Evaluating your operating statement provides an excellent snapshot of your agency’s financial health.
It’s almost embarrassing to say, but many insurance agents don’t pay attention to the operating statements (profit & loss statements) produced by their expensive agency management systems — and most don’t even print their balance sheets because they don’t recognize the importance of the information they contain.
A few minor alterations to your operating statement (eliminating such non-cash items as bad debt and depreciation and amortization from the P&L; and adding such non-operating cash needs as debt principal payments) will give you your cash flow situation at any time. And that’s just a small step short of actually being able to project future cash flow at least one month in advance. Wouldn’t that be nice to know each month!
Even more important, the liquidity ratios that can be drawn from your balance sheet truly tell you the health of your business at the moment that the balance sheet is drawn. Although an operating statement is useful as a budgeting and year-to-date tool for profitability and cash flow, the balance sheet’s purpose is the same as a complete physical exam: To determine both your general health and specific indicators of the functions of your system. A balance sheet provides the data to test the liquidity of your business. All you need are the formulas and benchmarks to convert this data to meaningful results.
Here are the formulas and liquidity ratio benchmarks that you should apply monthly to your Balance Sheet. Running a balance sheet without applying these ratios is like collecting data but never evaluating it:
CURRENT RATIO
The general liquidity ratio measures your agency’s short-term health. If current assets can’t meet current liabilities (within 12 months), you need to strengthen your liquidity.
Formula: Current Assets/Current Liabilities
Benchmark: At least 100%
ACID TEST
The acid test is a primary liquidity measure used to determine whether the firm can meet its current obligations.
Formula: (Cash + Receivables)/Payables
Benchmark: At least 90%
RECEIVABLES TO PAYABLES
A poor receivables-to-payables ratio indicates a poor collector.
Formula: Trade (Co.) (or All) Receivables/Trade (premiums) (or All) Payables.
Benchmark: Less than 75%
TANGIBLE NET WORTH (TNW)
The 'book' value of your company (not the Book of Business value, which is excluded).
Formula: Total Owners Equity (Treasury Stock subtracted) less Intangible Assets (such as Goodwill, Purchased Renewals or Expirations, Covenants) and any loans to officers or owners that arent likely to be repaid.
Benchmark: Should be a positive number unless the agency is in the process of being perpetuated (causing negative TNW). But in that instance it should be a positively growing number each year toward an eventual positive number.
WORKING CAPITAL
Measures the extent to which the excess of current assets over current liabilities can cover operating expenses.
Formula: Current Assets less Current Liabilities.
Benchmark: Take the Average Daily Cash Expenses of the agency Total Expenses of the prior year, less non-cash items (Bad Debt and Deprec & Amort divided by 365) and divide it into the Working Capital. 30 days should be the minimum required. Forty-five to 60 days defines a cash-healthy agency.
These formulas will assist you in determining the health of your agency. You should run them on your balance sheet every month and gauge your progress. If you have problems in one or more areas of liquidity, take remedial action.
Dont be afraid to get a 'Check-Up' for your agency regularly. If bad things are happening, there are solutions. Its far worse to wait until you cant make payroll or cant pay the carriers to find out about your liquidity problems.