Using financial records……
To answer all sorts of
questions you or others
may have…
Craig Chase, Field Specialist
Farm & Ag Business Management
Plan for today
• Quickly review goal setting and planning
• Six reasons to keep financial records
– We are going to cover these six reasons in our
allotted time today.
– However, we are going to work toward those
reasons by asking and then answering common
questions I hear from producers and comments I
hear from lenders and financial analysts…
Goal Setting and Planning
• How much production do I need to
have?
• How big do I need to be (number of
acres, head of livestock, etc.)?
Issue of Scale
• Assume you want to grow vegetables.
• You also want to make $30,000 per
year net income.
• Question: How many acres do you need
to have in production?
Issue of Scale
• Assume your goal is to have a net
income ratio of 30 percent.
• Gross revenue would need to be
$100,000 ($30,000 / 30%).
• Number of acres assuming $15,000
gross revenue per acre would need to
be 6.7 ($100,000 / $15,000).
– (e.g. $15,000 = 50 shares/acre @ $300 / share)
Additional Planning Needs
• What will my labor, equipment, and land
needs be as I expand?
• How do I decide where to invest my
money first?
• What do I do when things don’t go as
planned (pp. 31-42)?
Reason #1
• How is my farm doing financially?
• How much of my farm do I own?
• How much money am I actually making
farming?
Financial Condition and Profitability
• Financial condition can be shown by the
balance sheet.
• Profitability can be illustrated by the income
statement.
• Both of these statements need to be for your
entire farming operation.
Balance Sheet, as of 12/31/2011
Assets
Current Assets
Cash
15,000
Prepaid expenses
10,000
Accounts receivable
1,000
Supplies
6,000
Int/Long Term Assets
Machinery/equip
83,000
Real estate
140,000
Buildings/improve
35,000
Total Assets
$290,000
Liabilities
Current Liabilities
Operating loan
10,000
Accounts payable
2,000
Current L/T debt
12,000
Int/Long Term Liabilities
Mach/equip loans
64,000
Real estate loans
82,000
Total liabilities
176,000
Net worth
114,000
Total Liab/Net Worth
$290,000
Income Statement; Yr ending 12/31/2011
Sale of crops
Other income
Gross Income
Car and truck, gas and oil, repairs
Depreciation
Fertilizer, Seed, Crop Inputs
Insurance, interest, repairs, taxes
Labor
Supplies
Utilities
Total Expenses
Net Income
$140,000
4,000
144,000
12,200
36,000
19,800
18,400
24,600
8,000
8,000
$127,000
$ 17,000
Answers
• Did I make any money?
– Net income of $17,000
– Net income plus depreciation of $53,000
• How much of my farm do I own?
– Net worth of $114,000
• What do you think about these numbers?
– What if the farm is 20 vegetable acres?
– What if the farm is 10 vegetable acres?
Limitations
• Balance sheet illustrates what is owned and
owed at one point in time (pp. 89-100).
• Income statement presents what was made
over one time period (pp. 101-109).
• Profitability and financial condition give you
limited information regarding details of the
farm.
Limitations
• Size (scale) of farm affects how the results
are interpreted.
• Neither statement identifies potential
problems with cash flow (pp. 110-120).
Exercises 1 and 2
• Take 10 minutes answering exercises 1 and
2 related to developing an income statement
and balance sheet.
Balance Sheet, as of 12/31/2011
Assets
Current Assets
Cash
Supplies
Int/Long Term Assets
Machinery/equip
Real estate
Buildings/improve
Total Assets
Liabilities
2,000
1,500
8,500
25,000
6,000
$43,000
Current Liabilities
Current L/T debt
Int/Long Term Liabilities
Real estate loans
Total liabilities
Net worth
Total Liab/Net Worth
2,000
12,000
14,000
29,000
$43,000
Income Statement; Yr ending 12/31/2011
Sale of shares
Other income (misc sales)
Gross Income
$37,500
4,000
41,500
Direct cash operating expenses
Indirect cash operating expenses
Depreciation
Total Expenses
25,000
5,000
4,500
$34,500
Net Income
$7,000
Reason #2
• How does my farm compare to other farms?
• What are the strengths and weaknesses of
my farm?
• What could I do different to be more
profitable?
Benchmarking
• Benchmarking refers to comparing your
numbers to other farms similar to yours.
• For example, if your cost to produce your
crops or livestock are high compared to
others, then your budget should be evaluated
carefully to determine where the costs are
different and why.
• Developing and understanding financial
ratios is an excellent way to track your
financial progress (pp. 122-138).
Comparing Financials – A few ratios
Your farm
Current ratio
Debt-to-asset
Operating profit ratio
Asset turnover ratio
Operating expense ratio
Net income ratio
2.6
21%
1%
28%
76%
5%
Benchmark
2.24
39%
26%
38%
59%
25%
Comparing Financials
• What are the strengths?
– Balance sheet is strong – current ratio and debtto-asset.
• What are the weaknesses?
– Operating profit ratio, operating expense ratio,
and net income ratio.
• What could be done differently?
– Evaluate operating expenses. Probably could
make product mix and production changes.
– Evaluate revenue compared to expenses.
Limitations
• Whole farm analysis can only tell you in
general where your strengths and
weaknesses are.
– Your operating expenses are too high, your
overall production is too low. Works very well for
simple farming operations (few enterprises).
• Financial ratios give you a limited view of
your farm - what specific management
decisions can be made?
Exercises 3
• Take 10 minutes answering exercise 3
related to developing ratios for your income
statement and balance sheet.
Exercise 3 - Ratios
• 1. Current ratio
– Ans. 1.75 ($3,500 / $2,000)
• 2. Debt-to-asset ratio
– Ans. 32% ($14,000 / $43,000)
• 3. Operating profit ratio
– Ans. -10.4% (($7,000 + $700 – $12,000) /
$41,500)
Exercise 3 - Ratios
• 4. Asset turnover ratio
– Ans. 96.5% ($41,500 / $43,000)
• 5. Operating expense ratio
– Ans. 70.6% ($41,500 – $7,000 – $700 - $4,500) /
$41,500
• 6. Net income ratio
– Ans. 16.9% ($7,000 / $41,500)
Ratios
• Keep in mind there are 21 commonly-used
farm financial ratios that can be used to
evaluate your farm.
• Each has its place. For example when
looking at increasing your debt (through a
farm investment), you would want to analyze
your term debt coverage ratios to determine
how much debt your farming business can
handle without increasing financial risk.
Reason #3
• How much money can I borrow?
• What will a lender think of my idea?
• What information should I pull together to
show my lender?
Risk Rating Scale
• All lenders have a risk rating scale…
• Components of that scale may include:
–
–
–
–
–
–
–
–
–
Ability to service (pay-off) debt
Net worth trend (positive or negative)
Current ratio
Debt-to-asset or equity-to-asset ratio
Character
Management ability
Collateral
Payment history (credit report)
Length of relationship with lender
Risk Rating Scale
• Each component is weighted.
• Ask your lender what goes into his/her scale.
• Know what your numbers are that he/she
uses.
A Tale of Two Farms…
Farm A
Debt service
5
Net worth change
5
Current ratio
4
Equity-to-asset ratio
4
Character
5
Management ability
5
Collateral
5
Payment history
5
Relationship
5
Weighted Average Score 96
“Premium”
Farm B
Debt service
4
Net worth change
3
Current ratio
1
Equity-to-asset ratio
3
Character
3
Management ability
3
Collateral
5
Payment history
4
Relationship
4
Weighted Average Score 72
“Average”
Answers – It Depends…
• If you are a “Premium” it is much easier to
find a lender and get a better deal.
• If your lender knows something about your
business, is willing to actively learn, and
make a farm visit at least once per year.
• If you come prepared (financials completed),
know financial terms, and ask questions
about borrowing options.
• If you find out what you need to do to get a
better deal – shop around.
Reason #4
• Can I do a better job of production (can I be
more efficient)?
• Which crops (livestock) should I grow (raise)?
• How do I price my product(s)?
• Which market(s) makes the most sense?
Enterprise Budget
• An enterprise budget is an estimate of
costs and returns to produce a product
(pp. 160-172).
• For producers who grow a large number
of different products.
– Develop budgets for those products that
contribute the most to business goals.
Enterprise Budget
• Or start with an enterprise budget for each
major part of your business.
– Example, CSA with poultry/livestock. Complete
a CSA and livestock budget.
– CSA with multiple seasons and use of high
tunnels/greenhouses. Complete an enterprise
budget for each season (spring, summer, fall) or
production system (open ground, high tunnel,
greenhouse).
• The process is the same for all scale of
farming operations.
Simplified Enterprise Budget
Salad Greens (4x100 ft bed)
Revenue: 30 lbs @ $5.00/lb
$150.00
Crop inputs: (Seed, fertilizer, etc.)
7.00
Labor
28.00
Supplies
1.00
Ownership (machinery, land, irrigation)
11.00
Total cost
$ 47.00
Return over total cost
$103.00
Simplified Enterprise Budget
Green Beans (4x100 ft bed)
Revenue: 120 lbs @ $3.00/lb
$360.00
Crop inputs: (Seed, fertilizer, etc.)
23.00
Labor
182.00
Supplies
4.00
Ownership (machinery, land, irrigation)
11.00
Total cost
$ 220.00
Return over total cost
$140.00
Enterprise Budget Analysis
• Enterprise budgets can be used to:
– Look at how changes in production practices
could improve profits.
– Review your product mix.
– Price your product.
Changing Production Practices
• Use the budgets to calculate breakeven prices and yields.
– For example, cost per lb. of beans sold was
$1.83 ($220/120 lbs).
– Compare this number to other producers or
published budgets to determine where costs
are different and why.
– NOTE: add marketing costs to your cost of
production.
Changing Production Practices
• A second reason – track key costs.
– Green bean example, $182 (or 83%) of the
total production cost is labor. Most of the labor
is weeding and harvesting.
– Question - can labor be lowered without
reducing yields (i.e., can labor be more efficient)?
– Crop inputs is a small percentage (10%) of total
production costs, a 10% reduction in costs
won’t affect total production costs significantly.
Don’t spend time on small items…
Product Mix
• Enterprise budgets allow for a
comparison of profitability and labor
usage among the various crops grown.
• For example, green bean returns over
total costs was $140. Labor usage was
18.25 hrs. Returns over total cost per
hour was $7.69.
Product Mix
Returns over Total Costs
Hours of Labor
Returns over Total/Hr
Asparagus
$ 35.47
2.95
$ 12.02
Basil
$ 164.19
6.90
$ 23.80
Carrots
$ 54.02
5.35
$ 10.10
Cherry Tomatoes
$ 181.11
11.20
$ 16.17
Eggplant
$ 85.02
6.45
$ 13.18
Specialty Green Beans
$ 140.27
18.25
$ 7.69
Garlic
$ 43.89
7.15
$ 6.13
Greens
$ 102.90
2.80
$ 36.75
Heirloom Tomatoes
$ 547.21
11.20
$ 48.86
Potatoes
$ 61.65
5.10
$ 12.09
Red Raspberries
$ 131.50
6.15
$ 21.38
Snow Peas
$ 58.45
7.65
$ 7.64
Strawberries
$ 55.46
1.55
$ 35.78
Comparing Budgets
• A quick comparison of the crops in the
previous slide indicates annual returns
over total costs ranged from $35.47 to
$547.21.
• Labor usage ranged from 1.55 to 18.25
hours.
• Returns over total costs per hour ranged
from $6.13 - $48.86.
Product Mix Summary
• Labor in most cases is your limited
resource - limited number of hours for
any farming operation.
• Analyze not only returns over total costs,
but also returns over total costs per hour.
• Some products with lower returns over
total costs may have higher returns over
total costs per hour because of low labor
requirements.
Pricing
• Number #1 question…what price should
I sell my products at (pp. 191-197)?
• For an individual product, what does it
cost me to produce AND market that
product?
• If tomatoes cost me $1.90 per lb. to
produce and market, what should my
price be?
Pricing (side note)
• NOTE that we are not going over how to
determine market costs today.
• Marketing costs are extremely important,
however, as they can be 2-5 times the cost
of production.
• Marketing costs are covered in the book on
pp. 180-190.
Pricing
• What are your consumers willing to pay
and what is your competition allowing?
• How much above your breakeven cost
are these prices?
• What is your net farm income ratio goal
(10yr Iowa average for all kinds of farms
was 20-25%)?
Pricing
• So if you want to net 20% of your gross
income and your break-even cost is
$1.90 per lb., your sales price would be
$2.38 per lb (2.38-1.90=0.48; 20% of
$2.38).
• Will your consumers and competition
allow this price (maybe higher)? The
goal is for the farm, not one product.
Pricing
• Same process regardless of what you
are producing…
• Example – CSA share cost you $240
per share to produce and market, price
it at $300.
• Chickens cost you $2 per lb to produce
and market, price at $2.50 per lb.
Exercises 4 and 5
• Take 15 minutes answering exercises 4 and
5 related to product mix and pricing using
enterprise records.
Exercise 4 – Product Mix
• What were your suggestions, if any?
Exercise 5 - Pricing
• What is her per share cost for production and
marketing?
– Ans. $345 (($25,000+ $5,000 + $4,500) / 100)
• What does she need to charge to achieve
her net income goal?
– Ans. $431.25 ($345 / .80) if all income is to come
from shares, if 10% of total gross income comes
from other sources, then this number can be
reduced by 10%, or approximately $388 per
share.
Partial Budget
• A partial budget allows you to analyze a
portion of your farm to determine if minor
adjustments should be made (pp. 173-179).
• For example, should you:
– Add an enterprise
– Change your product mix or production practices
– Custom hire or purchase machinery
– Change marketing outlets
– Purchase transplants or grow from seed…
Partial Budget
• Partial budgets allows you to compare two
alternatives side-by-side.
• The analysis tells you one of the alternatives
is comparatively better than the other.
Partial Budget Components
• There are seven components to a partial
budget: increased revenue, reduced cost,
reduced revenue, increased cost, total
positive effects, total negative effects, and
net change.
Partial Budget Example
Change Product Mix from Snow Peas to Salad Mix
Positive Effects
Increases in revenue (1)
Sales of salad greens
Decreases in cost (2)
7.65 hrs labor @ $10/hr
Input & packaging costs
Total decrease in costs
Total positive effects (5)
Net change (7)
Negative Effects
Decreases in revenue (3)
$150.00 Sales of snow peas
Increases in cost (4)
$76.50 2.8 hrs of labor @ $10/hr
29.48 Input and packaging costs
105.98 Total increase in costs
$255.98 Total negative effects (6)
$44.45
175.00
28.00
8.53
36.53
$211.53
Partial Budget Example
Change Marketing Outlet from Farmers’ Market to Institutional Market
Positive Effects
Increases in revenue (1)
Institutional market sales
Negative Effects
Decreases in revenue (3)
$3,600 Farmers’ market sales
Decreases in cost (2)
Farmers’ market labor costs
$1,200
Farmers’ mkt. supply, trans. costs 400
Total decrease in costs
$1,600
Total positive effects (5)
Net change (7)
Increases in cost (4)
Institutional market labor costs $800
Inst’l mkt. supply, trans. cost
200
Total increase in costs
$1,000
$5,200 Total negative effects (6)
-$300
$4,500
$5,500
Answers
• Production change – key question: can you
either increase yields without increasing
costs or decrease costs while maintaining
yields?
• Product mix – compare products based on
your most limiting factor. If labor, determine
which products return the most to you per
hour. The ranking will likely be different on a
per hour basis (e.g. green beans).
Answers
• Pricing – you need to know your costs or
otherwise you are shooting in the dark. Add
a desired return to your total cost of
producing and marketing your product(s).
Compare that price to customers’ willingness
and competition.
• Market outlet – compare outlets that are
available to you. Don’t focus on selling price
(gross revenue), focus on net returns.
Limitations
• As always, the decisions you make are only
as good as the numbers you used to make
them. Some numbers are better than none;
more is better…
• Partial budgets compare two alternatives,
neither which may be the best alternative
available to you.
• Partial budgets (all types of budgets) look at
only $, other factors come into play as well in
your decisions (health, environment, etc.)
Reason #5
• Should I purchase a 1-row potato harvester?
• Should I purchase transplants or grow from
seed?
Partial Budget Example
Analyze the purchase of a new 1-row potato harvester ($2,000, 7-yr life)
Positive Effects
Increases in revenue (1)
Decreases in cost (2)
Labor (50 hrs)
Total decrease in costs
Negative Effects
Decreases in revenue (3)
Increases in cost (4)
$500 Labor (1 hrs)
$ 10
Capital recovery cost
180
Taxes, housing, insurance (1%)
20
Repairs and maintenance (2%)
40
$500 Total increase in costs
$250
Total positive effects (5)
$500 Total negative effects (6)
Net change (7)
$250 (per half acre)
$250
Partial Budget Example
Purchase 100 transplants rather than growing from seed
Positive Effects
Increases in revenue (1)
Negative Effects
Decreases in revenue (3)
Decreases in cost (2)
Labor developing transplants
Crop inputs (soil mix, seed, etc)
Total decrease in costs
Increases in cost (4)
$10 Transplants ($1.50 ea)
5
$15 Total increase in costs
$150
Total positive effects (5)
$15
$150
Net change (7)
-$135
Total negative effects (6)
$150
Exercise 6
• Take 10 minutes answering exercise 6
related to changing marketing outlets using a
partial budget.
Exercise 6 - Partial Budget
Change Marketing Outlet from Farmers’ Market to Institutional Market
Positive Effects
Increases in revenue (1)
Institutional market sales
Negative Effects
Decreases in revenue (3)
$9,100 Farmers’ market sales
Decreases in cost (2)
Farmers’ market labor costs
Farmers’ market trans costs
Farmers’ market supply costs
Total decrease in costs
Increases in cost (4)
$4,800 Institutional market labor costs $1,600
$1,600 Institutional market trans costs $800
500 Institutional market supply costs 300
$6,900 Total increase in costs
$2,700
Total positive effects (5)
Net change (7)
$16,000 Total negative effects (6)
-$700
$14,000
$16,700
Summary
• Income statements, balance sheets,
enterprise budgets, and partial budgets can
make your decisions much easier.
• They can also point to both strengths and
weaknesses in your farm.
Summary Step 1 – A few ratios
You start with a few ratios…
Current ratio
Debt-to-asset
Operating profit ratio
Asset turnover ratio
Operating expense ratio
Net income ratio
2.6
21%
1%
28%
76%
5%
good
good
low
low
high
low
You decide to see if you can lower your expenses
and raise your revenues to improve your ratios
related to the income statement.
Step 2 – Enterprise Analysis
• You realize labor is a constraint. You determine
to focus on crops with a higher return per hour.
Less
Green beans
Snow peas
Garlic
More
Salad greens
Carrots
Potatoes
• Result of the shift would be more revenue per
hour worked.
• You also look to see where production changes
could be made to increase yields or lower costs.
Step 3 – Partial Budget Comparisons
• With more potatoes, you will be crunched for time
during harvest, you can gain efficiencies with a
potato harvester.
• Other partial budget analyses that you completed
indicate you should continue with farmers’
markets and grow your own transplants.
• However, with more of certain products you will
look at alternative markets for the excess.
Step 4 – Pricing
• You set your income goal at 20% of gross
revenue.
• You look at individual enterprises to determine
how close you are and evaluate possible
increases where you are low.
• If customers or competition will not allow you to
get close to your income goal you evaluate
whether that crop is needed.
Summary
• Spend the time to pull together some
financial numbers; it will likely be the best
investment you have ever made.
• Spend time understanding your numbers and
looking at possible improvements (we all
have strengths and weaknesses).
• Always keep in mind your financial farm goal
and your questions and work through your
records to find your answers…
And the Sixth Reason….
• Taxes…
• But don’t make management decisions solely
on tax management. Make them because it
is a good business decision and it will lead
you toward your overall income goal.
Last Thoughts…
• You should develop an annual budget
for your farm and then monitor it (pp.
199-218).
• You should go over factors to improve
profits (pp. 139-144) for ideas on how to
improve your profitability.
Questions…..
Any questions or comments?
Thank You for This Opportunity!
Craig A. Chase
Farm Management – Local Food Systems & Alternative Enterprises
312 Westbrook Lane
Ames, IA 50662
(319) 238-2997
cchase@iastate.edu
http://www.extension.iastate.edu/agdm/fieldstaff/cchase.html