Spencer Ag Business Curriculum 2012 FINANCIAL ANALYSIS Spencer Ag Business Curriculum 2012

Financial Analysis How can we tell if a farm is doing well? What are the strengths and weaknesses of the farm?

Net Worth Statement Provides information at a point in time ASSETS-LIABILITIES= Net Worth Assets: all items that have value Current Assets Items that are converted to cash within one year Examples: Cash, purchased seed/supplies, feeder livestock, grain on hand

Net Worth Statement Intermediate Assets Long Term Assets Items that are used for more than one year- up to 7,8 years Examples: Breeding livestock, machinery/equipment Long Term Assets 10-15 years and up Examples: Land, buildings

Net Worth Statement Liabilities: monetary obligations or debt ASSETS-LIABILITIES= Net Worth Current Liabilities Money owed within one year Examples: Accounts payable, operating loan balance

Net Worth Statement Intermediate Liabilities Long Term Liabilities Money owed beyond one year Examples: Remaining loan balance (under 10 years) Like a car payment Long Term Liabilities Money Owed on long term Mortgage Examples: Land, Long term building improvements (house loan)

Net Worth Statement Components Total Assets (TA) – Total Liabilities (TL) Also known as Owner’s Equity (OE)

Financial Analysis Types of Financial Analysis Comparative Analysis Projected Analysis Ratio Analysis

Financial Analysis Solvency Liquidity Profitability

Net Worth Statement Analysis Liquidity Ability to convert to cash Pay off short term debt Current Ratio (CR) = Current Assets (CA) Current Liabilities (CL) Intermediate Ratio (IR) = (CA + IA) (CL + IL)

Liquidity (having cash when needed) Current ratio = current assets current liabilities Working capital = (current assets - current liabilities)

LIQUIDITY Current ratio should be 2.0 or better Farms with continuous sales can have 1.5, but farms with infrequent sales may need 3.0 Working capital typically equals 25 % to 35 % of total expenses (annual)

Net Worth Statement Analysis Solvency Collateral: ability to pay off long term debt Net Capital Ratio = Total Assets (TA) Total Liabilities (TL) Debt to Equity Ratio (IR) = Total Liabilities Owner’s Equity Lenders typically loan amounts equal to or less than 50% of assets

SOLVENCY: Comparing assets to liabilities Net worth - $ Debt-to-asset ratio (or other ratio) Debt-to-asset ratios of 30 % to 40 % are typical, though many farms have no debt.

Leverage: degree in debt Total debt-to-asset ratio <---10%-------20%--------40%------60%--> low average high High leverage means the farm net worth will grow faster when margins are high and lose equity faster when margins are low.

Income Statements Provides information between points Receipts Expenses Operating (Variable) Fixed Net Cash Income = Gross Receipts (GR) – Cash Expenses (CE) Adjustments

Income Statement Analysis Operating Ratio = Operating Expenses Gross Income Fixed Ratio = Fixed Expenses Gross Ratio = Total Expenses

Income Statement Analysis Income to Investment Ratio Capital Turnover = (Unadjusted Gross Income + Non-cash Adjustments) Average Capital Investments Higher Ratio = quicker asset turnover At least 0.2 ratio desired

More Ratio Analysis Return on Equity Capital = Net Farm Income – Operator Allowance Return on Total Capital = (Net Farm Income + Interest) – Operator Allowance Rate of Return on Total Capital = Return on Capital Average Capital Investment

More Ratio Analysis Rate of Return on Equity Capital = Average Net Worth Rate of Return on Borrowed Capital = (Return on Total Capital – Return to Equity Capital) (Average Capital Investment – Average Net Worth) Comparisons

In the End… Ending Assets = Ending Liabilities = Ending Equity = Beginning Assets + Non-Cash Reinvestment + Change in Inventory – Depreciation Ending Liabilities = Beginning Liabilities + New Debt – Debt Paid Ending Equity = Beginning OE + Net Farm Income – Family Expenses – Taxes

Final Key Considerations Long Term Assets Appropriately Value—Be Conservative Net Worth Statements Base Values on Current Values not Market Values