Spot The Difference

As a manufacturer or engineer, you will no doubt have a particular way that you calculate your gross profit figure in your monthly management or annual statutory accounts.  It’s a figure with a meaning you understand and maybe specific to your business.

It is likely to be something like this:

I often hear businesses express this as a percentage, telling me that the gross margin is n%.

Is this the figure you give to your insurance broker when they ask you for your Gross Profit figure?  I hope not, or at least if you do, I hope they ask you to explain how you reached this figure.

Definition

Insurance has its own definition of Gross Profit which makes matters really complicated and leads to misunderstanding for you, the policyholder, unless it is clearly explained.   It also causes a shortfall in coverage which can be catastrophic in the event of a claim.  I will demonstrate how this can happen.

This is the insurance definition:

The amount by which the sum of the amount of the Turnover and the amount of the closing stock and work in progress shall exceed the amount of the opening stock and work in progress and the amount of the Uninsured Working Expenses (UWE).

Not particularly helpful is it?  As we now need to work out what UWE are.  Here is another definition for you:

Uninsured Working Expenses:

Purchases (less discounts received), Carriage, packing and freight, Discounts allowed, Bad debts

Looks fairly straight forward, however, Purchases can be deceptive.  There is no clear definition here.   As a manufacturer, you incur several costs to make your products.  For example, items such as direct labour, payments to subcontractors, power and other utilities are all costs that contribute to the manufacturing process. From an insurance point of view, however, these are not purchases.  The easiest way to look at Purchases is simply as raw materials.

Make Sure You’re Correctly Covered

So if we look at the calculation again.  This is your Gross Profit figure for your insurance cover.

There is a significant difference in the 2 figures.  You can see that the direct labour and utilities have been removed from the Cost of Sales figure.  If your Gross Profit figure doesn’t include these then in the event of a claim, they are not covered within a settlement.  And you may argue that if production stops, you won’t have the expense of wages or power etc but chances are that you would want to retain your skilled staff, and as most losses are partial losses, with some form of production continuing,  you would still have to pay the electricity bill!

Getting the Gross Profit figure right is crucial to a business’s survival.

I recently read an article which said that some insurers are adopting the term ‘Insurable Profit’ in their wordings.  To me, this is a good move forward as it serves as a distinction between the 2 terms forcing there to be some thinking behind the figure you give to your insurance broker.

Whatever term is used, it should be explained to you in the process of a risk review carried out by your insurance broker.  If it isn’t, then maybe it’s time for a change.

Please contact me on 01235 868535 or jo@spencerinsurance.co.uk.