Understanding financial statements of an insurance company

Financial Times
This article aims to help investors to understand insurance companies better and thus make the right investment decisions. Business Model An insurance company basically agrees to take the risk of an individual in exchange for a price.  Insurance companies make profits  by charging the right price for the risk they undertake (Underwriting) and  also by investing the large pool of funds they collect in terms of premiums. Income Statement The key metrics in the income statement of an insurance company are: * Gross Written Premium or Sales (GWP) –  The amount of risk premiums an insurance company has underwritten in the period of the financial statement.  *Reinsurance and Net written Premium -  Insurance companies will pass some of their premiums to other insurance companies to reduce risks.  This outflow of premiums is known as ceding reinsurance.  Net Written premium = GWP –Reinsurance Ceded.  * Net Earned premium-  All written premiums may not be earned over the period of the financial statement.  This is because customers would pay premiums in advance.  The part of the premiums which are earned over the financial statements duration are known as net earned premiums. * Investment Income and Other income –  An insurance company will receive significant amounts of cash from policy holders.  It will invest the cash.  Investment income therefore becomes a significant line of income for an insurance company.   Other income would be those which are earned from other insurance related activities.  Often this would comprise various fees which an insurance company may charge policy holders for services provided. *Revenue -  This would be the total income earned for a financial statement period.  It would therefore be the sum of  Earned Premiums,  Investment income and  Other income.  * Benefits –  This is the claims incurred for the period.  Incurred includes both paid claims and reserve movements to Balance Sheet.  In line with accounting prudence an insurance company will have to hold more or less reserves in line with changes in claims patterns and economic conditions. * Underwriting and Acquisition costs -  This would be Commissions paid in relation to insurance sales. * Operating and Administrative expenses -  These would be costs of operations of the insurance company.  Key Income Statement Metrics The following metrics can be used when comparing between insurance companies: Claims ratio –  Claims (Benefits)/Net Earned Premiums.   Other things being equal; lower the ratio better the performance. Expense ratio –  Total Underwriting and Operating Expenses/ Revenue.  Combined Ratio -  Measurement of how an insurance company’s revenue when excluding investment income covers its expenses.   Total expenses/( Revenue – Investment Income).   Ideally the ratio should be less than 100% and this indicates that both are making profits because of investment income and not from insurance business. Message to the Investor The insurance business is technical and complex when compared to other industries.  By understanding the business model and the method of accounting investors can make better decisions towards shareholder value. (By Ravi Mahendra.  The writer is an accountant working in the UK). http://www.sundaytimes.lk/071028/FinancialTimes/ft3025.html

https://www.lonpac.com/web/my/quarterly-financial-statements
https://www.group.qbe.com/investor-centre/reports-presentations

How do you identify an exceptional company with a durable competitive advantage from the LIABILITIES IN THE BALANCE SHEET?

How do you identify an exceptional company with a durable competitive advantage?

Financial statements are where you can search for companies with a durable competitive advantage that is going to make one super rich.

BALANCE SHEET

The balance sheet is a snapshot of the company's financial condition on the particular date that the balance sheet is generated.

Assets minus Liabilities = Net worth or Shareholders' Equity

Current Liabilities

Account Payable, Accrued Expenses and Other Current Liabilities

Accounts payable is money owed to suppliers that have provided goods and services to the company on credit.

Accrued expenses are liabilities that the company has incurred but has yet to be invoiced for.  

These expenses include sales tax payable, wages payable and accrued rent payable.

Other Liabilities is a slush fund for all short term debts that didn’t qualify to be included in the above categories.

Account payable, accrued expenses and other debts can tell us a lot about the current situation of a business but as stand alone entries they tell us little about the long term economic nature of the business and whether or not it has a durable competitive advantage.

However, the amount of short and long term debt that a company carries can tell a great deal about the long term economics of a business and whether or not it has a durable competitive advantage.

Short Term Debt

This includes commercial paper and short term bank loans.

Short term money is cheaper than long term money.

It is possible to make money borrowing short term and lending it long term. 

We just borrow more money short-term to pay back the short term debt that is coming due (rolling over the debt). 

The problem works well until the short term rates jump above what you lent the money long at. 

You have to refinance your short term debt at a rate in excess of what you loaned it out at.

Another problem of borrowing short term to lend this money long term is when your creditors decide not to loan you any more money short term. 

Suddenly you have to pay back all that money you borrowed short term and lent long term (e.g. Bear Stearns). 

The smartest and safest way to make money in banking is to borrow it long term and lend it long term.

When it comes to investing in financial institutions, you should shy away from companies that are bigger borrowers of short-term money than of long-term money. 

While being aggressive can mean making lots of money over the short term, it has often led to financial disasters over the long term. 

In troubled financial times, it is the stable conservative banks that have the competitive advantage over the aggressive banks that have gotten themselves into trouble.

The durability equates with the stability that comes with being conservative. 

It has money when the others have losses, which creates opportunity.

Aggressive borrowers of short term money are often at the mercy of sudden shifts in the credit markets, which puts their entire operation at risk and equates with a loss of any kind of durability in their business model.

Long Term Debt Coming Due in current year

As a rule, companies with a durable competitive advantage require little or no long-term debt to maintain their business operations and therefore have little or no long term debt ever coming due.

A company that has a lot of long term debt coming due, we probably are not dealing with a company that has a long term competitive advantage.

Buying a company that has a durable competitive advantage going through troubled times due to a one time solvable event, it is best to check how much of the company’s long term debt is due in the years ahead. 

Too much debt coming due in a single year can spook investors, which will give us a lower price to buy in at.

With mediocre company that is experiencing serious problems, too much debt coming due in a current year can lead to cash flow problems and certain bankruptcy.

Total Current Liabilities and the Current Ratio

A current ratio of over one is considered good and anything below one, bad. 

But, as previously discussed, companies with a durable competitive advantage often have current ratios under one.

Current ratio is of great importance in determining the liquidity of a marginal to average business, it is of little use in telling us whether or not a company has a durable competitive advantage.

Long Term Debt

Long term debts are debts that mature anytime out past a year.

The amount of long term debt a company carries on its books tells a lot about the economic nature of the business.

Companies that have a durable competitive advantage often carry little or no long term debt on their balance sheets.

This is because these companies are so profitable that they are self financing when they need to expand the business or make acquisitions, so there is never a need to borrow large sums of money.

Take a look at the long term debt load that the company has been carrying for the last ten years and not just in the current year.

If there have been ten years of operations with little or no long term debt on the company’s balance sheet it is a good bet that the company has some kind of strong competitive advantage working in its favour.

The company should have sufficient yearly net earnings to pay off all of its long term debt within a three or four year earnings period.

Companies that have enough earning power to pay off their long term debt in under three or four years are good candidates in the search for the excellent business with a long term competitive advantage.

These companies are so profitable and carrying little or no debt, they are often the targets of leveraged buyouts. 

This is where the buyer borrows huge amounts of money against the cash flow of the company to finance the purchase.

After the leveraged buyout, the business is then saddled with large amounts of debts.

In cases like these, the company’s bonds are often the better bet, in that the company’s earning power will be focused on paying off the debt and not growing the company.

Deferred Income Tax, Minority Interest and Other Liabilities

Deferred Income Tax is tax that is due but hasn’t been paid.

This figure tells us little about whether or not the company has a durable competitive advantage.

When a company acquires the stock of another, it books the price it paid for the stock as an asset under long term investments.

When it acquires more than 80% of the stock of a company, it can shift the acquired company’s entire balance sheet onto its balance sheet. 

The same applies to the income statement.

The Minority Interest entry represents the value of the acquired company that the acquirer does not own.

This shows up as a liability to balance the equation, since the acquirer booked 100% of the acquired company’s assets and liabilities, even though it owns from 80% to less than 100%.

What does Minority Interests have to do with identifying a company with a durable competitive advantage? 

Not much.

Other Liabilities:  This is a catchall category  that includes such liabilities as judgments against the company, non-current benefits, interest on tax liabilities, unpaid fines and derivative instruments. 

None of these helps us in our search for the durable competitive advantage.

Total Liabilities and the Debt to Shareholders’ Equity Ratio

The debt to shareholders’ equity ratio can be used to help us identify whether or not a business has a durable competitive advantage.

The debt to shareholder’s equity ratio helps us identify whether or not a company is using debt to finance its operations or equity (which includes retained earnings).

The company with a durable competitive advantage will be using its earning power to finance its operations and therefore, in theory, should show a higher level of shareholders’ equity and a lower level of total liabilities.

The company without a competitive advantage will be using debt to finance its operations and therefore should show just the opposite, a lower level of shareholders’ equity and a higher level of total liabilities.

Debt to Shareholders’ Equity Ratio = Total Liabilities / Shareholders’ Equity

The problem with using the debt to equity ratio as an identifier is that the economics of companies with a durable competitive advantage are so great that they don’t need to maintain any shareholders’ equity. 

Because of their great earning power, they will often spend their built-up equity/retained earnings on buying back their stock, which decreases their equity/retained earnings base. 

That in turn, increases their debt to equity ratio, often to the point that their debt to equity ratio looks like that of a mediocre business – one without a durable competitive advantage. 

It is easy to see the contrast between companies with a durable competitive advantage and those without it when we look at the treasury share-adjusted debt to shareholders’ equity ratio. 

If we add back into the equity the value of all the treasury stock acquired through stock buybacks, then the debt to equity ratio of these companies with durable competitive advantage can be clearly noticed.

With financial institutions like banks, the ratios, on average tend to be much higher than those of their manufacturing cousins.

Banks borrow tremendous amounts of money and then loan it all back out, making money on the spread between what they paid for the money and what they can loan it out for.

This leads to an enormous amount of liabilities which are offset by a tremendous amount of assets.

On average, the big banks have $10 in liabilities for every dollar of shareholders’ equity they keep on their book.  

That is, banks are highly leveraged operations.

The simple rule:  unless we are looking at a financial institution, any time we see an adjusted debt to shareholders’ equity ratio below 0.8 (the lower the better), there is a good chance that the company in question has the coveted durable competitive advantage we are looking for. 

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#Treasury share adjusted

Financial Statements: Introduction

Table of Contents

1. Financial Statements: Introduction
2. Financial Statements: Who's In Charge?
3. Financial Statements: The System
4. Financial Statements: Cash Flow
5. Financial Statements: Earnings
6. Financial Statements: Revenue
7. Financial Statements: Working Capital
8. Financial Statements: Long-Lived Assets
9. Financial Statements: Long-Term Liabilities
10. Financial Statements: Pension Plans
11. Financial Statements: Conclusion

Financial Statements:

Introduction
By David Harper

Whether you watch analysts on CNBC or read articles in The Wall Street Journal, you'll hear experts insisting on the importance of "doing your homework" before investing in a company. In other words, investors should dig deep into the company's financial statements and analyze everything from the auditor's report to the footnotes. But what does this advice really mean, and how does an investor follow it?

The aim of this tutorial is to answer these questions by providing a succinct yet advanced overview of financial statements analysis. If you already have a grasp of the definition of the balance sheet and the structure of an income statement, this tutorial will give you a deeper understanding of how to analyze these reports and how to identify the "red flags" and "gold nuggets" of a company. In other words, it will teach you the important factors that make or break an investment decision.

If you are new to financial statements, don't despair - you can get the background knowledge you need in the Intro To Fundamental Analysis tutorial. Read more: http://www.investopedia.com/university/financialstatements/#ixzz279MZnu00

Understanding Bank Financial Statements

By Jerome Felix , eHow Contributor

Understanding bank financial statements is easy when you go through each statement slowly. The three main financial statements are the income statement, balance sheet and cash flow. A bank’s financial statement is similar to any other financial statement. These statements give you a snapshot of how the bank is doing financially.

 

Instructions

1  Understand financial statements by reviewing terms related to these statements. There are three       main types of bank financial statements: the income statement, the balance sheet and the cash flow statement. To get a thorough understanding of financial statements, do some research online to familiarize yourself.

1. • 2
     The bank income statement shows total revenues, total expenses and total tax. Notice that this statement starts with revenues, subtracts total expenses and then subtracts taxes. Go through the revenues, expenses and tax; you’ll notice many items within those groups.
   • 3
     The balance sheet lists the bank’s total assets, total liabilities and owner’s equity. The formula for the bank’s balance sheet is “assets” minus “liabilities” is equal to “owner’s equity.” The owner’s equity means the value of the bank owner's ownership of the bank.
   • 4
     The bank’s cash flow statement is a snapshot of its cash operations. This is a summary of operation activity cash, investing activity cash, finance activity cash and net cash change. This summary traces cash in-flow and cash out-flow.
   • 5
     Review the bank’s statement of owner’s equity. This statement records the prior equity, and then adjusts it with investments, withdrawals and income to get the final equity.

Read more: Understanding Bank Financial Statements | eHow.com http://www.ehow.com/how_4557967_understanding-bank-financial-statements.html#ixzz1fY6FKAwv
http://www.ehow.com/how_4557967_understanding-bank-financial-statements.html

How to Analyze a Banks Financial Statement

By an eHow Contributor

Related Searches:A bank's financial statements are composed of three sections: the balance sheet, income statement and cash flow statement. The financial statements of a bank are complex because banks sell diverse financial products and services, and, they undertake their own financing and investment activities. However, once you learn the basics of reading financial statements---whether for a bank or another type of business---you'll understand what all the numbers mean.

Difficulty:

 

Challenging

Instructions

1. • 1
     Start with the balance sheet which shows the value of what the bank owns or money that is owed to the bank (assets), the amount of money that the bank itself owes (liabilities), and the amount of money invested by shareholders into the bank (shareholder's equity) at a specific point in time. An easy way to remember the data on the balance sheet is: assets = liabilities + shareholder's equity.

     The assets for a large commercial bank, for example, can be extensive. The biggest line item is typically its loans and leases which are made to consumers, businesses and institutions. Be sure to read the summary notes that follow the financial statements to find more details about each of the bank's assets.

     Review the liabilities section which includes the bank's deposits made by its customers as well as the bank's short- and long-term debt which are loans, lines of credits and notes that the bank has less than one year (short-term) or more than one year (long-term) to pay back.

     The final section of the balance sheet to review is the shareholder's equity composed of capital stock plus retained earnings. Capital stock is the total amount of money shareholders have invested in the bank's stock. Retained earnings are the earnings that the bank has not paid out yet as dividends to its shareholders.
   • 2
     Refer to the income statement which provides information on the bank's profitability. It covers a specific period of time and details income from the bank's loans, lease financing, securities available for sale and other items. Like consumers and businesses, banks themselves borrow money to cover their own expenses and maximize profits. The last line of the income statement---the net income---shows the bank's total profits after all expenses and taxes have been paid.
   • 3
     Review the cash flows statement which tracks a bank's cash inflows and outflows over a specific period of time. Cash comes in and goes out of a bank from its operating, investing and financing activities. The cash flow statement will show the beginning cash balance and the ending cash balance after reporting all the bank's deposits (cash inflows) and payments (cash outflows).
   • 4
     Calculate key profitability, liquidity, activity and solvency ratios to assess a bank's overall performance. You can download a free template of these ratios from Microsoft Office Online (http://office.microsoft.com/en-us/templates/). Use data from the bank's current and past financial statements to calculate and compare these ratios.

     Try comparing the bank's ratios to composite ratios for other banks from Standard & Poor's Indices listings (http://www.standardandpoors.com/indices/main/en/us/). When you calculate and compare ratios, you'll get a summary of the bank's financial health and its performance relative to the competition.

Read more: How to Analyze a Banks Financial Statement | eHow.com http://www.ehow.com/how_5973660_analyze-banks-financial-statement.html#ixzz1fY7IWIBu