THE FOUR FACES OF PROFITABILITY: PART I
by Diane Herbert and Pamela Millard
Even if you see a healthy profit when you look at the bottom line, you might want to consider your profitability from more than one perspective. (Part One of Two).
Profit is profit, right? Income minus expenses. It’s how business owners measure success. It’s the bottom line and where we want to start and end in any business.
However, agency owners have different goals. Some are investing in growth — new producers or upgraded technology. Others are planning for retirement. Will they sell the business to outsiders or transfer it to the next generation? The goals of the business and the individual will drive decisions about profit: How much or how little is enough and whether to take it out or reinvest it.
Some look at industry averages, or benchmarks, and say, “Well, my profit is about average, so I’m doing okay,” or “Hey, I’m doing better than average.” Although industry averages are useful, each agency owner must look at their own numbers within the context of their business goals to determine a reasonable return.
Even if you see a healthy profit when you look at the bottom line, you might want to consider your profitability from more than one perspective. There are a few other ways to look at profitability that will give you additional insight into what’s contributing to (or detracting from) your profit, and how you can improve it.
SHOW ME THE MONEY!
It’s been proven over and over: What gets measured gets done. That’s why it’s important for agencies to develop their own benchmarks and look at results over time.
Because several industry groups and consulting firms accumulate and publish data, there’s plenty of information available for looking at Pre-Tax Profit, which the industry generally uses as the yardstick. This is the best place to start.
The 2001 Best Practices Study (Independent Insurance Agents of America, Inc., and Reagan Consulting, 2001) reported average pre-tax profits for participating agents between about 10% and 18%. For the 25% most profitable agencies, the averages ran about 18% to 42%, depending on size. For agencies with the 25% highest growth rate, it ran7% to 34%. The study compares agencies within revenue categories ranging from $500,000 to more $10 million — and, interestingly, higher average profits do not correlate with revenue size.
The distinction between average agencies and agencies that are either growing rapidly or focused on profit is important. If you’re hiring new producers and support staff or buying books of business, it will show up on the bottom line.
The Best Practices Study also reports average results for Pro-Forma Pre-Tax Profit. This measure is a better indication of return on investment because it removes such discretionary expenses as excess owner compensation, bonuses, and perks. In effect, it removes any expenses that would not be paid if the business were owned by a third party managing the business for profit.
As a comparison benchmark, this is a more relevant measure of profitability if you want to compare agencies. The return on investment is the true measure of the success of a business. Owning an insurance agency is a risky business. If you’re not getting a good return on your investment, would you be better off investing your money elsewhere? Could you make more money working for someone else?
When comparing your results to those of the various studies, keep in mind that no two studies have the same results. In fact, many of the studies show vastly different results and sometimes come to widely varying conclusions. Pick one or two studies at the most, and use them exclusively year after year. Watch the trends, as well as the actual statistics.
Also, averages can be misleading. The results aren’t specific to your local business conditions, and market demographics. They can’t take into account the unique personality of your agency or your individual goals and objectives. In addition, because these are averages, individual agency results will be higher or lower than the averages. Just as important, no one wants to be average. The “average” agencies might survive, but they certainly won’t thrive in the years to come. If your results are “average” or below, you need to take a close look at what’s holding you back.
It’s not just the pure bottom-line results that you need to consider. Look closely at what’s behind the numbers. That’s what counts. That — and what you can do to improve upon them continuously.
THE REAL DEAL
A more meaningful measure of profit is Cash Flow from Operations. This is operating profit in the sense that it removes non-commission income (contingents and investments), as well as such non-cash expenses as depreciation and amortization. This is an indicator of your ability to cover cash expenses with commission income.
There’s no question that agencies should manage to maximize profit sharing and investment income. However, the past year or two have proven the volatility and variability of these sources of revenues, as some agencies have experienced disappointing results. Many industry consultants feel that as many as half of all agencies are not making an operating profit.
This year, the Best Practices Study includes a measure of operating pre-tax profit. This measure keeps owner compensation and removes contingent and investment income. Again, there’s a very broad range of results, ranging from a 3% loss to a 25% profit. Although it’s good to look at your own operating profit in comparison with other agencies of similar size, there’s still more to the numbers.
The second part of this article will discuss Departmental Profitability and Producer Profitability — and offer recommendations on boosting your agency’s profits.
Diane Herbert and Pamela Millard are partners in Transformation Advisors, a client-focused management consulting firm. You can contact Herbert at (239) 948-6888, Millard at (530) 295-1083, or either of them at Web site www.transformationadvisors.com.