ACG - Agency Consulting Group

The PIPELINE

A national monthly newsletter for agency principals dedicated to agency management topic

Change Is A Certainty.

How do you know if your agency is doing well?

We still meet agents who use the "checkbook philosophy". Their answer to the question above is, "If I can pay all my bills and there's money left in the checkbook at the end of the month - we're doing well!" If this is your philosophy, throw this issue of the Pipeline into the trash - it will be of no use to you.

Other agents generate Operating Statements on a monthly basis, comparing current year-to-date with last year. Their answer to the question is, "If revenues and profits are growing larger this year - we're doing well!" Unfortunately, aside from having computers that generate financial statements, these agents are simply an advanced version of our "checkbook philosophy" agent.

Revenue and Profit measurements are very important. They are also like Siamese Twins, it is very dangerous to separate them. We are all in business to earn profits and most of us would like to do so with growth. But those agents who determine their success by one or the other of these measures may find themselves growing into bankruptcy or profiting themselves out of business.

Gluttony Growth

We must eat to live. So it makes sense to eat the right foods to provide the nutrition, vitamins and minerals that our bodies need to perform well. However, if you eat too much (even of the right things) over a prolonged period, your body can not pay the cost of that growth. Your performance diminishes and, eventually, you die. Uncontrolled growth in business can also cost more in expenses than the actual growth could support. That's why we must keep an eye on expenses as we grow. For instance, if every producer requires a new administrative assistant (or csr), you will be hard-pressed to sponsor those combined costs (with attendant expenses) with growth. Sure, the producers will be sponsored to grow the book of business, but at what cost? If your marginal costs are greater than your marginal growth, you will lose profit and, eventually, go out of business.

Anorexic Budgeting

On the other hand, many agents are frugal to the point of anorexia. Extreme dieting seems to achieve the goals of weight loss, but the end result is death. Paying very low wages yields low performing employees. Eliminating advertising and marketing costs adds to the bottom line in the short run, but will starve any chance of growth in the long run. Agents who squeeze the expense dollar without regard to sponsoring growth find that they have fewer dollars to squeeze each year as costs rise and growth is not present. Eventually, they squeeze themselves out of existence.

While the twins of Growth and Profit are the primary measures of success, many other ingredients will forewarn you of potential problems. A Management Information System (MIS) can be designed as an early warning system for your business to permit you to make appropriate changes early enough to avoid the problems affecting growth and profit.

Agency Consulting Group, Inc. has designed MIS for many agencies. While each is tailored to the specific areas of importance for the agencies served, all have sufficient common ground to provide a template to agents for general use. The first common ground for all MIS is brevity. Most agency owners are not interested in stacks of paper to analyze in order to determine the health of their agencies. An MIS Report should be no more than two pages long and should provide sufficient information to the agency managers and owners to satisfy an absentee owner. The absentee owner is our definition of the extreme case. If you owned an agency 1000 miles away from you, what would you need (and at what frequency) to feel comfortable that everything is on target (or to understand what is going wrong)? Answering that question provided us with the categories of management information reporting necessary in an agency.

MIS Categories

Weekly

1. Service Production - How many items were completed last week? Compared to the last four week average? Compared to a six-month rolling average?

2. Backlog - How much do we have left at the end of the week (that could have been progressed if we had more time) ?

3. New Business - How many accounts (and policies) were written? How much commission was booked? List new business by name

4. Lost Business - How many (and specifically which) accounts were lost and how much commission did they represent? Identify reasons for each loss

Monthly

1. Financial - Has revenue grown? As projected in the Plan and Budget (if we have these tools)? Have expenses been controlled? To the degree expected in the Plan and Budget? Has expense growth been less than revenue growth? How do this year's profits compare against our own history? Against industry averages?

2. Financial Liquidity - Do we generate balance sheets? Do we understand them? Do we create Liquidity Ratios and track them against similar periods of the prior year?

3. Receivables - What is our total net receivables? Are they better or worse compared to last month? How are our potential bad debts (over 90 day receivables)? Compared to last month? Do the same customers owe us money over 90 days consistently?

4. Cash Projection - Based on billings and prior year direct bill statements, what are our cash expectation in the next 30 days? Considering our projected expenses in the next 30 days (using last year's monthly expense for the similar month as a guide), will our cash cover our costs in the next 30 days?

5. Production Reports (by department - i.e. Personal Lines, Commercial Lines) - Compare our monthly and year-to-date commission position against both last year and against our Plan. What is our Net Position (New Business - Lost Business) for the month and for year-to-date?

WEEKLY BACKLOG, PRODUCTIVITY AND PRODUCTION REPORTS

Agency Consulting Group, Inc. has developed a recording system that permits most agencies to keep track of Incoming work (calls, mail and walk-ins) relatively automatically. Week-end backlog remains manually listed. We have automated methods available, but agency management (and the employees, themselves) preferred the manual system because it both identified backlog and reminded the employees of next steps needed. Prior week backlogs plus current week incoming minus current week backlog yields Service Production - the amount of work by item count completed by the individual, department and agency in the course of the week. If this information is measured regularly, rolling 4-week averages and rolling 6-month averages can be established and tracked. Comparing current week with 4-week average and rolling 6-month average gives the agency a really good picture of the trends of service related work.

Once enough data exists to maintain 4-week and 6-month rolling averages, you can develop Line Trends. A Line Trend is the percentage difference between the 4-week and 6-month rolling average in the three primary Productivity Categories (Incoming work, Backlog, and Output). The other major measurement tool is Productivity Trend. This is defined as the difference between the Line Trend for Output and the Line Trend for Incoming work.

Example:

AGENCY XYZ

COMMERCIAL LINES

Rolling

Rolling

Line

Productivity

Week Ending

April X

6 Mo Avg

4 wk Avg

Trend

Trend

Output

638

517.5

612

18%

-4%

Backlog

624

529.2

616.5

16%

Incoming

653

521.3

638.5

22%

The importance of Line Trends and Productivity Trends is as an early warning system if your incoming growth is exceeding your department's processing capability over a prolonged period (we all have crisis periods). If so, either you must change your systems and procedures to simplify the processing and accomplish more transactions with the people you have - or - staff up. Otherwise, you will eventually face heavy and consistent backlogs that makes service levels slow and poor.

MONTHLY MIS

From a financial standpoint it is important to measure Total Revenue Growth (vs. last year at the similar time period), Commission Income Growth, Expenses and Profit. These should be measured on a monthly basis as well as Year-To-Date and should be compared to both prior year and to budget (if one exists).

Most agency management systems provide you with a monthly balance sheet (whether or not you pay any attention to it). The reason that the balance sheet is so important is that it provides you a snapshot check-up of the agency's health every month. Like a thermometer, blood pressure reading and blood test, the balance sheet can QUICKLY tell you if something is going wrong in the business. Here are the standard Liquidity Ratios that should be calculated. Agency Consulting Group, Inc. has an Excel spreadsheet available that does these tests automatically when you enter the Balance Sheet data. Call us if you'd like one.

Liquidity Ratios Formulas

SHOULD BE

Feb-98

Feb-97

CURRENT RATIO

> 100%

82%

67%

Current Assets/Current Liabilities

RECEIVABLE/PAYABLE RATIO

< 75%

57%

54%

Carrier Receivables/Carrier Payables

TRUST ACCOUNT

> 100%

86%

78%

Cash+Savings+Receivables/Payables

TANGIBLE NET WORTH

> 0

($73,844)

($139,537)

Total Stockholders Equity - Ren/Exp minus Covenants,

Goodwill, and Other Assets

TANGIBLE NET WORTH AS A % OF REVENUE

> 15%

-59%

-147%

Tangible Net Worth/Annual NET Revenue

RATIO OF EARNINGS TO TANGIBLE NET WORTH

> 16%

-38%

22%

Annl Before Tax Earnings/TNW

ACID TEST

> 90%

87%

82%

Cash+Savings+Receivables

+Marketable Securities/ Co. Payables

LONG TERM DEBT TO EQUITY

< 150%

-160%

-64%

Total Other Liabs./Total Stock. Equity

DEBT TO ASSETS

114%

133%

Current Liab+Other Liab/Total Assets

WORKING CAPITAL

($116,811)

($182,190)

Current Assets - Current Liabilities

DAYS OF WORKING CAPITAL

-40.6

-62.7

Working Capital/(Total CASH Expenses/365)

This agency obviously has some problems, but is trending in the right direction.

RECEIVABLE REVIEW

No Surprises - That's the motto under which every agency owner should operate. The light of scrutiny shines brightly on customer owing the agency money, especially over a prolonged period. At 45 to 60 days after billing, most carriers bill an agency for payment. Customers delaying payments beyond that period cause the agency to use ITS money to pay for the client's premiums until payment is received. Many agencies have converted to direct billing to avoid that issue, but many commercial accounts still use agency payment terms. Measurement of Bad Debts (over 90 day outstanding receivables) and aged receivables (all monies due beyond 30 days) permits the agency owner to recognize the source of the agency's collection problems and take immediate actions to solve them.

CASH PROJECTIONS

What is a worse surprise than to be asked to infuse the agency with additional funds because of a "cash crunch"? Could some bills have been delayed or avoided if you knew that a cash crunch was developing? A monthly Cash Report will give you sufficient forewarning to take remedial action and, perhaps, avoid the crunch entirely.

A number of tools exist to provide you with information about your upcoming cash position. First, look at last year's cashflow in the same month. Identify the direct bill commission income received during the same month last year. Unless something radical has happened you will receive similar revenue from that source this year. Your agency management system can easily tell you how much agency billings are outstanding and your Aged Accounts Receivable Report tells you how much is Current (owed within 30 days). You should be able to gauge the amount to be received in each Receivable category based on your historical receipts from each category, Simply take the amount owed in the Current category in one month and compare it to the 30-60 day category in the next month. You should be able to identify the percentage of the current category paid within that 30 day period. If you do this over a prolonged period, you will have your average receipts from that category in 30 days. Perform similar ratios on the other receivable categories. Use those percentages to identify how much is expected to be collected in the next four weeks based on current billings. Rely on your expiration lists for items that will be freshly billed during the period in question.

Use last year history for the month (and this year's projection) to identify cash needs during the four week period to determine how your cash position will change and if funding or changes is expensing is needed in the short term.

PRODUCTION REPORTS

Each operating department (i.e. Personal Lines, Commercial Lines) should compare its monthly and year-to-date results with prior year and against Plan budgets. Use your agency management system's Sales Analysis Report by Transaction Type for the department in question. You will see Average Commission Rates and Total Commission Growth (premiums are also reported but are of little importance to an agency). The most important calculation is the department's NET POSITION (New Business less Cancellations). This measures whether the department has gained or lost market position during the month and year-to-date. It also gauges the success or failure of marketing and retention programs and permits you to quickly take remedial action if the Plan Objectives are not succeeding.

Every agency will also have other items that, if measured, will aid the owners and managers in their efforts to manage growth and success. However, these items are fairly standard requests from most of the agencies asking Agency Consulting Group, Inc. for help in designing and implementing Management Information Systems.