Recommendations on Using Financial Information Dr. Barbara M. Wheeling Montana State University Billings Financial Benchmarking Process of comparing the performance of an enterprise against the performance of other similar enterprises through the use of comparable and reliable data Trends Farm benchmarks on the production side are common • Yields, weaning weights, pounds of milk, etc. Increasing use of financial data in farm benchmarking • Benchmarking databases • Articles, webinars, worksheets • Consultant services, surveys U. S. databases (examples) • CFFM, Purdue Extension, Illinois FBFM, Farm Credit Services • NPPC, NCBA, DHIA International databases (examples) • UK, New Zealand, Canada, Australia, South Africa, France Comparability Comparability requires • Reliable accounting information • Similar inputs • Similar systems of classifying income, expenses, assets and liabilities • Similar procedures for constructing financial statements • Similar procedures for calculating financial ratios and measures Benchmarks Previous year’s data • Comparative Analysis: Year-to-year comparisons for a farm over time • Common-size statements can also be compared from year to year Base year’s data • Trends over multiple years may be more meaningful than current year compared to past year Data from farm-to-farm comparisons • “How is my neighbor doing?” • Comparisons with averages of similar farms Ratios Financial ratios “level the playing field”: Example: Farm “A” Accrual Adjusted Net Income = $50,000, Total Assets = $400,000 Return on Assets = 12.5% Example: Farm “B” Accrual Adjusted Net Income = $100,000, Total Assets = $1,000,000 Return on Assets = 10.0% Issues to Consider Comparability from an Accounting Perspective • SFAC #2: Common accounting methods are central to comparison of financial information • Compromised by • incomplete or inaccurate information • inconsistency in accounting methods Example: • Debt/Asset ratio Balance sheet that includes deferred taxes Debt = $555,339 Assets = $1,107,764 Debt/Asset = 50.1% Balance sheet that excludes deferred taxes Debt = $338,596 Assets = $1,107,764 (Data from Appendix A, Financial Guidelines for Agricultural Producers, 2011.) Debt/Asset = 30.6% Accounting factors affecting comparability (a partial list) • Farm organization, entity mix • Cash vs accrual or accrual-adjusted accounting • Valuation methods • Treatments for owner withdrawals, investments, wages, income taxes • Financial statement dates • Non-farm activities Example of cash-basis vs accrual-adjusted accounting: • Net Farm Income From Operations Ratio Cash-basis: $26,000 ÷ 175,000 = 14.86% Accrual-adjusted: $70,000 ÷ 200,000 = 35% (Data from Appendix E, Financial Guidelines for Agricultural Producers, 2011.) Comparability from a Business Perspective • Variability in farm characteristics is ultimately reflected in financial statements • Benchmarking against similar farms can help identify and explain how producer’s decisions are affecting financial performance Farm characteristics affecting comparability (a partial list) • Farm size • Farm type • Farm location • Ownership of land • Management and financing decisions • Group exercise (Handout) Further Analysis • Comparisons are the beginning of more in-depth analysis. • Explanations of the differences between a farm’s data and the benchmarks are necessary to truly understand what can be controlled by the farm manager. • Variance analysis becomes a useful tool. • Examine the components of the ratios. Example: Years Ended December 31, 'X8 Gross Revenues Net Income from Operations Total Assets 'X7 $304,699 $304,699 54,306 57,205 $ 753,147 $ 748,509 • Question to ask: Gross Revenues maintained at the same level in ‘X8 as in ‘X7. Is that a good result? Answer: It depends! • If Gross Revenues did not change, what caused the decline in Net Farm Income from Operations? • Total Assets increased—why? Buildup of inventory? Purchase of new machinery or other assets? Was this a good business decision? • What does it mean if Total Assets decrease?