It is almost embarrassing to say, but most insurance agents reckon their success by the balance in their checkbook. They don’t pay attention to those superb Operating Statements (Profit & Loss Statements) produced by their expensive Agency Management Systems and most don’t even print their Balance Sheets because either they don’t recognize the importance of the information contained in them – or they wish to bury their heads in the sand because they feel that what they don’t know about the health of their agency can’t hurt them.
WRONG! WRONG! WRONG!
First, your operating statement is a much better picture of your profits and losses, your cashflow potential and your potential tax liabilities than your checking account would ever be. A few minor alterations to it (elimination of non-cash items from the P&L – like bad debt and depreciation and amortization – and adding non-operating cash needs – like debt principal payments) will give you your cashflow situation at any time. And that is just a small step short of actually being able to project future cashflow at least one month in advance. Wouldn’t that be nice to know each month!
And, even more importantly, the LIQUIDITY RATIOS that can be driven from your balance sheet truly tells you the health of your business at the moment in time that the balance sheet is drawn. While the usefulness of an Operating Statement is as a budgeting and year-to-date tool for profitability and cashflow, the Balance Sheet’s purpose is the same as a full physical exam by your doctor. He runs tests to determine both your general health and specific indicators of the functions of your system. Similarly, a Balance Sheet provides the data to test the Liquidity of your business. All you need are the formulas and benchmarks to convert that data to meaningful test results.
So here are the formulas and Liquidity Ratio benchmarks that you should apply on a monthly basis to your Balance Sheet. Running a balance sheet without applying these ratios is like collecting data but never evaluating it.
CURRENT RATIO – This general liquidity ratio measures an agency’s short term health. If current assets cannot meet current liabilities (within 12 months), the agency’s liquidity must be strengthened.
Formula – Current Assets divided by Current Liabilities
Benchmark – at least 100%
ACID TEST – The acid test is a primary liquidity measure used to determine if the firm can meet its current obligations.
Formula – (Cash + Receivables)/ Payables
Benchmark – at least 90%
RECEIVABLES TO PAYABLES – A poor receivables to payables ratio is an indicator of a poor collector.
Formula – Trade (Co.) (or All) Receivables divided by Trade (premiums) (or All) Payables.
Benchmark – Less than 75%
TANGIBLE NET WORTH – The ‘book’ value of your company (not the Book of Business value and doesn’t include that value).
Formula – Total Owners Equity (Treasury Stock subtracted) less Intangible Assets (like Goodwill, Purchased Renewals or Expirations, Covenants) and any loans to officers or owners that are not 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 that operating expenses can be covered by the excess of current assets over current liabilities.
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 minimum required. 45 – 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. If you don’t know what to do call us (800-779-2430) and we’ll help you. If you would like a copy of Agency Consulting Group, Inc.’s Balance Sheet that includes the Liquidity Ratios built in, send $25 to Agency Consulting Group, Inc, 507 N. Kings Hwy, Cherry Hill, NJ 08034 and we’ll e-mail you (or ship you) an Excel file containing the Balance Sheet Template, complete with Liquidity Ratios that you can complete monthly (or as desired) to test the health of your agency (or any with whom you might contemplate an acquisition or merger).
Don’t be afraid to get a ‘Check-Up’ for your agency regularly. If bad things are happening, there are solutions. It is far worse to wait until you can’t make payroll or can’t pay the carriers to find out about your liquidity problems.