Department of Applied Economics and Management Cornell University Ithaca, NY Dr. Wen-fei Uva Senior Extension Associate What is Your Profitability? - Using Financial Records to Improve Business Performance Modified by Georgia Agricultural Education Curriculum Office July, 2002

What We Are Going to Do Today?  What Is in Financial Analysis?  Calculating Your Costs.  Evaluating Your Profitability

What Is in Business Management? The ability to use resources in an efficient manner so as to maximize returns to meet: +Business goals +Personal goals Financial ManagementAchieving your goals requires Financial Management

What Is Financial Management? greatest returnsThe ability to allocate financial resources in the areas which generate the greatest returns. Financial Management Decisions You Need to Make:

* Pricing Your Product One of the most critical components of marketing. A common concern! Critical in achieving sales and profitability Need to know your COSTS

* Making Business Decisions Are your sales covering your costs? Which product lines generate the most income? Should you operate year-round or shut down in the winter? Contributions to fixed costs Optimum mix of product lines Goal setting and increased efficiency

* Making Investment Decisions Input substitution +Capital for labor: installing automated irrigation system or not? +Buying vs. raising your own bedding plants Enterprise changes +Whether or not to sell a particular product +Adding another operation to your business What is the best investment for my money

Are Your Financially Healthy and Wise? ¢Do you keep good financial records? +Keep records for more than just taxes! +Use a computer program! +Financial information should be at your fingertips at all times

Are Your Financially Healthy and Wise? ¢Do you construct financial statements? +Income statement, balance sheet, cash flow statement +Banks require these statements +Can often be tedious to complete -- work with your accountant ¢Do you look at your financial sheets from your accountant? +Do you understand all the lines? - cost of good sold, retained earnings etc.

¢Do You Perform Financial Analysis? +Cost analysis - costs to operate the business and profitability +Ratio analysis - Gross Margin Return On Investment, Return on Asset, Inventory Turns +Enterprise analysis - What is your most profitability product line? Are Your Financially Healthy and Wise?

¢Do you know how your business compare with industry benchmarks +How do you compare to other firms in the industry? - Gross Margin, Inventory Turns, Profit Margin +Set performance goals +Track your performance over time (trend analysis) ¢Repeat process annually Are Your Financially Healthy and Wise?

Calculating Production Costs A Record Keeping System for You Pricing for Profit

Operation/Production Records ¢Seasonality for each department or product line ¢Physical operation records ¢Labor requirements for each department, season, or product line ¢Resource flow budgets

Financial Records ¢Income records +By product, crop, or department +By dates (monthly) +By marketing channel and promotion activities

¢Expenses Records +Variable costs +Variable costs: cost items that vary with production volume (Direct and Indirect). êCosts of plant materials, pots, soil, hourly labor, advertising. +Fixed costs +Fixed costs: cost items that do not vary with production volume (Overhead costs). êCosts of rent, property taxes, management salary and family living expenses. êAllocate these costs to each product could be tricky (by floor space, time in store, etc.) ê25 to 50% of total costs.

¢Expenses Records - cont. +Marketing costs +Marketing costs: êAdvertising, packaging, shipping, billing, and special promotion, display, etc. êIt could also be assigned to variable and fixed costs, but why look at it separately? êProduction efficiency vs. marketing efficiency ê5 to 15% of total costs

¢Financial Statements and Performance Measures +Income statement, balance sheet, cash flow budget +Liquidity, solvency, profitability, financial efficiency, repayment capacity measures

Ownership Records ¢Asset Inventory +Business assets, ownership type, control arrangement, opportunity costs ¢Ownership Arrangement +Resource sharing, owner compensation, responsibilities ¢Estate Plan +Exit/entry and retirement plans (will, trust, insurance, buy-sell agreements)

Profit Pricing for Profit Variable Costs Fixed Costs Price (Revenue) Contribution Break-even

Cost Equation Unit Costs ($) = Fixed Costs ($)Variable Costs ($) + Units Produced (lbs, dozens, bag) (Don’t forget to take into account shrinkage)

Analyze Enterprise Profitability Step 1: Determine How You Want to Allocate the Fixed Costs By Area & Length of Operation

Step 2: Calculate SFW Needed for a Enterprise (ex. 5,000 pots of 4” Geraniums)

Step 3: Calculate Costs - Direct Variable Costs

Step 3: Calculate Costs - Indirect Variable Costs

Step 3: Calculate Costs - Fixed Costs

Step 4: Calculate Enterprise Profitability

Step 5: Breakeven Analysis

= VOLUME (PRICE-COST) PROFIT Profit Equation 4,800 pots* ($3.25/unit - $2.78/unit) = $2,256 4,800 pots* ($3.00/unit - $2.78/unit) = $1,056 10,25410,254 pots* ($3.00/unit - $2.78/unit) = $2,256 For $250,000 in sales, a 4% price increase (4 cent increase for every dollar) give you $10,000 more profit.

Evaluating Business Profitability Financial Ratios Efficiency Measures

Financial Ratios Profitability Ratios Gross Margin: (Revenue - Variable Costs)  Revenue -- (around 50%) Profit Margin: (Revenue - Total Costs)  Revenue -- (around 10-15%) Return on Assets Net Business Income  Average Total Assets How efficient are you using your resources to produce income.

Financial Ratios Inventory Ratio (3.5) Cost of Good Sold  Average Inventory How fast are you turnover your inventory Liquidity Current Ratio: Current Liability  Current Assets Your ability to cover current debt (liability) Solvency Debt-to Asset Ratio: Total Liability  Total Assets The percentage of the business’s assets to which creditors have claim.

Efficiency Measures Operating Efficiency Sales per Full Time Worker Equivalent Net Income pre FT Worker Equivalent Sales per Square Foot Cost Efficiency Labor as percent of sales Operating expenses as percent of sales Costs per square foot (or square foot week) Profitability Net Income per Owner Net Income per Owner Hour Net Income per Square Foot