In our first segment, we explained why the Balance Sheet and liquidity ratios are important to a business owner and we explained the Acid Test and Working Capital liquidity ratios. In the second segment, we discussed the Current Ratio, the Receivables to Payables Ratio and Trust Accounts. This month, in our final section, we will wrap up our analysis of Liquidity Ratios by analyzing the agency’s Tangible Net Worth (TNW), its TNW: Revenue Ratio, its Profits: TNW Ratio, the Debt:Equity Ratio and its Debts: Assets Ratio. While the liquidity ratios discussed in the last two sections are urgent indicators of today’s and this year’s liquidity, the measures below are critical to the continued operation and long term health of the agency.

TANGIBLE NET WORTH (or Hard Net Worth, commonly referred to by the acronym TNW) represents the worth of the agency excluding its intangible assets like goodwill, covenants not to compete, Treasury Stock and the value of acquired client bases (often titled Renewals/Expirations). TNW is an important part of a business’ value in that it defines the liquidation value of the business. In insurance agencies the TNW is added to the value of the agency’s book of business to derive a Fair Market Value for the agency. The insurance agencies who operate professionally and fiscally conservative build a TNW of cash and other liquid assets. As opposed to most other businesses that have stock-in-trade that comprises large amounts of value, we are a service company with little hard assets at our disposal except for hard cash. So, not surprisingly, most insurance agencies who do not stockpile cash have little TNW.

Unfortunately, our “dirty little secret” is that more than 50% of the agencies in the United States have a NEGATIVE TNW!! In real terms this means that if the agency were to be sold as a corporation (its stock including TNW) or liquidated (i.e. upon the death of the owner), the corporate entity would be short assets to pay its total liabilities and would have to find money somewhere to satisfy its creditors. Having a negative TNW is very bad unless you expect to die with your corporation or business entity still in place. That certainly is possible and we have seen many agencies change hands as asset purchases, in part because of the poor fiscal habits of the selling agency and a negative TNW that would reduce value if sold along with the agency book of business.

Tangible Net Worth should be positive and growing. This is especially true if the agency expects to grow by the addition of producers, acquisitions, and adding locations. Each of these is capital intensive and would otherwise require borrowing money from either the owner or from a financial institution.

Tangible Net Worth : Revenue Ratio defines TNW as a percentage of agency total income. This generally defines a profitable agency that is saving, either in cash or equity, in a ratio that would be attractive to an investor as a place to invest his money, even in a closely held business like an insurance agency. That marker has been 15% ROI sought by investors for riskier ventures like small, privately held service businesses. So if you are ever to wish to attract investors or outside perpetuators, this marker of liquidity, TNW: Revenue should be 15% or better.

Profits: TNW Ratio measures the rate of return of an agency to its owners. It is another indicator of an agency’s attractiveness to investors or banks in the event it ever needs money, but it can also define the very conservative agency that builds up a strong TNW, but no longer makes a profit and might be using down its equity in a long-term decline. We have seen agencies who have built TNW of $500,000 or more from historically profitable times but whose profits do not meet the 16% minimum Profits: TNW Ratio defining a healthy, growing and profitable business. If an agency has built $100,000 of TNW, it operations should be generating at least $16,000 of profits to reflect a business still growing its TNW and equity. Profits, for this measure, are profits before taxes.

Debt: Equity Ratio defines how “leveraged” a business is compared to its equity. Owners Equity is defined as Capital Stock value, retained earnings, and annual profit reduced by any Treasury Stock. Treasury stock is the buy-back of stock from departed owners. Debt : Equity Ratio is Total Liabilities divided by Shareholders Equity. It is expected that aggressively growing agencies will create debt to sponsor growth – acquisition of agencies is a prime example. But if Debt to Equity reaches more than 150% (the agency’s debt is more than 150% of its entire equity position) it is defined as too thin to withstand any downturn and could face financial hardship or ruin in a bad market. It would have no further borrowing power.

Debt is not a bad thing as long as the cost of the debt is offset by additional earnings from the assets acquired by the debt. But if the debt is used for less or non-revenue generating purposes, the cost of the debt reduces agency profits and could lead to long term financial ruin.

Debt: Asset Ratio reflects the agency’s total liabilities (to all sources) against its total assets. This is not the same as the Current Ratio that define only the Current portion of Assets vs. the Current portion of liabilities. If an agency has a Debt: Asset Ratio less than 100%, it means that most of the agency’s assets are financed through its equity. If the ratio is more than 100% it is “leveraged” – some of its assets are financed through debt. While leveraging is not bad, it is dangerous to be too leveraged (Debt: Asset Ratios far in excess of 100%). Fiscally conservative agencies have well controlled Debt: Asset Ratios. The lower the ratio, the better valued the agency. But agencies that wish to grow and remain a Going Concern should not be afraid of leveraging their businesses in support of the growth plans.

Some Liquidity Ratios are very simple and straightforward and easy to explain to any business owner. Others are more esoteric, but just as important markers of the health of your business. I hope we have explained them in simple enough terms that salespeople turned business owners, as most of us describe ourselves, can still understand and measure the success and health of our own agencies through the use of these Liquidity Ratios as found in our balance sheets.

We have created our own Balance Sheet program (written in Excel) that easily converts your balance sheet to liquidity ratios. The Balance Sheet Program can be purchased on line at or you can get a one month trial version for free by calling 800-779-2430. The cost of the program is $150 and comes with lifetime updates as we encounter or update the liquidity ratios in the future.

As always, we are available to analyze, discuss and solve any liquidity problems for any independent agencies noting something amiss in these critical areas. Simply call us 800-779-2430 or e-mail info to speak to a specialist who can help.