Oklahoma State University Department of Agricultural Economics Oklahoma State University

 Increase the instruction of agricultural economics in Oklahoma high schools  Extend the skill set of high school ag teachers  Increase high school students (future ag producers and business leaders) knowledge of agricultural economics ◦ By extension, reach their parents  Increase interest in agricultural economics degrees and courses Oklahoma State University

 This is the first of a series of continuing education opportunities for high school ag educators  Over next two years, we are committed to offering curricula and training to at least 250 high school ag teachers ◦ Obligated under two federal grants  We will be delivering annual, on-campus in- services each summer ◦ Series of modules to be used in high schools Oklahoma State University

 Budgeting! ◦ If a business plan does not work on paper, it will NOT work in practice  Tools ◦ Enterprise budgeting (covered here) ◦ Cashflow budgeting (covered here) ◦ Partial budgeting ◦ Whole farm budgeting ◦ Capital budgeting ◦ Projected financial statements  Balance sheets (covered here) Oklahoma State University

 A budget is a forecast ◦ It is forward looking  A statement is a historical document ◦ Looks back in time ◦ Or, is a snapshot of the current situation  This module will look at BUDGETING ◦ The basis of farm business planning  Also introduce the basics of Ag. Law ◦ What does every farmer/rancher need to know? Oklahoma State University

 All documents are provided on CD ◦ Includes the case study and problem sets + keys  This PowerPoint is on the CD ◦ Cut-n-paste as needed!  OSU Cooperative Extension Service (CES) Factsheets with more information ◦ OK Beginning Farmer Loan Program ◦ Budgeting and balance sheets  Information on our degrees and careers in agricultural economics Oklahoma State University

 All lessons are based on a common case study  High school freshman with a show heifer  Wants to expand her “herd” ◦ Buy a bred cow ◦ Needs beginning farm loan, line of credit ◦ Must supply business plan to bank  Students will be taught the tools and then use them to analyze the case study Oklahoma State University

 Owns ◦ Show heifer, current value $1000 ◦ Blower, current value $300 ◦ $500 cash  Purchase a bred cow for $750 in January ◦ Calve in February ◦ Wean in October, Sell in December after preconditioning Oklahoma State University

 Annual planning process  Develop alternative production, marketing and financing plans  Compare alternatives using budgeting tools ◦ Partial, Enterprise, Whole farm, Cash flow & Capital budgeting  Implement plan + revise as situation warrants  Observe results—Financial Statements  Assess successes/failures—Analysis  Repeat annually Oklahoma State University

 Concerned with the economic ADVISABILITY of a production alternative ◦ Corn, soybeans, hogs, cattle,…  Projects returns to Unpaid factors of production and management  Unpaid factors ◦ Family labor ◦ Owner’s equity ◦ Some fixed inputs if can’t allocate expenses Oklahoma State University

 Compare alternate enterprises ◦ RoundUp Ready vs. Conventional canola ◦ Canola vs. Wheat ◦ Grass stockers vs. Hay production/sale  Compute breakeven price and production ◦ What sales price do returns = 0? ◦ What output level do returns = 0? Oklahoma State University

 Historical costs and production—if you have historical production!  Published data ◦ Experiment Station data ◦ OK CES ◦ Online budgets  OSU Budget generator—Need access? Call us! (  National Budget library ( Oklahoma State University

 Revenues ◦ Cash  Sales  Services ◦ Non-cash  Increase in the value of raised breeding livestock  Expenses ◦ Cash ◦ Non-cash  DEPRECIATION  Returns to unpaid labor, management and capital = Revenues - Expenses Oklahoma State University

 Cash sales ◦ Quantity sold × price ◦ Examples:  100 bushels of corn × $3.40 = $340  260 pound hog × $0.75 = $195  4 tons of hay × $40 = $160  Cash received for services ◦ Example: custom work  Government program payments ◦ Subsidies ◦ Crop insurance proceeds Oklahoma State University

 Raised and gifted breeding stock can increase in value  For example, value increases ◦ Heifer to Bred heifer ◦ Bred heifer to 1 st calf heifer ◦ 1 st calf heifer to 3-year old  Use additional production expenses at each step to adjust value (non-cash revenue) Oklahoma State University

 Feed, fuel, veterinary, utilities, insurance, property taxes, hired labor, seed, fertilizer, rent,…  Interest on operating expenses ◦ Paid on percent of operating expenses that are financed with debt ◦ Note, “interest on percent financed with equity is a non-cash expense (Opportunity cost)  NOT AN EXPENSE—Principal payments! Oklahoma State University

 How to estimate operating interest  Sum cash operating expenses/2  Multiply by the interest rate/12  Multiply by the number of months $s are borrowed  Multiply by the percent debt financed  Cash operation/2 × Interest/12 × months × percent financed  = operating interest expense Oklahoma State University

 $500 cash expenses, 50% debt financed  8 months in growing season  7% interest rate  Calculation ◦ $500/2 × 0.07/12 × 8 × 0.5 = $5.83 average Monthly # % financed investment interest months rate Oklahoma State University

 Durable (long-lived assets) decrease in value over time due to wear and obsolescence ◦ Exception—NO DEPRECIATION FOR LAND  Use STRAIGHT LINE depreciation method for class purposes ◦ Other methods for TAXES

 Annual depreciation expense =  (Purchase price – salvage value)/useful life  Example: ◦ Purchase tractor for $100,000 ◦ Sell after 6 years for $40,000 ◦ Annual depreciation = ◦ ($100,000 – $40,000)/6 years = ◦ $60,000/6 years= $10,000/year Oklahoma State University

 Breakeven sale price ◦ Sale price where revenue = expense ◦ Computed as Total expense/output ◦ Example: Hog production cost $130 per head and each hog weighs 260 pounds at sale  BE Price = $130/260 pounds = $0.50 per pound  Breakeven output (production) level ◦ Output level where revenue = expense ◦ Computed as Total expense/sale price ◦ Example: Hog sale price = $0.65 per pound ◦ BE output = $130/$0.65 per pound = 200 pounds Oklahoma State University

 To get beginning farm loan needs an enterprise budget  Revenue ◦ Sell calf in December for $693 ◦ Increase in value of heifer = production costs for the year  Feed = $172.80, Vaccinations = $4, Parasite control = $4  Total = $ Oklahoma State University

 Expenses ◦ Heifer feed $ ◦ Cow feed $88.20 ◦ Calf feed $21.60 ◦ Parasite control $10 ◦ Vaccinations $16 ◦ Ear tag $1 ◦ Depreciation  Blower  Purchase cow Oklahoma State University

 Depreciation—blower ◦ Purchase price = $300 ◦ Salvage value =$200 ◦ Useful life = 5 years ◦ Annual depreciation = ($300-$200)/5 = $20/year  Cow depreciation ◦ Purchase price = $750 ◦ Salvage value = $470 ◦ Useful life = 7 years ◦ Annual depreciation = ($750-$470)/7 = $40/year Oklahoma State University

 Interest on operating ◦ 100% financed ◦ Cash operating expenses = $ ◦ 5% Interest rate ◦ 12 months financing  Calculation ◦ Operating interest = /2 × 0.05/12 × 12 = $7.74  Interest on long-term debt ◦ $250 × 0.05 = $12.50 Oklahoma State University

Revenue Calf sales$ Increase in value of raised breeding livestock$ Total revenue$ Expenses Feed purchases$ Grazing expenses Veterinary expenses$ Other cash expenses (ear tag)$ 1.00 Depreciation$ Operating interest$ 7.74 Interest on long-term debt$ Total Expenses$ Returns to Unpaid Labor, Management and Equity Capital$483.96

 BE Price = $390/630 pounds = $0.62/ pound  BE Output = $390/$1.10 per pound = 355 pounds Oklahoma State University

 Cash flow budgeting is concerned with FEASIBILITY of an enterprise ◦ Is sufficient cash generated to meet obligations generated by the project?  Long-term investments often have a negative cash flow, e.g., land purchases, until debt retired ◦ Subsidize cash flow with other enterprises, e.g., off-farm income Oklahoma State University

 Focus is on CASH  Include ALL sources of cash and ALL uses of cash  Sources of cash: ◦ Full sale price of land, buildings, machinery, breeding stock, feeder livestock, crops ◦ Government program payments, crop insurance ◦ Starting cash balance ◦ Off-farm income ◦ Gifts & inheritances ◦ Proceeds from planned borrowing Oklahoma State University

 Uses of cash ◦ Cash expenses ◦ Full purchase price of land, buildings, equipment, breeding stock ◦ Principal payments ◦ Interest payments ◦ Family living expenses Oklahoma State University

 Can a project cash flow but not be profitable? ◦ Yes! ◦ Depreciation is NOT a cash flow but is an expense ◦ So profit can be negative even though project cash flows!  Can a project be profitable but not cash flow? ◦ Yes! ◦ Principal payments are NOT an expense but are a cash demand ◦ So cash flow can be negative while profit > 0! Oklahoma State University

 Megan’s banker wants to see a cash flow budget  Starting point: Enterprise budget ◦ What are the sources of cash? ◦ What are the uses of cash? Oklahoma State University

 Any additional sources of cash? ◦ Planned loan proceeds  Cow note  Operating note  Any additional uses of cash? ◦ Principal payments  Cow note  Operating note Oklahoma State University

Sources of cash Beginning cash balance$ Livestock sales$ Proceeds-cow note$ Proceeds-operating note$ Total sources of cash$ Uses of cash Cash expenses$ Breeding stock purchases$ Principal payments$ Interest payment long-term$ Operating note repayment$ Interest on operating note$ 7.74 Total uses of cash$ Net cash surplus or deficit$

 A balance sheet is a systematic listing of everything ◦ Owned (assets) ◦ Owed to others (liabilities) ◦ Owner’s equity (net worth) ◦ Basic identity: Assets = Liabilities + Owner equity ◦ Or, Assets – Liabilities = Owner equity  A “snapshot” of the business’ financial health ◦ Several years’ balance sheets measure long-term success of business  Current and Non-current assets and liabilities Oklahoma State University

 Current assets--“liquid” assets ◦ Assets that can be sold without affecting long-term profit-generating capacity ◦ Cash and near cash assets  Bank account balance, certificates of deposit ◦ Owned and sold within one year  Feeder livestock, crops, assets held for sale ◦ Assets to be used up in production process in less than one year  Inventories of fuel, chemicals, feed, parts,… ◦ Other  Cash invested in growing crops and feeder livestock Oklahoma State University

 Cannot be sold (liquidated) without harming long-term profit-generation capacity ◦ Land, breeding stock, machinery, buildings ◦ Stock in agricultural cooperatives  Difficult to sell quickly and realize full market value ◦ How low would you need to price your house to sell it TODAY? Oklahoma State University

 Financial obligations that are payable (due) within 12 months ◦ Charge account balances (feed store, chemical dealer) ◦ Operating note balance ◦ Accrued property taxes ◦ Accrued interest on long-term debt ◦ Loan payments due in next 12 months  Current portion of long-term debt Oklahoma State University

 Portion of long-term debt due in 12+ months  Note, need to calculate ◦ Principal balance (i.e., total amount owed) – amount owed in next 12 months (current portion)  Example: $100,000 note ◦ Payment required in next 12 months = $8,000 ◦ Current liability = $8,000 ◦ Non-current liability = $92,000 Oklahoma State University

 Computed as ◦ Owner’s equity = Total assets – Total liability  Sources of Owner’s equity ◦ Contributed capital  $s invested from outside the business ◦ Retained earnings  Profit that has not been taken out of the business by the owner(s) ◦ Change in market value of assets  Land value trends up over time Oklahoma State University

 Cost-basis balance sheet ◦ Non-current assets valued at  Cost – accumulated depreciation ◦ All other assets at market value ◦ Used to measure businesses performance over time  Market-basis balance sheet ◦ All assets valued at market value ◦ Used to measure liquidation value of the business ◦ Use for class assignments Oklahoma State University

Current assetsCurrent liabilities Cash, near-cash, supplies, accounts receivable, crops held for sale, livestock held for sale, cash invested in growing crops $Accounts payable, accrued taxes (property), operating note balance, accrued interest, current portion of long-term debt $ Non-current assetsNon-current liabilities Machinery, equipment, breeding livestock, fencing, land $Non-current portion of machinery and equipment notes, non- current portion of breeding stock notes, non-current portion of mortgages $ Total assets$Total liabilities$ Owner’s equity$ Total liabilities + Owner’s equity $ Balance sheet format

Oklahoma State University  Solvency measures the business’ ability to payoff all financial obligations  Debt-to-asset ratio (D/A) = portion of assets “owed” to creditors  Equity-to-asset ratio (E/A)= portion of assets “owned” by the business owners  Debt-to-equity ratio (D/E)= relative portion of debt financing to equity financing ◦ Also call “leverage ratio”

Oklahoma State University  Want D/A to be small  Want E/A to be big ◦ Can never be over 1.0  Want D/E to be small ◦ Can never be less than 0

Oklahoma State University  Working capital = current assets – current liabilities ◦ Want > 0  Current ratio = Current assets / current liabilities ◦ Want > 1 ◦ Businesses with lots of sales will have a high current ratio

 At the beginning of the year Megan owns ◦ Heifer $1000 ◦ Blower $300 ◦ Cash $500  Has no debt Oklahoma State University

Current assetsCurrent liabilities Cash$500Total current liabilities$0 Total current assets$500Non-current liabilities Non-current assetsTotal non-current liabilities $0 Blower$300Total liabilities$0 Heifer$1000Owner’s equity$1800 Total non-current assets $1300 Total Assets$1800Liabilities + Owner’s equity $1800 Oklahoma State University

 Assets ◦ Cash balance $??? (Where do you get this?) ◦ Heifer $1200 ◦ Bred cow $800 ◦ Blower $250  Liabilities ◦ Operating note balance $??? ◦ Cow note balance $???  Current portion & Non-current portion  Then compute Owner’s equity Oklahoma State University

 Cash balance $287 (see cash flow budget)  Operating note balance $0 (paid off in Dec.)  Total on cow note: ◦ Borrowed $250 ◦ Paid $79 in December ◦ Owes $171  Current portion $83  Non-current portion $88 Oklahoma State University

Projected of end of year balance sheet Current assetsCurrent liabilities Cash $284 Operating note $0 Cow note payment $83 Total current assets $284 Interest on cow note $9 Non-current assets Total current liabilities $92 Blower $250 Non-current liabilities Show heifer $1,200 Cow note $88 Cow $800 Total non-current liabilities $88 Total non-current assets $2,250 Total liabilities $180 Total assets $2,534 Owner’s equity $2,354 Total liabilities + Owner’s equity $2,534

Oklahoma State University  End-of-year solvency measures ◦ D/A= $180/$2534 = 0.07 ◦ E/A = $2354/$2534 = 0.93 ◦ D/E = $180/$2354 = 0.08  End-of-year liquidity measures ◦ Working capital = $284 - $92 = $192 ◦ Current ratio = $284/$92 = 3.09

 The manuscript contains links to online resources  The binder contains OSU Extension factsheets with more examples  Call! We’ll be glad to help you out!

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