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A couple posts ago, we posted a little self-assessment so that people could see how well they knew workers’ compensation insurance.  We wrote a short blurb before the actual questions that joked about it being a pop quiz… just a playful little write up to make things more fun.

But it got us thinking… do you remember your last pop quiz?

Probably in high school or maybe college, you walk into your next class just minding your own business.  It’s been a good day so far, nothing too special.  Your buddy told you a pretty good joke in the passing period, and you’re just laughing at the memory when, all of a sudden, your teacher walks to the front of the class and says it: “Pop quiz.”

It’s just a bad situation.  Your about to get tested on… on… well, that’s the problem!  You know you have a test coming, but you have no idea what you’re getting tested on.  That right there is a horrible feeling.

And that’s how most business owners feel when they start getting questions from their insurance carriers.  They know it’s a test, and they know that failing this test means an increase in premiums or even losing insurance, but they don’t know what exactly their getting tested on!

We want to help with that.  At Whiteboard, we’re not able to stop the tests, but we can at least help to prepare you, so…

Let’s talk financials.

From time to time, when underwriting your insurance, a carrier may ask for your financial statements.  If this has happened to you, it was probably a bit nerve wracking, but let’s walk through what exactly your underwriters are looking for.

First, they look at something called your Current Ratio.  If you’re looking at your business’ balance sheet, this is simply your total current assets divided by your total current liabilities.  Just in case you’re not super familiar with a balance sheet, your total current assets consists of anything that can be turned into cash within 1 year (Cash, Accounts Receivable, Inventory).  Likewise, your total current liabilities consist of any debt that you must pay within a year (Accounts Payable, Accrued Taxes, Current Portion of Long Term Debt, Note Payable).  Your insurance carrier wants this ratio to come out above a 1.5 as it is a measure of your short term debt paying ability.

Sometimes, however, the carrier is unsure of the quality of inventory and will instead look at the Quick Ratio.  This is simply the total current assets minus the inventory divided by the total current liabilities.  Essentially, it’s the first equation without inventory.  This is another measure for debt paying ability, but this time they are looking for a 1.0 or better.

Next, carriers will look at Sales Change Percentage.  This is the difference between this year’s net sales and last year’s net sales divided by last year’s net sales.  This one is a bit easier to interpret: you want a positive number and the bigger, the better.  For obvious reasons, an upward trend in sales makes your business look good.

Fourth, they’ll check your Debt Ratio.  This is your total liabilities divided by your total assets.  Simply put:  This is the total cash value of what you owe divided by what you own.  This is essentially a test of whether all debt can be managed with the assets on hand, and the magic number here is 0.5 or less.  Anything higher is considered too much debt.

The last ratio that underwriters will check is the Debt to Worth Ratio.  This is a debt ratio used to measure a company’s financial leverage, calculated by dividing a company’s total liabilities by its total capital. This ratio indicates how much debt a company is using to finance its assets relative to the amount of value represented in shareholders’ equity.  The goal for this ratio is any number less than 3, but the lower the better.  It looks better when a business’ owners are more invested.

Those are the 5 major points of concern for the insurance carriers when it comes to your financial statements, and they will test your business in each area.  The bright side is that with this knowledge, you now know what you’re being tested on.  Your business doesn’t have to ace the test, but better answers will yield more attention from carriers and more favorable premiums.