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 This four-part article offers a step-by-step, comprehensive plan for growing your agency’s business.
AGENCY FINANCIAL ANALYSIS
An agency’s long-term survival depends totally on profit maximization — and profit maximization depends on a number of variables. To achieve profit maximization, you need to must mesh all variables into the most efficient arrangement, which includes a balance between effective production and financial management.
We won’t deal with production here, but financial management should be defined simply as” the effective handling of an agency’s assets, liabilities, income, and expenses.” It’s an integral part of planning, organizing, directing, and controlling all aspects of the agency.
This guide refers to external standards — that is, the averages developed by the industry or the results attained by the most effective agencies. You can take your pick to set goals for your agency, but in no event should your goals be lower than the average for the industry.
Internal standards are the standards you develop for your agency to you determine where you are today. It’s up to you to decide whether this is satisfactory. If it is, you can focus your attention elsewhere. If it’s not, develop goals and expectations for future performance.
Once the standards are set, determine a regular reporting and review schedule. We recommend that reporting be done on an exception basis, so you can focus your attention on specific areas for improvement and not waste your time on normal events.
When a problem does occur, act on it immediately! Don’t just assume that it will go away. Call on the entire agency team for assistance. A profit-improvement program won’t work unless all employees understand the reasons for instituting the program and the methods to be used in implementation.
Every person in the agency must be sales, service, and expense-conscious to make progress in increasing sales and controlling costs.
Use these formulas to help determine the financial performance of your agency:
Required information
Accounts Receivable (current and aged -- for instance 15, 30, or 45 days old)
Cash
Total Liabilities
Current Liabilities
Total Premiums
Net Written Premium
Net Earnings
Total Assets
Current Assets
Owners Equity
Net Worth
Tangible Net Worth
Total Revenues
Intangible Assets
Stockholders Equity
Marginal Income Rate (commission revenue and variable costs divided by premium volume)
Total Fixed Cost Office Costs
Sales Costs
Total Number of Policies
Total Number of Employees
Total Number of Clerical Employees
Total Number of Producers
Total Commission
Contingency Commission Income (no contingencies)
Dollar Volume of Lapsed Policies
Dollar Volume of Renewals
Number of Lapsed Policies
Number of Policies Renewed
Liquidity Ratios
1. Receivable Ratio = Accounts Receivable/Current Liabilities .30
2. Cash Ratio = Cash/Current Liabilities 1.00
3. Quick Ratio = Accounts Receivable + Cash/Current Liabilities 1.3
Accounts receivable should not have more than 4% (15 days) of annual premium billings. This ratio measures you agency’s liquidity position, as well as the safety margin that the agency maintains to allow for the fluctuations in cash flow.
4. Collection Ratio = Accounts Receivable/Total Premium x 365 = 15 Days
The collection ratio measures the average number of days that uncollected accounts are outstanding and is a valuable gauge to the collectibility and currency of receivables.
Profitability Ratios
These ratios measure profitability to show how successfully assets and invested capital are used in the conduct of the agency.
5. Return on Assets = Net Earnings/Total Assets =10% (Productivity Ratio)
The return on total assets should exceed the return on an equivalent investment if the principal decided to convert all the assets to cash and invest in a low-risk interest-bearing account.
6. Return on Owners’ Equity = Net Earnings/Owners Equity = 25% (Financial Ratio)
If No. 6 is lower than No. 5, the firm is losing money.
This ratio indicates the return on the owners’ contribution to the agency and should be considerably higher than the return on total assets. It reflects their use of capital provided to the business (liabilities) that are less costly than capital provided by the owners (owners’ equity).
Capital Ratios
These ratios should not be crucial, since insurance agencies should not be capital intensive.
7. Capital Turnover = Net Written Premium/Total Assets = 200% (two to one)
This indicates the efficiency at which assets are employed and measures the rate of recovery of assets through premium written.
8. Working Capital = Current Assets-Current Liabilities/Total Assets-Current Liabilities = 30% (check against No. 4 for quality of current assets)
The denominator indicates funds furnished by the owners and long-term creditors. This sum represents a margin of safety available to current creditors.
Margins for Creditors
9. Equity Ratio = Net Worth/Total Assets x 100 (the higher the ratio, the stronger the financial position of the agency) = 25%-30%
This is a test of financial strength, and is of special interest to long-term creditors. The higher the ratio, the stronger the agency’s financial position.
10. Tangible Ratio = Tangible Net Worth/Total Revenues x 100 = 35%-40%
This measures efficiency in the employment of net worth in you agency’s operations. A high ratio could indicate a very efficient operation. Financial people usually see a high ratio as a danger sign because the agency might need large amounts of credit for current operations.
11. Intangible Ratio = Intangible Assets/Stockholders Equity x 100 = 25%
This standard measures aggressiveness in acquisitions. This figure can be distorted if the agency puts goodwill on its statement even when another agency isn’t purchased. The size of this ratio related to stockholders’ equity gives some measure of the rate of acquisitions with contributed capital. A lower figure than normal gives some indication that agency acquisitions, if any, are being made with internal funds rather than contributed capital.
Efficiency Ratios
Profit doesn’t tell the entire story. Many agencies are profitable but not efficient.
12. Expense Ratio Total Agency Expense/Net Commission Income
This ratio provides a performance indicator: Just take your current ratio and do what you must to improve it a little bit every year. Also, be certain to check your expense ratio performance against the ratios developed in Rough Notes’ “What It Costs” to see how your agency compares.
13. Office Cost Per Policy = Office Cost/Number of Policies
Determine this cost by dividing the number of policies by agency expenses. This approach ignores the fact that average cost per policy derives from total costs and the number of policies written. Thus if your goal were to reduce the average cost per policy, you could do it by writing more policies. The second problem is that because insurance agency costs are mostly fixed most agencies can write an additional policy without increasing costs. This is essential to solid agency performance. Make every employee revenue producing and focus on acquisition and retention of every customer.
14. Sales Cost Per Policy = Sales Cost/Number of Policies
Remember that low-premium items can be profitable if the cost of handling the policy is low. On the other hand, high-premium policies can be unprofitable if handling costs are high. The purpose of the average cost per policy is to trigger a question: Should the policy be written when compared to the cost of handling the particular account?
15. Commission per Employee Total Commission/Total Employees (Calculate the spread — that is, the revenue per employee minus compensation per employee for three years — and look at the trends.)
The figure here is not as important as the trend. Position your agency to generate more income per employee, and make sure everyone is committed to it.
16. Commission Per Clerical Employee = Total Commission/Number of Clerical Employees.
This ratio measures the efficiency of the clerical staff. Note: The maximum should be 1.5 clerical workers to every outside producer!
17. Commission Per Producer Total Commission/Total Producers
This ratio is not common because of the difficulty of determining the number of salespeople in many agencies. Increasing it is an essential goal for profitable growth.
18. Renewal Ratio = $ Volume of Lapsed/$ Volume of Renewals
Since acquisition expense is often so high, renewal retention is crucial to your agency’s long-term profitability and value. If producers own a piece of their business, retention will be critical to their long-term success.
19. Renewal Ratio = No. of Policies Lapsed/No. of Policies Renewed
In the long run, this is a better measurement because it’s not influenced by premium inflation or distorted by large accounts. Combined with the average premium per policy, this can be an effective planning tool.
Break-Even Analysis
20. Break Even = Total Fixed Cost/Marginal Income Rate
21. Marginal Income Rate Commission Revenue - Variable Costs/Premium Volume
This formula states that break-even volume is the point at which total revenue equals total costs. Stated in other terms, beyond a volume of XXX, are no fixed costs need to be covered and anything above that amount is mostly profit. Variable costs must be deducted from income above break-even volume, but the remainder is pure profit. This analysis essentially implies that the best way to increase your profit is through internal techniques.
22. Contingency Commission = 7% of Agency Income
To determine historical cash flow, study your bank-balance statements for past three years. The purpose is to look for excess balances and then reduce non-interest-bearing accounts to the bare minimum.
To improve cash flow:
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Reduce outside accounts receivable
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Pay, finance, or cancel
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Make all premium due on inception of the policy
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Bill on binders
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Manage deposits daily
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Manage due dates in the first two or three weeks of accounts payable period
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Use money in the trust account-only what the law allows
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Check all companies’ three- and five-year loss ratios
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Reduce expenses, including travel, entertainment, auto, phone etc.
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