Financial check

How well a broker knows its clients' business is likely to determine how well it will be able to anticipate and respond to client needs. This can be at several different levels.

Learning about a company's business is vital in order to understand the conditions in which the company is working.

However, understanding a company's financial performance is also vital for a broker yet, for many brokers, a company's annual report and accounts is nothing more than meaningless sets of figures.

While no one should expect a broker to become an accountant overnight, being able to understand the basics of annual report and accounts and what they tell you about a customer's business can provide a powerful insight for the future development of your relationship with that company.

For example, is a company cash rich and therefore likely to benefit from up-front payment discounts, that could be negotiated on its behalf? Or is a company cash-poor, so that instalment payments would be a welcome solution to spread the load of insurance premiums?

As a start, there are a number of pieces of information in the report and accounts that can provide useful clues to the financial stability of a company - even before you get into understanding the figures.

For example, how long has the company been in business; how many directors does it have; how many employees does it have?

By comparing this information with information on other companies in the same industry sector, you will immediately get a general picture of the company's standing.

Probably the most important figures in the accounts are in the profit and loss account and balance sheet, see boxes below.

Both of these sets of figures will show the trends in a company's financial performance over the past two or three years.

Several financial results of a business can usefully be measured using comparisons and there are some common comparisons that are regularly used. These are referred to as ratios as they attempt to calculate the relationship between one figure and another.

Here are some useful ratios from the profit and loss account:

Gross profit margin = Gross profit x 100 / Turnover (sales)

The gross profit margin can be used to check how the business controls costs and profitability.

Net profit margin = Net profit before tax x 100 / Turnover (sales)

This ratio expresses the net profit as a percentage of sales. It can also be compared to the gross profit margin percentage to establish the proportion of gross profit that has been consumed by general running costs.

Interest cover = Profit before interest & tax / Annual interest payable

This ratio shows whether the company is generating sufficient cash flow to cover the interest due on its loans.

Some useful ratios from the balance sheet:

The current ratio = Current assets / Current liabilities

This ratio shows what current assets are available to pay immediate debts, e.g. if the current ratio was 1.5 then for every £1 owed to creditors there is £1.50 in current assets which could be made available.

Debt to = Total debt (outside borrowings) x 100 equity ratio / Equity (shareholders funds)

A highly indebted company might find it difficult to raise additional capital.

Debtors' collection period = Trade debtors x 365 / Turnover (sales)

This shows how long it is taking to collect debts from customers.

Creditors' payment period = Trade creditors x 365 / Cost of sales

This shows how quickly the business pays its creditors. It is important to compare the creditors' payment period and the debtors' payment period - it should take longer to pay creditors than to collect money from debtors.

In considering the credit position of a business, the financial analysis is only one part of the overall picture. It is important to consider other factors such as industry type, repayment history and pro rata return of premium.

But, armed with this additional knowledge, a broker is likely to be able to make a much more accurate judgment about the future business opportunities of a customer, as well as put together a premium proposal that is more likely to meet the customer's needs.

Questions
The ratios are as follows. However, we have left out the explanations for the final three. Your task is to decide what the ratios mean to the business.

a Gross profit margin
2002: 8.3% - 2001: 6%

Gross profit margin has improved so it is increasing profitability.

b Net profit margin
2002: 3.8% - 2001: 1.8%

This has improved significantly so the company is reducing its running costs.

c Interest cover
2002: 24 - 2001: 16

This is excellent. The company is easily able to cover the interest on current borrowings.

d The current ratio
2002: 1.2 - 2001: 1.2

No change, but it still has £1.20 of current assets available for every £1 of current liability which is good.

e Debt to equity ratio
2002: 53% - 2001: 39%

f Debtors' collection period
2002: 66.9 days - 2001: 73.0 days

g Creditor's payment period
2002: 54.1 days - 2001: 65.0 days