Financial Analysis
Ag Management
Chapter 3
Financial Statements Necessary to
Determine Financial Condition
• Net worth Statement
• Income Statement
• Cash Flow
Net Worth Statement
• A “snapshot” of a financial situation that lists
assets, liabilities, and net worth
3 Parts of Net Worth Statement
• Net Worth
• Assets
• Liabilities
Assets
• Items that have a market value
• 2 Categories
▫ Current
▫ Non-Current
Current Assets
• Cash or other assets which can be converted to
cash through normal operations of business
during the year
• Examples
▫
▫
▫
▫
Checking and/or Savings Accounts
Receivables
Inventory held for sale
Other near-cash items such as securities, stocks
and bonds and the cash value of life insurance
Non Current Assets
• All assets controlled by the farm or ranch
business having a useful life greater than 1 year
• 2 categories
▫ Intermediate
▫ Fixed
Intermediate Assets (Non Current)
• Resources or production items with a useful life
of 1-10 years
• Include most assets used to support production
or in the production process
• Examples
▫ Equipment
▫ Machinery
▫ Breeding Livestock
Long Term Assets (Non Current)
• Permanent items
• Examples
▫ Land
▫ Improvements on buildings
Liabilities
• All the debt obligations of the business
• Two types
▫ Current
▫ Non Current
Current Liabilities
• Debts due within the operating year, normally a
12 month period
• Examples
▫
▫
▫
▫
Notes & accounts payable
Rents
Taxes
Interest plus principle payments due on
intermediate or long-term debt within the next 12
months
Non Current Liabilities
• Debts due past (or after) one year
• Two categories
▫ Intermediate
▫ Long Term
Intermediate Liability
• Non real estate debt that corresponds to
intermediate assets
• Loan terms are normally for a period of 12
months or more but less than 10 years
• Examples
▫ Loans for




Improvements to Real Estate
Equipment Purchases
Breeding livestock and dairy stock
Capital requirements for major adjustments in farm
operations
Long Term Liabilities
• Mortgages and land contracts on real estate
minus principle due within 12 months
Net Worth
• The amount of money you can put in your
pocket before taxes if you were to sell all your
assets and pay off all your liabilities
• Net Worth = Assets-Liabilities
• See p. 3-5
3 Kinds of Financial Analysis
• Comparative
• Projected
• Ratio
Comparative Analysis
• Measuring and analyzing the trends found in net
worth statements over a period of months &
years.
• Important to compare the same dates each year
• Looks at Assets, Liabilities & Net Worth
Projected Analysis
• Used to estimate future changes in equity
Making a Projected Analysis
• Making balance sheets for the future for
expected farm situations and analyzing them to
see problem trends
• Usually made when cash flow statements are
made
Ratio Analysis
• Used to measure the financial condition of one
farm against other farms
Ratio Analysis Maybe Difficult
Because….
• Ratio’s showing strengths and weaknesses may
not be clearly defined
• What is good for one business may not be good
for another
3 Financial Indicators that can be
Calculated from the Net Worth
Statement
• Liquidity
• Solvency
• Equity
Liquidity
• The ability of a business to generate enough cash
to pay bills without disrupting business
3 Formulas to Measure Liquidity
• Current
• Working
• Debt Structure
How Current Ratio Measure’s Liquidity
• Current Ratio=Current Assets/Current
Liabilities
How Working Capital Measures
Liquidity
• Total Current Farm Assets – Total Current Farm
Liabilities
What Debt Structure Reveals About
Farm Liabilities
• Measured by dividing current liabilities by total
liabilities
▫ Current Liabilities/ Total Liabilities
• The higher this percentage the more assets
would be needed to service debt.
Solvency
• Measures the ability of all assets if sold at
market value to cover all debts
Calculations to Measure Solvency
• Debt-to-Asset Ratio
• Debt-to-Equity Ratio
• Equity-to-Asset Ratio
Debt-to-Asset Ratio
• Measures the amount of risk in regard to debt
against the farm or ranch
• Calculated by
▫ Total Farm Liabilities/Total Farm Assets
• Lenders prefer to provide loans which are equal
to or less than 50 percent of assets.
Debt-to-Equity Ratio
• Shows the relationship between owned and
borrowed capital
• Measured by
▫ Total Liabilities/Net Worth
• Lenders prefer a debt-to-equity ratio of less than
1 because this shows that the owner’s net worth
or contribution is more than the borrowed funds
Equity-to-Asset Ratio
• Measures the relationship of the farm’s net
worth and total farm assets
• Measured by
▫ Total Farm Net Worth/Total Farm Assets
• Allows you to see if total assets exceed total
liabilities
Income Statements are Used
• Give the figure of either income or figure loss
Income
• Money received from the sale of crops, livestock,
and livestock products during the year.
• Receipts should also include government
payments and miscellaneous sources of farm
income
Expenses
• Money paid out to operate the business
Calculation for Net Cash Income
• Net Cash Income =Cash Income – Cash Expense
• Net Cash Income is what remains after
subtracting Operating and Fixed Expenses
Non Cash Adjustments Must Be Made
by Comparing and Ending Values for…
•
•
•
•
Expenses payable
Prepaid expense
Adjustments in inventories
Change in interest payable
Net Farm Income
• Net cash income and the adjustments added
together
Financial Efficiency Ratios
• Ratio’s that compute what percent of total
revenue is attributed to the relevant category
Four Financial Efficiency Ratios
• Operating-Expense Ratio=
▫ Total Expenses-Depreciation and Interest/Total
Income
• Depreciation-Expense Ratio=
▫ Total Depreciation Expense/ Total Income
• Interest-Expense Ratio=
▫ Total Interest Expense/Total Income
• Net Farm Income From Operations Ratio=
▫ Net Farm Income From Operations/Total Income
• See p.3-12 fig. 21 for examples
Operating Expense Ratio
• Percent of income that consist of operating
expenses. (excluding interest and depreciation
expenses)
Depreciation Expense Ratio
• Total depreciation expense divided by total
revenue. Indicates the percentage of total
income allocated to depreciation.
Interest-Expense Ratio
• Total interest expense (cash interest paid plus
change in interest payable) divided by total
income. Ratio show the percentage of income
devoted to interest.
Net Farm Income From Operations
Ratio
• Net farm income from operations divided by
total income . Show the percentage or ratio of
total income that actually ends up as net farm
income from operations.
• Good check is to ensure that all four ratios total
to 100%.
Net Worth Statements Look At
• The financial picture at a point in time.
Income Statements Indicate the
Performance of
• The farm business within a period
▫ The period can be defined as any period but it is
typically between one net worth statement and the
next (usually 1 year)
Asset-Turnover Ratio
• Useful measure to show how effectively farm
assets are being used
• Calculated by
▫ Gross Revenue/Average Total Farm Assets
 Gross Revenue is gross receipts from farming plus
(or minus) total non-cash adjustments
 Average total farm assets is in year one plus year two
divided by two.
Value Favorable for Asset-Turnover
Ratio
• The higher the asset turnover ratio, the quicker
the turnover of assets and generally the greater
the likelihood of profits
Not Shown on Income Statements
• 1 category of labor not shown on income
statements– A
charge for unpaid
operator and family labor
Operator and Family Labor Allowance
• Determined from a 2,080 hour work year
Return to Equity Capital and
Management
• Return to Equity Capital and
Management=Net Farm Income –
Operator and Family Labor Allowance
Profitability Ratios
• Rate of Return on Borrowed Capital (COD)=
▫ Return on Farm Assets-Return to Equity Capital and
Management/Average Total Farm Assets-Average Net
Worth
• Rate of Return on Farm Assets (ROA)=
▫ Net Farm Income + Total Interest Expense –Operator and
Family Labor Allowance
• Rate of Return on Farm Equity (ROE)=
▫ Return to Equity Capital and Management/Average Farm
Net Worth
• Operating Profit Margin Ratio (OPMR)=
▫ Net Farm Income + Total Interest Expense – Withdrawals
for Operator and Family Labor/ Total Income
• See p.3-14 to 3-16 for examples
Rate of Return on Assets Show
Profitability by
• Adjusting net farm income as if no interest has
been paid, thus treating the total farm assets like
equity capital
Rate of Returns on Equity Ratio Is
• The rate of return on equity in the farm
• The ratio show’s the farm’s return on net worth
How the Rate of Return on Borrowed
Capital is Used
• Evaluating whether returns are great enough to
pay the cost of borrowing funds
• Comparing return on borrowed capital with the
return on equity capital
Operating Profit Margin Shows
Profitability By
• Defines profit as a percentage of total revenue
• Formula
▫ Net Farm Income + Total Interest Expense –
Withdrawals for operator and family labor/ Total
Income
3 Components of Ending Net Worth
Statement
• Ending Assets
▫ Beginning Assets + Non-Cash Reinvestment +
Changes in Inventory – Depreciation = Ending
Assets
• Ending Liabilities
▫ Beginning Liabilities + New Debt Added – Debt
Repaid = Ending Liabilities
• Ending Owner Equity
▫ Beginning Owner Equity + Net Farm Income –
Family Living and Income Taxes= Ending Owner
Equity
3 Reasons Valuing Fixed Assets is
Difficult
• Fixed assets can’t easily be changed to capital
like current and other noncurrent assets
• Fixed assets are usually part of the business for
many years; often they are part of the entire life
of the business
• Values on financial statements must be
estimated in order to get credit and to plan for
future enterprises
• It is best to be conservative when valuing fixed
assets, therefore it is best to use BOOK VALUE
Summary
• Financial statements are like a health report
• There are 2 financial statements to consider
▫ Net Worth
▫ Income
• Net worth statement and income statement provide financial
measures of strengths and weaknesses of the farm business.
They help pinpoint problems.
• The Net worth statement provides information about what
assets are owned and what liabilities are owed. It is a picture
of the farm business at a point in time, usually annually.
• The income statement show the financial performance of the
farm business from one net worth statement to another.
• The two financial statements together are powerful tools for
farm and ranch business management.
Assignment
• Chapter 3 Assignment Sheets 1 and 2 p. 39-42
▫ DUE--- Tuesday Sept 21
• Chapter 3 Review Questions
▫ DUE--- Thursday Sept 23
• Chapter 3 Quiz– Thursday Sept 23