When calculating the insurable gross profit for a business, it is important that you first start with the policy definition of Gross Profit. While this definition varies depending upon the policy you have selected, we will base this exercise on the assumption we are using the ISR Mark IV, as the definition used in this typical Australian wording is reflective of those used in Europe, South Africa, and much of the Asia Pacific.
The definition of Gross profit reads:
From this definition, you can see that stock movements are accounted for. The cost to produce (or purchase) all goods (not just those sold) during the period are all considered. Failing to do so could result in a business being over insured or, concerningly, underinsured. From the example provided below, you will soon understand why it is our recommendation that you always make the necessary adjustment, even though some business package policies do not require stock movements be accounted for. This goes back to one of the fundamental principles of accounting: “matching expenses with revenue“.
Using some fictional figures, we will run two calculations of Insurable gross profit. In the first, we will consider movements in stock levels, and in the second we will not.
The difference in gross profit in this case comes back to the business investing in building their stock reserves. This may occur for any number of reasons, including: taking advantage of a special offer, reducing their taxable income for the year, reinvesting into the future or one obvious reason, being a start-up. Failure to account for stock movements can lead to an incorrect insurable gross profit being reached. The above example clearly demonstrates this, with the client being under insured by $50,000.
“Failure to account for stock movements can lead to an incorrect insurable gross profit being reached. The above example clearly demonstrates this, with the client being under insured by $50,000.“
Steve Manning, CEO of LMI Group
Conversely, as outlined below, neglecting to account for stock movement can result in the client being left over insured. This occurs when the insured is selling down its stock reserves. This could again happen for several reasons, perhaps making room for a new model or waiting for a favourable exchange rate before replenishing stocks.
Where can I find the stock figures?
You will find the Opening and Closing Stock figures in one of two locations. In some instances, you will find them within the Profit and Loss (P&L) Statement, however, they are more commonly found within the client’s Balance Sheet. Don’t forget to request this along with the P&L Statement when gathering your information.
Once you have the two documents, login to LMI BICalculator.com and follow the simple step by step process to calculate the correct sum insured. Using unique combinations of training and a simple information gathering process, LMI BICalculator helps guide you to the correct sum insured. Most importantly, BICalculator prompts you at the correct time to enter the stock figures explaining each question in detail as it goes.
Unsure where to get started? Does your client have a complex set of accounts? We can help! The team at LMI Forensics are there to help. With years of experience they will work with you to get behind the numbers, ensuring your client is correctly insured.
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