New Risk Management Materials
for the Smaller Enterprise Manager
John P. Hewlett – University of Wyoming Extension
Jeffery E. Tranel – Colorado State University Extension
Rodney Sharp – Colorado State University Extension
1
2
http://RightRisk.org
Ag Survivor
Five Scenarios
• EWS Farms
• Public Lands
• The King Family
Ranch
• The Lazy U Ranch
• The Wheatfields
3
Strategic Risk
Management Process
10 Steps to
Manage Risk
1.
Determine Financial Health
2.
Determine Risk Preference
3.
Establish Risk Goals
4.
Determine Risk Sources
5.
Identify Management
Alternatives
6.
Estimate Likelihoods
7.
Rank Management
Alternatives
8.
Implement Plans
9.
Monitor & Adjust
10. Replan
What is Good Management?
Inertia
(Inaction)
Random
Action
Doing the
Right Things
Inadequate
Doing the Right
Things Right
Management Continuum
Excellent
5
Other Projects
• Additional risk management CD
modules
– A Lasting Legacy
 Values and Life Lessons &
Personal Possession and
Sentimental Value
 Wishes To Be Fulfilled &
Financial Assets and
Real Estate
• Insuring Success for Wyoming Agriculture
• 10-step process for managing risk for
smaller-agricultural operators
6
Taxes for Agricultural
Enterprises Course
Feasibility of Alternative
Rural Enterprises Course
7
9
Section 1:
Definition of a Farm
Your Goals
• To make money?
• To pay no taxes? Minimize taxes? Pay more taxes every
year?
• To maintain equity (net worth)? Increase equity?
“A farmer will never go
broke paying taxes”
- Anonymous Farmer
11
For Profit Farming
• It is a business if there
is net income or profit in
three of last five years
• Activities consisting of
breeding, showing or
raising horses, it is a
business if there is a
profit in two of last
seven years for horses
12
Intent to Profit
• Farming for profit
–
–
–
–
–
–
–
–
–
Operate in business like manner
Time and effort
Depend on farming for livelihood
Losses due to circumstances beyond your control
Change operation in attempt to increase profitability
Have necessary knowledge
Past success
Profits earned in some years
Expect profits in future years
13
Hobby Farming
• Definition
– Profit is not primary motive
– Farm income not primary
source of income
• Tax Implications
– Limit on deductions
– Cannot use loss to offset
income from other activities
– Report income on Form 1040
and deduct expenses on
Schedule A (Form 1040)
14
Qualified Farmer?
• 2/3 of Gross Income must
come from
farming/ranching in current
or prior year
• Gross Income = All Income
15
Material Participation
16
Gross Farm Income
Farm Income = Income from Farming/Ranching (Schedule F)
+ Gross Farm Rental Income (Form 4835)
+ Gross Farm Income (Schedule E, Parts II & III)
+ Gains from Sale of Breeding Animals (Form 4797)
17
Income Flows
18
Section 2:
Importance of Records
Cash Method of Accounting
• Income is generally recorded
in the year received
• Expenses are generally
recorded in year paid
• Income and expenses in a
single year may not match
causing fluctuations in tax
liabilities
• Used by most farmers
20
Cash Method of Accounting
Exceptions:
• The purchase costs of items
purchased for resale (yearling
cattle for example) are carried
forward to the year in which
the items are sold
• Certain conservation
expenses must be capitalized
21
Accrual Method of Accounting
• Income is recorded in the
year earned, even if not
received
• Expenses are generally
reported in the same year as
the associated income
• Income and expenses of an
event or activity match,
resulting in less fluctuation in
profit or loss
• Used by non-farm businesses
22
Accrual Method of Accounting
Exceptions:
• Certain conservation
expenses must be capitalized
• Business expenses and
interest owed to a related
person who uses the cash
method of accounting are not
deductible until actual
payment is made and the
income is included in the
related person’s gross
income
23
Reasons for Keeping Records
• Determining profits
• Planning the future
• Measuring progress
towards goals
• Communicating
• Reporting taxes
24
Record Keeping Methods
• Hand kept
• Computerized
• Commercial
25
Inflow / Income Categories
•
•
•
•
•
•
•
•
•
Grain
Hay
Cattle
Custom work
Government payments
Insurance
Breeding animals
Feeder animals
Other
26
Outflow / Expense Categories
•
•
•
•
•
•
•
•
•
Auto
Chemicals
Custom hire
Feed purchased
Fertilizer
Freight and trucking
Fuel
Insurance
Interest
•
•
•
•
•
•
•
•
•
Labor
Rents and leases
Repairs
Seed and transplants
Supplies
Taxes
Utilities
Veterinary
Other
27
Section 3:
Farm Income
Section 3: Farm Income
•
•
•
•
•
•
Sales of livestock and other items purchased for resale
Sales of livestock, produce, grains and other products
Commodity Credit Corporation (CCC) loans
Agricultural program payments
Conservation Reserve Program (CRP) payments
Other income
29
Form 1040 Schedule F Income
30
Farm Income Categories
31
Farm Income Categories
32
Hedging as Risk Management
• Hedging transactions entered
into in normal course of
business
• For risk management
purposes
• As forward contracts, futures
contracts, options
• Commodity is produced on
the farm or directly affects the
business
• Generally an ordinary gain or
loss
• Reported on Schedule F
33
Hedging as Speculation
• Hedging transactions
entered into which are not
part of the ordinary business
of farm
• Has specific record keeping
requirements
• Reported on Form 1040
34
Hedging vs. Speculation
• Hedging Transactions
• Speculation Transactions
35
Activity:
Farm Income or Not Farm Income
36
Section 4:
Farm Expenses
Section 4: Farm Expenses
• Car and light truck
expenses
• Conservation expenses
• PrePaid livestock feed
• Labor
• Business use of the home
• Depreciation
38
Form 1040 Schedule F Expenses
39
Car and Light Truck Expenses
• Up to 75%
– Directly in connection with farming
– In first year the vehicle is placed in service
– Cannot change to another method at later
time
• 100%
– Must have records of proof
– Must be used for business the percentage
that is claimed
40
Car and Light Truck Mileage
• Standard mileage rate (only for
business miles):
• Cannot be used if operating 5+
cars and light trucks at the
same time
• Not deductible for commuting
miles
41
Depreciation
• Annual deduction recognizing
that assets wear out or become
obsolete
• Types of tangible property
• To be depreciable, property must
meet conditions
• Records of depreciation on
capital assets must be kept by
the taxpayer
42
Depreciation – Breeding Livestock
• Raised breeding livestock:
– Not typically depreciated
– Incurred expenses deducted as ordinary farm expenses
– Have no basis when sold
 Sale price less selling costs equal capital gains
43
Depreciation Limits
• Limits
–
–
–
–
–
Passenger automobiles of < 6,000 lbs (GVW)
Entertainment and recreational property
Computers
Cellular telephones
Generally, most assets that lend themselves to personal use
44
Depreciation – Section 179
• Allows deducting all or part of
qualifying property in the year
“placed in service”
• Qualifying property
• Property must be used more than
50% for qualified business use
45
Prepaid Livestock Feed
• Deduct the cost of livestock feed to
be consumed in a later year if
(meet all tests)
• Deductions for prepaid livestock
feed may be limited to 50% of
other deductible farm expenses
46
Wages for Labor
• Deduct reasonable wages
• Use fair market value of any
assets given to hired labor
• Deduct as farm expenses
the costs of boarding farm
employees
• Issue Form W-2 for all
employees
47
Contract vs. Employee Labor
• Entered as “custom hire”
• Cost must be capitalized
• See “20 Factors” for
determining employee
versus custom hire
• Individual contractors
receiving more than $600
must receive a Form 1099MISC
48
Prepaid Farm Supplies
• Amounts paid during the tax year
for feed, seed, fertilizer, and
similar farm supplies
• Must use cash method of
accounting
• Limited to 50% of other
deductible farm expenses
49
Exceptions to 50% Limit
• This 50% limit does not apply
to farm-related taxpayers
under certain circumstances
• Definition of a farm-related
taxpayer
50
Hired Labor- Family Members
• Deduct reasonable wages and
other compensation paid your
child
• Deduct reasonable wages and
other compensation paid your
spouse
51
Business Use of Home
• Can deduct expenses for
business use of home if part of
the home is used exclusively and
regularly
• Deduction limit applies
• Any depreciation taken reduces
the home’s basis
52
Business Use of Home - Telephones
• Cannot deduct cost of basic local telephone service for
the first telephone line into the home
• Can deduct:
– Business long-distance changes on the first line
– Cost of second telephone line into the home if used exclusively
for farm business
53
Activity:
Deductible Farm Expense or Not
54
Section 5:
Strategies for
Managing Tax Liability
Section 5: Strategies for Managing Tax Liability
•
•
•
•
Setting goals
Minimize income taxes owed
Reducing profits
Depreciation Section 179 allowance
56
Tax Management Goals
• It may not be best to
minimize taxes
• Should maximize after tax
income across multiple
years
• Matching depreciation
deductions to loan
payments
57
Defer Tax Payments
• Tax minimizing strategies
only defer (delay) income
tax payments
• Many farmers report crop
revenue in one year and
expenses on another
year’s tax return
• Large tax consequences
may result at a time
when financial hardship
already exists
58
Reducing Profits – Gross Income
• Postpone receipt of revenues
• Reduce revenues from livestock and crop sales
• Reduce non-livestock/crop revenues
59
Reducing Profits – Expenses
•
•
•
•
•
Prepay supplies
Prepay feed
Increase expenses
Increase depreciation
Pay higher than necessary
prices
• Use extraordinary amounts of
items
• Pay consultants
60
Depreciation Calculation
• What if you took a section 170 allowance?
• Assume you purchase a machine, such as a tractor, for
$125,000
61
Depreciation Calculation
• What if you took a section 170 allowance?
• Assume you purchase a machine, such as a tractor, for
$125,000
62
Depreciation Comparison
63
Increase Taxable Income
• Here are some reasons why someone might want to
increase taxable income:
64
Increase Taxable Income
• Here are some reasons why someone might want to
increase taxable income:
65
Increase Taxable Income
• Here are some reasons why someone might want to
increase taxable income:
66
Increase Taxable Income
• Here are some reasons why someone might want to
increase taxable income:
67
Increase Taxable Income
• Here are some reasons why someone might want to
increase taxable income:
68
Bob & Betty Workhorse
Exercise 1:
Bob & Betty Workhorse
69
Bob & Betty Workhorse
• Have 100 acres
• Livestock
–
10 beef cows


–
Purchased calves in December 2004




–
2005 sales = 8 calves @ 600 lbs
@ $115/cwt = $5,520
12 head for $8,190
Sold in 11 head in March
2005 for $8,994
One calf died in January 2005
Sold 1 cull cow (raised) for $536
• Used tractor and backhoe to work for neighbor
earning $6,500
70
Bob & Betty Workhorse
Sale of items purchased for resale = $8,994
Cost of items purchased for resale = 8,190
Sale of raised livestock
Custom work
Gross Income from Farming
Car and truck (2,345 miles @ $0.405, 840 miles @ $0.485)
Depreciation and section 179 ($2,578 + $800)
Feed purchased
Freight & trucking
Fuel
Rents – land, other
Repairs
Supplies
Utilities (barn/shop, 50% of internet)
Veterinary, breeding, and medicines
Other (travel & meals, office supplies/etc.)
Total Expenses
Net Farm Profit (or Loss)
804
5,520
6,500
$12,824
1,357
3,378
1,123
175
1,200
400
1,123
296
913
297
663
$10,925
$1,899
71
Bob & Betty Workhorse
• Income
– Farm Profits (schedule F)
– Capital Gains (form 4797)
– Total
1,899
564
$2,463
• Taxes
– Self Employment ($1,899 x 0.9235 x 15.3%)
– Income ($2,463 x 10%)
– Total
268
246
$514
• After Tax Income From Enterprise
– Total Income
– Taxes
– Net
2,463
514
$1,949
72
More Information
•
See your tax preparer.
•
Visit the IRS.
–
–
–
•
Telephone
Website (www.irs.gov)
Publications and Forms
(Publication 225,farmers tax
guide)
University.
73
Taxes for Agricultural
Enterprises Course
Feasibility of Alternative
Rural Enterprises Course
74
76
Section One:
Agriculture and
Rural Enterprises
Section 1:
Agriculture and Rural Enterprises
•
•
•
•
Definitions of Agricultural Enterprises
Common Traits
Alternative Enterprises
Factors for Success
78
Enterprise Definition
• Enterprise
– An activity that generates one or more saleable products
79
Common Traits of an Agricultural Enterprise
• Combines limited resources to generate dollars of return
• Can be separated from other enterprises by accounting
procedures to its receipts and expenses
• Has some element of risk and uncertainty
80
Enterprise Relationships:
One Relationship Can Impact the Other
81
Enterprises: A Means to Reaching Your Goals
• Maximize Profits
• Generate Minimum Income
Levels (Satisfying Behavior)
• Increase Net Worth
• Control a Larger Business
• Avoid or Reduce Losses
• Reduce Borrowing Needs
• Increase Family Living
82
Alternative Enterprises
• Alternative Livestock
Enterprises
• Alternative Crop
Enterprises
• Agritourism/Recreation
• Alternative Production
Systems
• Alternative Marketing
Strategies
83
Alternative Livestock Enterprises
Listed are the alternative livestock enterprises you might be
interested in – jot down any potential enterprises you might
have interest in.
–
–
–
–
–
–
–
–
–
–
Meat Goats
Elk/Deer
Sheep/Lambs
Pastured Poultry
Free Range Livestock
Exotics
Petting Farm
Specialty Meats
Bison/Buffalo
Organic/Natural
84
Alternative Crop Enterprises
Listed are the alternative crop enterprises. Take a minute and jot down any potential
enterprises you might have interest in:
•
•
•
•
•
•
•
Fiber
Forestry Products
Oilseeds
Forage
Specialty Legumes
Fruit/Vegetable
Seed
85
Agritourism/Recreation Enterprises
Listed are the agritourism/recreation enterprises. Take a
minute to list the ones in which you might be interested:
•
•
•
•
Hunting/Fishing
Guiding
Farm/Ranch Vacations
Hiking/Biking/
Snow Shoeing
• Bird Watching
•
•
•
•
•
•
Pony Rides
Camping/Picnics/Parties
Wildlife Viewing
Rock Climbing
Native Photography
Bed and Breakfast
86
Alternative Production Systems
•
•
•
•
•
•
Organic
Natural
No/Reduced Tillage
Grass Fed
Low/No Input
Value Added Processing
87
Alternative Marketing Strategies
• Alliances/Partnerships/Cooperatives CSA’s
(community supported agriculture)
– Direct Sales
– E-Commerce
– Farmers Markets
– U-Pick
88
Non-Farm Alternative Enterprises
•
•
•
•
•
•
•
•
Storage Units
Animal Boarding
Insect Production
Outdoor Classrooms
Entertainment
Crafts/Decorations/Furniture
Horse/Dog Training
Historic/Heritage
89
Reasons for Alternative Enterprises
• Increase Profits
• Reduce Risk
• Better Utilization of
Resources
90
SWOT Analysis
91
Strengths
92
Weaknesses
93
Opportunities
94
Threats
95
Section Two:
Selecting and Planning
for Alternative Enterprises
Section 2: Selecting and Planning
for Alternative Enterprises
• Assessing Feasibility
• Competitive Analysis
• Business Planning
97
Assessing the Feasibility
of Alternative Enterprises
•
•
•
•
Personal Assessment
Production Assessment
Market Assessment
Economic Assessment
98
Personal Assessment
• Personal and Family
Goals
• Important Personal
Characteristics
• General Business Skills
and Knowledge
99
Production Assessment
• Physical Resources
–
–
–
–
–
Land
Water
Equipment
Buildings
Skills
• Production Requirements
– Climate and Growing
Season
• Production Risks
– Disease
– Pests
– Weeds
100
Market Assessment
• Who are your customers?
• Market Potential
• Marketing Strategies
101
Economic Assessment
•
•
•
•
Start-up Costs
Financial Resources
Investments Analysis
Cash Flow Projections
– Sales projections
– Estimated operating costs
– Debt repayment
• Financial Analysis
– Budgets
– Financial statements
– Financial ratios
102
Competitive Advantage
• Better Able to Meet Your Customers Wants and Needs
– Valued Product Characteristics
– Preferred Market Outlets or Product Distribution
– Pricing Advantage (lower cost of production)
103
Activity: List your Competitors
Take a minute to jot down your three main competitors:
1) Product/Service_______________
2) Target Audience ______________
3) Primary Competitors:
Competitor # 1 _____________
Competitor # 2 _____________
Competitor # 3 _____________
104
Activity: Competitor Worksheet
Products and Services
Customer Needs
& Preferences
Customer
Importance
(1-5)
Your
Farm
Competitor
1
Competitor
2
Competitor
3
Product Quality
Product Availability
Selection/Variety
Product
Characteristics
Product
Appearance
105
Activity: Competitor Worksheet
Products and Services
Customer
Importance
(1-5)
Your
Farm
Competitor
Bob
Competitor
Sally
Competitor
Henry
Product Quality
5
4
3
1
5
Product Availability
3
3
1
5
2
Selection/Variety
2
2
2
5
2
Product
Characteristics
5
5
3
1
4
Product
Appearance
3
4
5
3
3
52
44
64
Customer Needs
& Preferences
70
106
Competitive Analysis Price
•
•
•
•
Cost Based Pricing
Discount Pricing
Luxury Pricing
Competitive Pricing
107
Activity: Competitor Worksheet
Pricing
Customer Needs
& Preferences
Customer
Importance
(1-5)
Your
Farm
Competitor
1
Competitor
2
Competitor
3
Competitive
Pricing
Discount Pricing
Luxury/Premium
Pricing
Cost Oriented
Pricing
Different Payment
Options
108
Competitive Analysis Promotion
• Packaging and Labeling
• Brand Recognition
• Guarantees and
Return Policies
• Coupons
• Advertising
109
Activity: Competitor Worksheet
Promotion
Customer Needs
& Preferences
Customer
Importance
(1-5)
Your
Farm
Competitor
1
Competitor
2
Competitor
3
Packaging and
Labeling
Brand Recognition
Guarantees and
Return Policies
Coupons
Advertising
110
Competitive Analysis
Product Distribution
• Product Distribution
–
–
–
–
–
–
Easier Access
More Convenient Location
Available Parking
Mail Order
E-Commerce
Etc.
111
Activity: Competitive Analysis Worksheet
Market Outlets
Customer Needs
& Preferences
Customer
Importance
(1-5)
Your
Farm
Competitor
1
Competitor
2
Competitor
3
Location
Convenience
Accessibility
Business Facilities
Internet Sales
112
Activity: Competitive Analysis Worksheet
Management and Personnel
Customer Needs
& Preferences
Customer
Importance
(1-5)
Your
Farm
Competitor
1
Competitor
2
Competitor
3
Management
Skills
Reputation/Image
Luxury/Premium
Pricing
Business Stability
Customer Service
113
Marketing Plan
• Current Situation
– Your business description
– Description of target market
•
•
•
•
•
Competitive Analysis
Market Objectives
Market Strategies
Action Plans
Marketing Budget
114
Business Plan
115
Business Plan Components
•
•
•
•
•
•
•
•
Business Description
Mission or Vision
Statements
Business Goals
Marketing Plan
Management and Key
Personnel
Financial Plan
116
Section Three:
Assessing Risks
Section 3:
Assessing Risks
•
•
•
•
Risk Preferences
Sources of Risk
Risk Management Strategies
RightRisk Example
118
Alternative Enterprises: Assess the Risks Involved
• RISK: The probability of an event occurring that can
impact your:
– Current profit level
– Financial situation (equity position)
– Satisfaction and well-being
119
Relationship Between Risk and Profit
High Risk = High Potential Profit
Low Risk = Low Potential Profit
120
Risk Preferences
• Risk Averse or Risk Avoiders
– Cautious individuals
– Prefer less risky sources of income/investments
– Willing to accept some probability of lower income or losses for
the opportunity of higher income
121
Risk Preferences
• Risk Neutral
– Individuals between risk adverse and risk preferring
– They choose the decision with the highest expected return
122
Risk Preferences
• Risk Preferrers or Risk Takers
– More adventuresome individuals
– Prefers more risky business alternatives
– Willing to accept some probability of lower income or losses for
the opportunity of higher income
123
Activity: Risk Preference Game
• You flip a coin
• For every heads tossed,
you win $140
• For every tails tossed,
you lose $100
• Would you play this game?
If so, what is the maximum
amount you would pay to
play this game?
–
–
–
–
Would you pay $5?
Would you pay $10?
Would you pay $20?
Would you pay $40?
124
Sources of Risk
•
•
•
•
•
Production
Marketing
Financial
Legal
Human
125
Production Risk
Anything that can affect crop yields or livestock
performance is referred to as production risk. This includes
such things as weather, pests, and diseases
126
Marketing Risk
• Marketing is that part
of your business that
transforms production
activities into
financial success
• Unanticipated market forces
can lead to dramatic
changes in market prices.
• These market forces
are referred to as marketing
risk
127
Financial Risk
Financial risk has three basic components:
1. The cost and availability
of debt capital
2. The ability to meet
cash flow needs in a
timely manner
3. The ability to maintain
and grow equity
128
Legal Risk
The legal risks commonly associated with agriculture fall
into four broad categories:
1. Appropriate legal business
structure and tax and
estate planning
2. Contractual arrangements
3. Tort liability
4. Statutory compliance,
including environmental
issues
129
Human Risk
• Human risk includes:
–
–
–
–
–
–
–
–
Inadequate management
Inadequate labor resources
Divorce
Illness
Death
Orientation and training
Management succession
Other human risks
130
Risk Management
• The objective of enterprise
diversification and risk
management is NOT to
eliminate risk
• Risk management is taking
the RIGHT risks to
maximize profit while
REDUCING income
variability and MEETING
strategic goals
131
RightRisk Example
• King Family Ranch
– 500 cows
 94% - weaning percent
 $350 cow costs
– 350 acres of hay
 $60 per acre costs
 Normal yield 2.5 ton per
acre or 875 ton
– Expected income - $51,996.50
per year
 Revenues - $247,996.50
 Expenses - $196,000.00
132
Buy or Sell Hay?
133
Buy or Sell Hay?
134
Buy or Sell Hay?
135
Risk-Return Frontier
136
Risk-Return Frontier
137
Risk-Return Frontier
138
http://RightRisk.org