A Cash-Flow Budget For An Insurance Agency

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Some agencies show a paper profit year in and year out. Suddenly one day, they're in financial difficulty. How can an agency making money get in trouble? What about the marginally profitable agency? How long can the unprofitable agency stay open before it must merge, sell, or file Chapter 11? These agencies have one thing in common: the need to understand and make good use of their cash position. They need to set up a cash-flow budget.

First, it's important to address the cash needs of an agency. We sell an intangible product: service. Other businesses sell tangible products that create inventory. When cash is needed, they simply sell off part of their inventory, at or below cost, to raise the money. If an agency has this problem, it can't raise money by running a sale on Homeowners and Auto policies or offering Commercial Lines at a discount. The money must come from reserves, personal funds, or a loan. Each of these solutions requires planning. Banks look at cash flow and a balance sheet before lending money, and the days of looking to carriers for help is ancient history.

What's more, the profit/loss (P/L) statement doesn't always tell the whole story. Our bottom line may show a profit while our cash position keeps getting weaker. Many cash expenditures are not recorded as expense. When paying back a loan, only the interest is recorded and payment of principle simply reduces cash. On major expenditures, we might be deducting only the depreciated amount, which could be just a small part of the total cash outlay. These types of cash transactions may be of particular concern for agencies wanting to expand through acquisitions or sales growth. The full cash outlay of an acquired agency can't always be written off as a cost of business, and sales growth may require new equipment with only depreciation as a deductible expense.

Another variable is whether the agency conducts business on a cash or accrual basis. Income may be recorded before the agency actually receives the cash-but expenses are due when they're incurred. Agencies on an accounts-current basis can run into a cash flow problem, with overdue improperly handled accounts and audits.

In New York, agencies may not commingle funds, but must instead maintain a separate premium account. Other states do not require this. Commingling tends to muddy the cash-flow picture.

GETTING THE FIGURES FOR YOUR CASH-FLOW BUDGET

Setting up a cash-flow budget should be simple, uncomplicated, and user friendly. Preparing one should take less than an hour, and reviewing it should be a matter of minutes. This budget is intended as a guide or reference tool. You can use a computer spreadsheet, or a three- to six-column journal sheet to prepare the report.

A cash-flow budget anticipates the agency's cash needs for a given period: three months, six months, or one year. Profit and loss need not be considered, since they can be distorted by depreciation, accrual or cash accounting, or cash outlays that aren't reflected on the P/L statement. This presentation discussed here will be for monthly and annual projections; for other periods, adjust the expense to reflect the expected cash outlay for that particular period.

The budget is broken down into three parts: fixed monthly expense, variable monthly expense, and annual expenditures. Post only the projected cash outlay.

Fixed Monthly Expense: These are fixed expenses incurred every month such as rent or mortgage, auto lease, equipment lease, loans, agency acquisition payments, or any other fixed monthly cash payments. Principals' salaries are often part of this list. If a business can't pay its owners every month, why be in business?

These expenses are usually addressed once - upon entering an agreement. But they have a long-range effect on cash. Remember, only part of the repayment on loans or agency acquisitions cost will show up as expense on the P/L statement, but they'll reduce cash substantially.

Fixed Variable: These are monthly expenses that vary every month. They include staff payroll, employee benefits, commissions to producers or others, phone, gas, electric, postage, and so forth. A check goes out every month, but not for the same amount. Most of these items are a direct expense to the agency. Take the high and low bills to create an average estimated monthly expense.

Annual Expenditures: These expenses are incurred at different times of the year. During the year, you have a second opportunity to adjust or reconsider them, or to take action when there's a positive cash flow for the period. They would include office supplies, taxes, insurance, professional fees, training and education, advertising and promotions, auto service, dues, subscriptions, donations, funding for buy/sell or key-person agreements, license fees, and any other cash outlay.

Major expenditures-such as for equipment, agency acquisitions, sales promotions, and even debt reduction-require cash. When dealing with equipment or large items, the P/L statement may only 'expense out' taxes and depreciation. The money required for these items will simply reduce cash, and may give one a false sense of profit. Conversely the P/L statement could be showing an operating loss, due to a large deduction for depreciation, while cash flow remains positive.

PREPARING MONTHLY AND ANNUAL REPORTS

You now have three sets of figures: monthly fixed, fixed-variable expenses, and annual expenses. You can now prepare monthly and annual projected reports.

Preparing a monthly report is simple. Total the fixed and variable figures to get the minimum monthly cash outlay needed in any one month. Then convert the annual expenditures into a monthly average. To do this, divide the annual total by 12, and add this amount to the fixed and variable totals.

Calculating your annual cash needs is just as easy. Multiply the fixed and variable monthly totals by 12 to get your annual cash needs, and then add this to the annual expenditures.

CALCULATING YOUR CASH INCOME

Your cash income is the money available to pay expenses for a given period. Start with cash on hand. Add direct bill commission to be received. For accounts receivable, note commissions to the agency rather than net premium to the carrier. Here are other items to include:

  • Fees for consulting or special services
  • Profit-sharing earned and waiting for the check
  • Sale of property-real, personal. or equipment
  • Interest-but only if added to an operating account, not if it's to be left with the principle
  • Agency debts to be collected
  • Deposits and new business-but only if they're to be remitted in the time frame being addressed, and then only commission income
  • Credits and refunds if they reduce cash outlay

MAKING ADJUSTMENTS

You now have the necessary information to discover any cash gaps. Simply match the projected expense against the expected cash income for the period under review. This is not net income. Short-term cash needs may be adequate, but could still lead to a shortfall by year's end. A worse scenario would be insufficient cash for short and long term while the P/L statement projects a profit for the year-it could happen! A better situation would be for the P/L statement to have an operation loss while cash shows to be in a positive position. This could happen if you have large deductions for depreciation on money spent in past years.

If you find cash on hand to be adequate or have a surplus, transfer the excess money to an interest-bearing account or some other short-term investment. Don't leave more money than necessary in the checking account.

By reviewing the payment dates for annual expenditures, you can easily adjust your cash needs for any period, whether monthly or quarterly. If income for a period is high and cash outlay looks low, it may be time to invest surplus cash, buy supplies in quantity at a cash discount, or simply reduce debt. If, on the other hand, income will be low and cash outlay high, you may need to control spending or rethink certain plans.

Every business has its peaks and valleys with cash flow. You may be showing a profit yet be short of cash. Some agencies chase their problems like firemen, every day putting out a new fire. Others avoid costly errors by planning to meet coming events.

A cash-flow budget gives management time to predict cash needs and make good decisions. For the short term, cash on hand, reserves, or personal funds may be adequate. Borrowing may be a solution. A preapproved line of credit with banks or other lenders is often recommended to avoid waiting until you need money to apply for a loan.

This budget is like any other management tool. It helps to prevent costly errors, saves time by avoiding unnecessary meetings to put out fires, and helps you to determine the best time for taking action on agency plans. Remember, we don't sell a tangible product; we sell service. Money is our commodity, so use it wisely!

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