holder, maturity, and release conditions. This enables project managers and accountants to see the full picture of committed and available funds when making decisions.

How to record cash surety bonds in your books.

When cash is provided as collateral, record a transfer from unrestricted cash to restricted cash or an asset account such as "cash held as security deposit." Concurrently, document any offsetting liability if the contract requires an obligation to the obligee, for example, "deposit liability" or "security deposit payable." If the cash is held by a third party and will be returned, a receivable may be appropriate when the release becomes probable.

If the bond is forfeited, recognize an expense or reduction in retained earnings according to the cause and timing of forfeiture. Clear journal entries and consistent chart of account mapping prevent misstatements and make reporting straightforward during audits or financial reviews.

Tracking restricted funds and ensuring transparency.

Maintain a register of all restricted cash amounts that captures the project, contracting party, account holder, effective date, and release conditions. Reconcile this register monthly against bank statements and project ledgers to identify discrepancies early. Transparency is particularly important when multiple stakeholders—sureties, owners, lenders—may have claims on locked funds.

Provide periodic internal reports showing restricted cash by project and expected release timelines. These reports assist operations and finance teams in prioritizing tasks and negotiating bond terms when necessary. Clear documentation also reduces the risk of disputes over the timing or amount of releases.

Tips for managing liquidity and forecasting cash flow.

Create rolling cash forecasts that incorporate bond funding requirements, anticipated releases tied to project milestones, and potential forfeiture scenarios. Stress-test forecasts under adverse conditions—delays, claims, or simultaneous bond demands—to understand worst-case liquidity needs. This helps secure appropriate credit facilities before urgent needs arise.

Negotiate staged or conditional releases of bond cash where possible. Some owners will agree to partial releases after certified completion of key milestones. Additionally, consider blending financing options such as short-term lines dedicated to bonded projects, which can reduce the need to convert long-term assets into cash prematurely.

Read more: What is the Difference Between a Cash and Surety Bond?

Tax considerations (e.g., refundable vs. forfeited bonds).

Tax treatment depends on whether the bond is ultimately returned or forfeited. If refunded, the cash held as collateral typically has no immediate tax consequence—the original funds simply move back into operating cash. If forfeited due to contractor default or failure, the forfeiture often produces a deductible business expense or reduces taxable profit, but timing and deductibility depend on jurisdictional tax rules.

Document the nature of any forfeiture thoroughly and consult a tax professional to determine proper treatment. Special attention should be paid to interest earned on restricted accounts, which may be taxable to the contractor if the bond agreement allows interest to accrue to the contractor, or to the obligee if otherwise stipulated.

Read more: Surety Bond Costs in California: What Construction Businesses Should Budget For

Read more: Illinois Construction Bonds: Secured vs. Unsecured and Their Accounting Impact

How Construction Cost Accounting Helps Contractors

Construction cost accounting systems allow precise allocation of restricted funds to their corresponding contracts, which aids in accurate job costing and gross margin calculations. By tracking bond-related cash separately, accountants can report true project liquidity and profitability, avoiding the distortion that would happen if restricted cash were treated as available operating funds.

Automated integration between banking, project management, and accounting systems reduces manual reconciliation work and highlights exceptions. Proper cost accounting also supports better bid pricing: when the cost of posting cash bonds is included in overhead and markup calculations, bids more closely reflect actual project economics.

Tips to Minimize the Financial Impact of Cash Bonds

Negotiate bond terms at the contracting stage—seek staged releases, shorter hold periods, or the use of a letter of credit instead of cash where acceptable. Building strong relationships with sureties and owners can lead to more favorable collateral terms over time, including reduced cash requirements as performance is demonstrated.

Maintain robust forecasting and dedicated credit facilities for bonded work to avoid operational strain. Explore alternatives such as surety pools, parent company guarantees, or other credit support mechanisms that may reduce the need for cash collateral. Finally, include the cost and cash impact of potential bonds in future bid estimates so margins account for the real financial burden of cash-backed guarantees.