Agency Management
Using Financial Statements As A Management Tool

Like business people generally, owners and managers of insurance agencies want to know how well they are doing and how much their business is worth. If you are among the few lucky ones, you have financial statements which can help you find the answers. If you are among the very, very few you will even know how to use your financial statements to do so. If you now believe that very few agencies have financial statements useful for managing their business and even fewer use them for this purpose, we are at least starting from the same position.

Most agents with whom we work are hesitant, if not even downright intimidated, by a discussion of even their own financial statements. However, it need not; and certainly should not; be this way. With very little effort, or cost, you should be able to get financial statements which are both friendly and useful to you, the owner/manager. Frankly, we believe that a good operating statement should be structured so that it looks like, talks like and represents the components of the business as YOU see it and run it. Whether you rely on someone inside your firm or pay an outsider to generate your financials, you should not be afraid to tell him or her how you manage your business and what is important to you; GAAP accounting not withstanding.

This gives rise to the question 'what is 'GAAP' accounting?' There are a lot of good stories from within and without the profession. Suffice it to say, GAAP stands for Generally Accepted Accounting Principles. This suggests there is a body of knowledge that says how things should be done. Which leads to principle #2. Not all accountants agree as to how all things should be done all the time so we, and you, will regularly see different approaches to the same set of facts; thus leading us to the third principle. Accounting (like many professions) is as much art as science. Why is this important to you? Because, you can (and should) have a lot of input as to how you want your financials to look and they should look like something you understand and want to use.

Although all financials grow out of your agency's systems (whether manual or automated), many agents choose to have them 'formalized' by an independent accountant. In this case, you will find three levels of 'formalization': compiled statements, review basis statements and audited statements. All will be rendered following Generally Accepted Accounting Principles (GAAP, again); however, the distinction is important and results in very different levels of acceptance and in cost to you.

At the top of the heap are audited financials. If you are a public company or are thinking of going public or are thinking of borrowing money, you will almost certainly have to have audited financials. The statements will officially be certified by the accountant. Effectively, they assure the reader that the independent auditor has taken steps to confirm that all that is stated therein is correct. For example she/he will actually write to your outstanding billings to confirm that each does in fact owe you money.

Review basis statements are very similar in terms of format and in terms of the review procedures utilized in audited statements save that there is no certification from the accountant.

At the lowest level are compiled statements. These are often described as simply an independent accountant's acceptance of your numbers presented back to you in a professional format with a fancy cover and a statement for services rendered. In our experience, they have little, if any, value to third parties such as banks and carriers and are generally useless as management tools. Notwithstanding, your financial statements (compiled ones included) and your accountant can, with your input, become important resources in managing your agency.

How Your Financial Tools Should Aid You
Your financial tools are of two types; the Income Statement and the Balance Sheet. The Income Statement summarizes how well you did over a period of time (the year, a quarter or a month). A good statement should give you enough detail to let you know how and why you did well or poorly. The Balance Sheet tells you the book value of your business by summarizing what your business owns (its assets) and what it owes (its liabilities). It is very important to understand that for an insurance agency, book value is seldom anywhere near the true value of the business.

A good Income Statement presentation should allow you to easily answer those several key questions which you want answered about the operations of your business. Because these questions differ among agencies and their owners, financial statement presentations should also differ. If you have 'formally' prepared statements, take a look at them now. The first line is usually 'Commission Income.' Obviously important. Obviously a good place to start. After all, it is nice to know that your commissions are going up and important to know if they are going down. But how useful is this information when it typically combines personal and commercial lines commissions with life insurance commissions and, all too often, contingent and bonus commissions in the one entry? Is this how you manage your agency?

Surely, the summary financial statement can't help you answer all your questions, but it should be designed and presented to help you answer those questions important to you. Are you interested in property/casualty commissions separate from life? Are you interested in new business commissions separate from renewal? Does it matter how much may have been paid to outside brokers from that paid to your in-house producers? What are your critical expense areas? Are they sufficiently detailed on your financial statement to allow you to confirm quickly that you are successfully managing your operations? If you have adopted operating standards for your agency, then your financial presentation should enable you to quickly determine for that period, and even facilitate comparison to prior periods, how you have performed against your standards. Since the major expense of an agency is its personnel expense, we recommend that your financial statement consistently aggregate salaries, inside producer commissions, payroll taxes and benefits under one heading so that you can readily see how well this major item is being controlled and how well you are faring versus your standards. If it is useful, these 'personnel' expenses usually range from 50% to 60% of net revenues, with well run agencies occasionally getting below 50%. Similarly, an agency's variable business related expenses, including: advertising and public relations, communications (telephone, postage, messengers, etc.) and travel and entertainment (including all automobile expenses) are often aggregated into one category which we find typically ranges from 8% to 11% of net revenues. The key, though, is how do you run your agency? What important operating standards or 'benchmarks' do you have? The format of your financials should show you these quickly and consistently

A few words about your Balance Sheet.
It is our experience that even fewer agents refer to the Balance Sheet. Many agents appear to believe that if they have more cash in the bank than last year that things must be going well; not always so. In fact, we've been asked to work with all too many agents who had more cash in the bank this year than last yet were in dire financial condition. Here again, your financial statements should be designed to help you manage your agency and see quickly how well you are doing against your standards. A couple of suggestions which can be easily incorporated into a Balance Sheet presentation are a separation of 'Cash on Hand' into working funds and fiduciary funds and a separation of Accounts Receivable' into less than 45 (or 60, etc.) days and greater than 45 (or 60, etc.) days

Rather than simply 'eyeballing' differences from period to period, it is useful to use financial ratios to measure your operations and financial condition. These, however, should reflect how you desire to run your agency. A lot of detailed ratios are published, but caution should be exerted before you say 'this is what we are going to look like.' For what it's worth, some of the benchmarks against which we measure agencies during a valuation or acquisition process follow. The categories are probably important to you, but the specific standard should be set to reflect your goals and your operation.

• •Operating Ratios
  •New property/casualty account commissions of at least 10% of prior year commissions.
  •Property/casualty contingent commissions of at least 5% of property/casualty commissions.
  •Life insurance commissions of at least 10% of property/casualty commissions.
  •Personnel expenses less than 60% of total net revenues.
  •Variable expenses less than 10% of total net revenues.
  •All other overhead less than 20% of total net revenues, including:
  •Rent of less than 7%.
  •Bad debts of less than 2%.
  •Balance Sheet Ratios
  •Current Assets at least 110% of Current Liabilities, but
  •Fiduciary Funds plus Accounts Receivable of less than 60 days at least equal to Accounts Payable
  •Working Cash (non fiduciary funds) equal to 45 days expenses