HOW A TRUST RATIO CAN FOOL YOU
1. Whether your agency has sufficient money to meet your obligations in the short term (30 days) and long term (one year), and
2. How your agency is trending in its liquidity – is it getting stronger, weaker or stable over a long period of time (through the course of the year or longer).
One of the key Ratios tested is your Trust Ratio. A Trust Ratio is Total Cash + Receivables divided by Payables and it should always be positive. Theoretically, the pure Trust Ratio includes ALL payables, insurance and others. However the “insurance” Trust Ratio is usually defined by Cash + Receivables divided by Insurance Payables (monies owed to insurance providers).
A better definition of Trust Ratio is the Debit Trust Ratio that separates out the credit receivable clients (monies collected in pre-bill situations that are not yet due to the carriers and credit balances on client accounts that are being held to apply to future payables). The Debit Trust Ratio excludes any credit receivables residing in your Aged Accounts Receivable accounts AND subtracts an equal amount of cash (to offset the received monies received that have no payable attached to them - yet).
Then we have one more calculation to do to achieve the Real Insurance Trust Ratio of an agency. The Ratio should take into account only “collectible” receivables. So while ALL 0 – 30 day and 30 – 60 day and 60 – 90 day receivables generally qualify, some or all of the receivables over 90 days should be eliminated as potential bad debt when calculating the agency’s Insurance Trust Ratio. The best way of deleting receivables that should be disqualified is by identifying each receivable that appears to be uncollectible (mostly in the >90 day Receivable category). However, many agents do this exercise a few times each year and use the percentage of Over 90 Day category that is defined by that analysis as a stable percentage to eliminate every month (until the analysis is done again).
Why is this important?
First, many states legally mandate that agencies be In Trust (at least in the grossest sense) because of the agent’s fiduciary responsibility to collect and remit monies to the carriers. In a few states this is a criminal, not a civil offense and avoids and identifies potential mis-use of agency funds.
The more logical reason is that if you have reasonable receivables (you generally collect your monies within 60 days) and you still have a negative Trust Ratio your agency has a cash drain that imperils your health and lowers your value. It means that any interruption of your regular billing and collection process could cause you to default to carriers (or to others to whom you regularly owe money).
Usually, the cash drain is caused by the owners taking too much out of the agency (based on the agency’s regular monthly cash obligations) although we find many reasons outside of the owner’s control as well.
It would be wise for you to calculate your Trust Ratio, Debit Trust Ratio and Insurance Trust Ratio every month and track any trends to allow you to change your spending and collection habits accordingly to keep your agency’s financials stable.
Agency Consulting Group, Inc. has a product called the Balance Sheet Liquidity Ratio that can be sent to you for only $30. It can be purchased through our website, www.agencyconsulting.com and paying for that service through PayPal. The Balance Sheet Liquidity Ratio allows you to test your own Liquidity Ratios (including the Trust Account) at will.