Formulas For Success? - Or Failure?
Our personal lives are generally more complicated and less predictable than this simple example. A business’ cash flow is exceedingly more complicated than an individual’s cash flow. However, big businesses have created models that permit them to project cash flow under certain conditions and subject those cash flow models to changes based on changing conditions.
As a result, these corporations can determine how much cash they have to float and whether they will have to utilize loans or lines of credit to overcome expected cash flow shortages.
If big corporations can project their cash flow with relative accuracy, why can’t insurance agencies? If cash flow is important to big business, shouldn’t it be equally important to small businesses?
How would you like to accurately project your cash flow for next month? How would you like to accurately project your cash flow for the entire next year?
If, as an agency owner, you have experienced cash shortages that required you to “go to the bank” to make payroll or pay your trust account, you understand the BOGEYMAN status that cash flow has become for many small business owners.
Agency Consulting Group, Inc. has evolved the methodology, worksheets and programs to identify an agency’s cash flow projections for the entire year and for each month. Once created, changing the projections to actual results each month will correct any assumptions that are changed as the year proceeds. Each agency’s situation is different, so the program is tailored to the specific agency, but many of the components of Cash Flow Projections are similar and can be defined for use generically by agents everywhere. If you would like Agency Consulting Group, Inc. to create your own Cash Flow Analysis and Projections, please call us (800-779-2430).
Within this article, I will show you how to determine your annual and monthly cash flow and permit you to kill the BOGEYMAN once and for all. If you model your cash flow report as we recommend, you will be able to alter your assumptions and determine how those changes will react on your income and expenses in the short term and the long term.
AGENCY CASH FLOW COMPONENTS
Agency cash in-flow is not equivalent to commissions, nor is cash out-flow necessarily equivalent to operating expenses. Most agencies generate expend cash in a variety of ways. All are important when modeling your cash flow analysis.
The primary components of cash in-flow are as follows:
1. Direct Bill – Commission Statements with checks and EFT (or Wire Transfers) from the carriers. Both personal lines and commercial lines direct billed policies either begin with deposits or renew without deposits. Most deposits are paid to the companies directly with agency income being generated on commission statements that come to the agency one to two months after the payments are made to the carrier. Those direct bill statements either come to the agency with checks or they are come to the agency with funds wire transferred into your operating account. If you generate a listing of direct-billed policies in Personal Lines and in Commercial Lines for each month, you know that you will receive the cash for those policies during the next year approximately on the second month after that renewal date.
2. Agency Bill Renewals
a. Apply two factors to your monthly renewals for the year:
i. Retention Expectation – Retention is defined as Total Annual Premiums – New Business/Prior Year Total Premiums. That percentage defines how much your agency historically renews of its annual premiums.
ii. Additional Hard/Soft Market Effect – Most parts of the country are finding the market hardening. If you feel your renewals will generate more premium this year than last, estimate the percentage increase and apply it to the retained premiums you estimated.
b. Prepaid Premiums – Agency billed items require billing and collections of gross premiums by the agency. Run a renewal report for full term billed policies each month in the year to project gross full term billed billings each month. If you are modeling a calendar year, also project (or use actual billings) for the last three months of the prior year since most agencies collect a percentage of billings each month for three to four months.
c. Installment Premiums – Many agencies use several installment plans for their clients. A grid should be created identifying every policy on installments, including number and schedule of installments for each client by each month of the year. The total of all installments scheduled for each month for all clients becomes the source of projected installment billings for the year (by month). Remember to project the renewal of existing policies using the same premium (unless otherwise known) and the same installment schedule for future installments on policies not yet renewed that will renew and be billed during the months of the year being analyzed.
d. Each agency has unique histories of collection of premiums. This history can be defined through an analysis of the Aged Accounts Receivable Report generated by your agency management system (See our Article, “Formulas For Success – Or Failure” elsewhere in this issue). Schedule the collections of each months Agency Billed Renewals according to the schedule of collection percentage each month defined by the Aged Receivables Analysis. These premiums will become your cash receipts into your Trust Account with commissions derived as cash receipts into your Operating Account each month.
3. Agency Billed New Business
Project your new business writing for the year. Identify the percentage of total business attributed to agency billed transactions last year and assume that the same percentage of new business will be allocated to agency billing in the next year. Identify the percentage of agency-billed renewals last year prepaid vs. on installments and attribute the same percentage of new business to prepaid and to installments this year. Assume the longest-term installments (a conservative estimate) for new business expected to be written on installments. Total the expected billings each month combining the projected annual billed new business and the new business installments expected for each month to identify the total projected billings each month for new business. Apply the same percentage of collections for the current month and for each category of subsequent months against the amount billed for new business each month. That will be the projections for collected premiums that will be the cash receipts for new business each month. This amount will be deposited to your Trust Account with the retained commissions acting as cash receipts to your Operating Account.
4. Direct Billed Cash Receipts –
a. First, create a schedule of Cash Receipts for each month of the prior year. Those cash receipts are comprised of Commission Statement check deposits, EFT (Electronic Funds Transfer or Wire Transfer), and Non-Operating Cash Receipts (i.e. contingency income, interest income, et al.).
b. Second, determine what percentage of the Operating Income (Commission Statement Checks plus EFT deposits) can be applied to PL and to CL. This can be done by identifying the percentage of Direct Billed revenues attributed to PL and CL on the P&L each month. Apply the same percentage to the corresponding month’s Operating Cash Receipts to project the cash effects on PL and CL.
c. Create your monthly projections for PL DB Cash Receipts by taking last year’s PL Cash Receipts for the month, applying a retention percentage to them (see 2 a.i., above) and adding 1/12 of your new business expectation to it.
d. CL DB Renewal Cash Receipts are generated by taking last year’s CL Cash Receipts for each month and applying the same retention and hard market factors to them as you did for Agency Billed items in 2 a, above.
e. In 3, above, we determined what percentage of CL new business was agency billed. Identify the remainder of the projected monthly new business as direct billed and collectable within the agency’s Cash Receipts.
5. Non-Operating Cash Income
a. Contingencies can be estimated near the end of the year based on growth, volume and loss ratio with each carrier. Review the last few years to determine when these funds arrive at the agency. The norm is February, March and April. Apply your projected contingency to the months that your agency normally received them.
b. Interest Income – project interest income by using the estimated interest rate that you are getting and the Agency Billed premium flow (identified above) for which you normally have 30 – 45 days float. Apply the interest rate factor to the average monthly float to calculate interest income potential.
c. Other income – Identify other income categories for the last few years from your Cash Receipts Report and project any trend, continuance or known “other” income for the next year (by month).
The primary components of cash out-flow are:
6. Premium Payables – In the cash-in flow calculation, you determined how much money flows into the agency for agency-billed items each month. Since most agencies do not pay the carriers until the agency has been paid, and since most companies have 30 – 45 day billing periods, you can estimate that monies collected this month will be payable to the companies two months from now. Post these amounts as cash out-flow, usually mid-month, for these companies each month.
7. Operating Expenses – These are the normal expenses of the agency. The primary and predictable expense is compensation. However, the agencies that budget are far advanced in the accurate calculations of out-going operating expenses.
8. Balance Sheet cash expenditures – The primary balance sheet entries that still cause cash expenditures are loans and lines of credit. Other expenditures must be analyzed for the previous year and projected for the cash flow year based on the agency’s current status and expected changes.
The sum of the monthly cash in-flow less the projected monthly total expenditures determines the cash position of the agency at the end of each month. This is used to determine if the agency will have excess monies to invest for either short or long-term interest or if monies will have to be borrowed to keep the agency afloat. Projecting cash flow is an advanced management effort that permits agents to predict and plan their spending based on the knowledge of when (and if) the agency’s cash flow will permit the spending. These components represent the most common ingredients of cash flow, but others exist, depending on the agency’s situation. Alter these components based on your needs and, if you need help constructing your cash flows, feel free to call me (Al Diamond) at 800-779-2430. Our cash flow analysis results in all of the forms and a programmed system to accurately predict cash flow (including changes made during the year if projections are not accurate).