balance sheet, income statement, understanding cash flows

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Fearless Farm Finances……
Organizing basic financial
information: balance
sheet, income statement,
understanding cash
flows…
Craig Chase, Field Specialist
Farm & Ag Business Management
Plan for this session
• Four reasons to develop a balance
sheet, an income statement, and a
statement of cash flows:
– We are going to cover these four 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…
Reason #1
• How is your farm doing financially?
• How much of your farm do you own?
• How much money are you actually making
farming?
Financial Condition and Profitability
• Financial condition can be shown by the
balance sheet (pp. 89-100).
• Profitability can be illustrated by the income
statement (pp. 101-109).
• Understanding how cash comes in and out of
the business can be illustrated by the cash
flow statement (pp. 110-120).
Balance Sheet, as of 12/31/2012
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 12/31/2012
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 you make any money?
– Net income of $17,000
– Net income plus depreciation of $53,000
• How much of your farm do you 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.
• Income statement presents what was made
over one time period.
• 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 12/31/2012
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 12/31/2012
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 your farm compare to other
farms?
• What are the strengths and weaknesses of
your farm?
• What could you 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 you borrow?
• What will a lender think of your idea?
• What information should you pull together to
show your 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.
Cash Flow Statement
• Cash flow statement is often the forgotten
statement.
• Question to be answered is: is there enough
cash flowing into your business to cover the
expenses occurred by your business? If not,
then what are you going to do about it?
• Remember that profitability and cash flow are
not the same thing – you can be profitable and
have a negative cash flow and vice versa (p.
112).
Cash Flow Statement
• Turn to page 114 of the Fearless Farm
Finances book…
• Three sections:
– Cash flow from operations
– Cash flow from investing
– Cash flow from financing
Cash Flow Statement
• How did Otto do?
• How did this year compare to earlier years
and to the cash flow budget developed at the
beginning of the year (cash flow budget is
different)? Why would this be important?
• Did Otto replace the right amount of capital
or did he intentionally not invest because it
would put him in a negative cash flow?
Summary
• Income statements and balance sheets can
make your decisions much easier.
• Cash flow statement indicates whether your
farm is bringing in more cash than
expending.
• 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.
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 Fourth 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
Marketing Food System Initiative Program Leader
Iowa State Local Food and Farm Program Coordinator
Farm Management – Local Food Systems and Alternative Enterprises
209 Curtiss Hall
Iowa State University
Ames, IA 50011
(515) 294-1854
[email protected]
http://www.extension.iastate.edu/agdm/fieldstaff/cchase.html
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