For some strange reason few agents want to approach or discuss the business income worksheet. The prospect of handing the client a five-page document with dozens of blank lines and asking them to provide seemingly private and confidential financial information discourages many agents from attempting to recommend or sell this most important coverage. The fear of having to actually explain the business income report/worksheet (CP 15 15) leaves all but the most hard-core agents cowering in the corner.

Granted, the above paragraph may be partially hyperbolic, but not by much. CP 15 15 (the Business Income Report/Worksheet) can be a scary document, especially if what it does and how it actually works is not fully understood.

The Reason for the Business Income Worksheet

Commercial property underwriters generally request a current property schedule detailing the locations, square footage, construction, occupancy, building values and content values being insured (along with any other information the underwriter deems important). That's exactly what the business income worksheet is, the time element (business income) equivalent of the commercial property schedule that details for the underwriter the qualified business income the carrier is being asked to insure.

The worksheet/report is nothing more than the starting point in the business income underwriting process. It is designed to produce the estimated "business income" and clue the agent to the amount of coverage and maximum coinsurance percentage required.

Completing the Worksheet

Not every line of the business income report/work sheet must be completed. Required is completion only two columns based on the classification of the insured as either a manufacturing or non-manufacturing operation. Manufacturing operations complete the first and third columns of the CP 15 15; non-manufacturing insureds use the second and fourth (dual purpose operations complete all lines as detailed in a future post).

The first applicable column (again, based on entity type) provides details about the most recently completed 12 month financial period. The second applicable column is an estimate of the upcoming 12 month coverage period.

Of the two, the estimate for the upcoming 12 months is the more important column. Business income coverage protects the insured against income losses experienced during the current policy year not based on what was done in the prior year. Likewise, coinsurance penalties are assessed based on the actual financial data of the current policy year not on the previous 12 months; so an accurate estimation of the coming 12 months is of utmost importance. Whether the estimated figures are developed using trending, models or just "gut feeling" really doesn't matter, the only necessity is for the estimate to closely mirror reality at the time of loss.

Both manufacturing and non-manufacturing insureds can find most of the information necessary to complete the CP 15 15 on its most current fiscal year-end income statement. The form does contain a few non-GAAP calculations as detailed in upcoming paragraphs. The estimate for the upcoming 12 months is basically a combination of the budgeting process and best-guess market projections.

Important Business Income Report/Worksheet Definitions

Business income report/worksheet terms are first defined in the following paragraphs then described. Each factor is calculation is discussed to provide a better understanding of the CP 15 15's methods for developing the total insurable business income.

The insured's classification as a manufacturing or non-manufacturing entity can alter the meaning of a term (as presented in the worksheet) or require different factors be used in the calculation of that particular figure. Where the definitions or calculations diverge, the differences will be enumerated. Also, there are terms that apply strictly to one or the other operational type, these will likewise be specified. Since the CP 15 15 must be completed using the accrual basis of accounting, each definition presented meets that requirement.

Gross Sales: The first line of the worksheet (Line "A") applies to both manufacturing and non-manufacturing operations. This figure can be found on the insured's income statement. This is the value of all invoices before customer discounts, allowances or returns.

Finished Stock Inventory at the Beginning of the Year (at sales value): Line "B" applies only to manufacturing operations. The sales value of finished stock at the beginning of the year is subtracted from gross sales. GAAP-compliant income statements generally do not specify the internal (cost) value of finished stock on hand from which the sales value of finished stock can be deciphered; a Cost of Goods Sold (COGS) Statement or separate internal calculation may be required.

Developing the sales value of finished stock requires that beginning inventory be divided into its component parts: 1) the cost of raw materials; 2) stock in process; and 3) finished stock value (internal cost). This breakdown is not an additional step as these figures are required to arrive at the CP 15 15's definition of COGS (the CP 15 15's unique calculation of COGS is detailed in an upcoming post).

Once divided into its component parts, at least two possible methods can be applied to the internal value of finished stock to calculate the sales value of finished stock:
1. "Mark up" (margin) method. The cost (internal value) of finished stock on hand and the desired profit margin are the primary factors in this calculation. The insured divides the cost of finished stock on hand by one minus the desired or normal "mark-up" (desired margin) percentage. For example, if the finished stock cost is $100,000 and the desired profit margin is 33.3 percent; the "sales value" of the finished stock is $149,925 ($100,000/ (1-33.3%)).
2. A potentially easier method is the "percentage-of-net-sales" (percentage) calculation. This method may prove to be less accurate than the "mark-up" method; but the result should be fairly close as it tends to follow the same logic but from the opposite direction. The COGS is divided by the Net Sales (COGS/NS) (net sales is "gross sales" less returns and allowances); this produces the cost of goods sold ratio. The cost of the finished stock is divided by the COGS ratio yielding the estimated sales value of finished stock on hand at the beginning of the calculation period. For example, where the COGS is $1,000,000 and the Net Sales is $1,500,000; the COGS Ratio is 0.67. If the cost of finished stock on hand is $100,000; the sales value of that stock is approximately $149,925 (in round numbers).

Developing the sales value using both methods may be the most advantageous to arrive at the closest estimate of the true sales value of finished stock on hand. Since GAAP standards and the CP 15 15's calculation method do not match, a best guess estimate may be all that can be garnered.

Finished Stock Inventory at the End of the Year (at sales value): Line "C" applies only to manufacturing risks. The sales value of finished stock on hand at the end of the fiscal period is ADDED to the gross sales. Developing this value is complicated by the same problems detailed in the calculation of the sales value of finished stock at the beginning of the year detailed above. Both the "mark up" method and the "percentage-of-net-sales" method can be applied to the internal value (cost) of the finished stock on hand at the end of the fiscal period to estimate the year-end sales value of finished stock on hand.

Gross Sales Value of Production: Line "D" of the worksheet once again applies only to manufacturing risks. This is the product of Gross Sales (Line "A") minus Finished Stock Inventory at the Beginning of the Year (Line "B") plus the Finished Stock Inventory at the End of the Year (Line "C").

Following

For all the information on Business Income coverage, take a look at Insurance Journal's book, "Business Income Insurance Demystified: The Simplified Guide to Time Element Coverages."