Chapter 6 - Financial Management Flashcards
The Financial Management Cycle
Know the financial situation Analyze income and expenses Classify financial data Adopt financial standards Make comparisons Take corrective action
Know the Financial Situation
Balance Sheet - Details the financial health of the brokerage at a point in time.
LEFT - Assets/Resources
RIGHT - Liabilities and Owner’s Equity
Total Assets = Liabilities + Equity
Analyze Income and Expenses
An analysis of the flow of transactions into and out of the business during the year is recorded on the Income Statement and on the Statement of Changes in financial position.
Classify Financial Data
Involves dividing income and expenses by type to enable brokerage management to visualize patterns in the flow of resources through the firm.
Categories will vary depending on the degree of detail required by the individual brokerage.
Income - Commissions, Fees, Interest
Expense - Dues and subscriptions, employment expenses, equipment leases, insurance, licensing, office expenses, utilities
Adopt Financial Standards
The Past Performance Standard - compares results during the current period with the same period last year or in a number of previous years. Inflation and market conditions must be taken into account.
Budget Standard - Best internal standard is a well-designed budget that includes guidance on meeting the goals it sets out. Most difficult standard to set.
External - Compare results with peers/competitors, available through published statistics. Best Practices.
Make Comparisons
Comparing actual results with internal and external standards reveals income and expense trends and variances from the standards.
All variances, whether positive or negative, require investigation to find out their cause and if it is something the brokerage can control.
Based on this analysis, management can decide what action, if any, is required.
Take Corrective Action
First, consider if the variance is an anomaly and will only happen during this period; or if the problem has been intensified during this reporting period.
Next, consider if the standard needs to be amended due to a change in the environment or conditions.
Then, consider alternative corrective actions and their potential outcomes.
Once all factors have been weighed, proceed with the appropriate correction.
Monitor the effects and modify if required.
Budgeting
The budget is used to coordinate the activities in the brokerage, encourages planning, is the basis for motivation and reward, and provides a control benchmark against which to measure actual performance over a period of time, usually a year.
Best Practices
Published by Independent Insurance Agents and Brokers Association of America, is obtainable from provincial member associations of the Insurance Brokers Association of Canada (IBAC), gives financial information divided by size of brokerage and establishes a number of standards with which the results from an individual brokerage can be compared.
Income Statement
Shows funds flowing into the firm - income
Shows the firm’s expenses, and the difference between the two - Profit.
Reflects the fact that profit is affected by the timing of receipts and expenditures as well as by their magnitude.
Statement of Changes in Financial Position
Completes the financial picture. It explains how and why the company’s cash position has changed during the year by showing where financial resources have come from and how they have been used.
Can be a starting point for determining whether the brokerage has sufficient cash flow to finance future operations and for forecasting future financing requirements.
Budgeting - Traditional Method
Takes last year’s spending and income as the base and increases or decreases the numbers by percentages or estimated amounts based on brokerage goals and forecasting.
Budgeting - Zero Based Accounting Method
A type of discretionary budgeting where the brokerage starts with a zero and develops its income and expenses from scratch without any preconceived numbers.
Financial Ratios
Simplify the data in financial reports.
Ratio analysis does not provide conclusive answers to business problems, but it does indicate to management and outside analysts where problems might exist and, therefore, where to investigate further.
One ratio used in isolation is not very informative - Compare a series of ratios over an extended time period.
Profitability Ratios
Profit Margin = Net Income/Sales
Return on Total Assets = Net Income/Total Assets
Return on Specific Assets = Net Income/Specific Assets
Return on Owner’s Equity = Net Income/Owner’s Equity
