3 Commit This Diagram to Memory Balance Sheet #1Cash FlowBalance Sheet #2Meeting financial obligationsGood old-fashioned recordkeepingFinancial SnapshotFinancial SnapshotWorking CapitalDebt/Asset RatioNet WorthWorking CapitalDebt/Asset RatioNet WorthIncome Statement(Profitability)Statement of cash flow (Sources and uses of money)We start by asking you to commit this image to your memory. This is how important financial documents fit together to give you information for making good decisions. The balance sheet is a single day of your business and personal wealth. Much like you take family pictures at a special time of the year and then line them up to see progress, this is the role of the balance sheet. A single day in time, one year apart, year after year establishes a trend for your business and personal life.The day to day financial activities are called cash flow, money deposited from sales of commodities, checks written to pay bills, etc. You might be checking your cash flow budget to see when you can expect to see money appear and disappear. It is pure professional to see a shortfall coming and deal with it instead of reacting to a shortfall and create stress. Cash flow is a plan to keep money productive moving you towards your goals. [AT THIS POINT YOU CAN SHARE RESOURCES LIKE RECORD BOOKS EITHER PAPER COPY OR ELECTRONIC, FAVORITE RECORDKEEPING SOFTWARE ETC. . . ]Once a year we stop to measure progress. That is the role of the income statement (NOT INCOME TAX). It tells us if the farm made money. Lenders will usually ask for Schedule F from your income tax filing as a substitute for an income statement, but think about it. For legitimate tax reasons and good tax planning you’ve just done everything in your power to make the income line low. The income statement reflects reality for a period of time, usually a year, and is an accrual accounting document which simply means you see all income and expenses in the year they were received or incurred. After doing an income statement, you can construct a statement of cash flow, which simply breaks down the SOURCES of income and USES of money. We won’t be going into this particular document with this lesson, but just so you know it’s there for the next in depth program we do with you.The income statement is the bridge between two balance sheets. Profits or losses from the operation will show up in the next balance sheet you construct. Profits add to net worth, losses reduce net worth. Other things that can affect your balance sheet are changes in inventory, grain, livestock, supplies, etc.; and the valuation of items at the time your put your balance sheet together. For example, your land was worth $100,0000 on the balance sheet from a year ago. Now, a year later when you are valuing your land again, it may be worth $105,000. These are assets that appreciate. Machinery assets and buildings/grain storage are depreciating assets so they will be less in value than the year before if you’ve done nothing to upgrade equipment. Okay, everybody got the image in your head?
4 Financial TermsVocabulary Handout & Benchmark HandoutLiquidity - working capital, current ratio and look to cash flow statementSolvency - what is left over after paying all debts; look to balance sheetProfitability - difference between expenses and incomeRepayment Capacity - generate cash to pay int. & prin.Financial Efficiency - percent of expenses to pay for interest, operating costs, depreciation, etc.
5 Cur rent Non Current Net Worth = Assets - Liabilities Balance Sheet as of [a single date] Consolidated Personal BusinessCur rentCurrent AssetsCurrent LiabilitiesNon Current AssetsNon Current LiabilitiesNon CurrentFor the purposes of this course we will be focusing on the balance sheet, training you to understand your current farm and family financial position.Lets look at the structure of a balance sheet and what we need to include in this document.Give me an example of something that fits into the current asset category.Net Worth or Owner EquityNet Worth = Assets - Liabilities
6 Net Worth = Assets - Liabilities Traditional Format Balance SheetCurrent Liabilities Operating loan, Int. & L.T. principal paymentsCurrent AssetsGrain, market hogsIntermediate AssetsCows, sows, plowsIntermediate LiabilitiesLong Term AssetsBuildings, LandPoint out that that some forms include an intermediate asset and liability sectionSome have assets at the top of a page and liabilities below.Long Term LiabilitiesNet Worth = Assets - Liabilities
7 Balance Sheet BasicsDone annually on the same date (kids’ school pictures)Some balance sheets are “Cost Basis”Some balance sheets are “Market Basis”Some are bothMost don’t include “Deferred Tax Liabilities”Note changes from adjustments in asset valuesNote that the spreadsheet printed in their book has an AG Deferred Taxes page. The information from that page (or worksheet) would then go into the AG Balance Sheet if they wanted to include the information for a more accurate snapshot of what it would take to convert those assets to cash.If the speaker is comfortable with the Deferred Tax Liabilities discussion they can expand a bit on the surprises that can result when depreciation is recaptured due to a transfer strategy or sale that isn’t properly executed.Have participants pull out the Balance Sheet Exercise, then assign the items to tables and give them a few minutes to find the numbers that are asked for. Five minutes should be sufficient, then another five minutes for participants to share where they found the information, and perhaps another 5-10 minutes of discussion on what each of the lines mean.
8 Key Ratios from the Balance Sheet Working CapitalCurrent RatioDebt/Asset RatioNet WorthWe are now going to look at some sample balance sheets and make some financial judgments using the four ratios you see on the screen.For this exercise a calculator will be helpful.Have the participants pull out page (page MTT notebook) with the AG Balance Sheet.They can also pull out the Farm Financial Ratios and Guidelines two page document or Financial Performance Measures (page MTT notebook) to assist them in the calculations. It may be just as easy for them to do the math on their slide notes lines.Note that the Financial Performance Measures has a column for them to compare their operation to similar operations, and ask them if their lender provides that service.Benchmark Ratios
9 Current RatioA ratio that measures the ability of the business to pay off current farm debts if current farm assets were soldCurrent Farm Assets / Current Farm Liabilities$1,197,000 / $111,021 = $10.78For every $1.00 of current debt there is $10.78 to pay itIf less than 1 you have problems!Refer to the page (page MTT notebook) with the AG Balance Sheet.Our example has $1,197,000 in current assets and $111,021 in current liabilities./ is What does that mean? Can this farm pay it’s current debt off?Some participants will have noticed the Current Asset to Debt Ratio (A/C) line in the lower right hand section of the balance sheet.
10 Working Capital (WC)The amount of operating capital available to the business in the short run to pay bills and support family living. Might think in terms of $/ crop acre or $/ cow.Current Farm Assets – Current Farm Liabilities = WC$1,197,000 - $111,021 = $1,085,979In our Ag Balance Sheet this is also calculated for them.It is Working Capital (A-C) $1,085,979.This provides an opportunity to pause and think about the different amounts that may be typical and why the amounts would be different. Attitudes toward liquidity, size of operation, age of operation, dominant enterprise, etcetera. Then if this is a cash grain area the multiple years of economic profits are an issue.You could have participants think about how this would have looked for their operation 5, 10, and 15 years ago. Then have them think about looking at the change in this number for their operation for the last five years with simple trend analysis.Have them think about this ratio for their beginning farmer and think about how certain asset transfer strategies could be limited by lower levels of working capital.
11 Measures of Solvency Debt to Asset Ratio Equity to Asset Ratio Debt to Equity RatioAll give the same information only in a different indexAll come from the balance sheetHow much of the business do you own compared to others?For now we’ll focus on the Debt to Asset Ratio.
12 Farm Debt to Asset Ratio The percentage of total assets financed by debtTotal Farm Liabilities / Total Farm Assets X 100$111,021 / $1,197,000 = .12 or 12% of assets are financedDebt to Asset is already on the balance sheet as Total Debt-to-Asset Ratio (D/B) 12%.When working with ratios always use the market value column of numbers.
13 Profitability Net Farm Income (from the Income Statement) Operating Profit Margin (Revenue less cash expenses)Here make sure you have the group. By that I mean make sure that you haven’t lost them with too much math or extrapolation.Visit with them about what these ratios tell you and which ones you use when looking at a farm’s capacity to take on another family without significant changes.Visit with the group about the ways shared management has improved the rate of return (better marketing, better cost control) or decreased the rate of return (increased costs – perhaps in hired labor as a way to provide cash flow to the incoming family).Ask them which of the measures they’ve used and which they’ve found misleading. You may get some surprising responses with insight that may stump you.
14 Net Farm IncomeNet farm income, as calculated by the accrual or inventory method, represents the economic return to your contributions to the farm business: labor, management, and net worth in land and other farm assets.Pull the Income Statement out of your book at page XXX (not in 2011 MTT notebook, but necessary and in the posted spreadsheet).See how similar it is to a Schedule F. The Cash Income and Cash Expenses even have (can come from IRS Schedule F) in the header.A farm income statement (sometimes called a profit and loss statement) is a summary of income and expenses that occurred during a specified accounting period, usually the calendar year for farmers. It is a measure of input and output in dollar values. It offers a capsule view of the value of what your farm produced for the time period covered and what it cost to produce it.Note that Net Farm Income (accrual) at the bottom RH of the statement is significantly different from the Net Farm Income (cash) in the far bottom RH corner. What could’ve been done to create more cash income? What happens when there’s a significant difference between the cash and accrual measures of Net Farm Income? (refer to Ag Deferred Taxes sheet if comfortable with that discussion)Note also that accrual adjustments require the prior year and current year numbers. This could be an opening to discuss accrual adjustments or not based on the interests of the group.
15 Uses of Net Farm Income Family Living withdrawal Pay Social Security and Income TaxesPay principle payments or investReturn to farm managementLook at this number long and hard. Envision two or three families needing to make family withdrawals on Net Farm Income. If the number will only support one family, what plans are there to expand the operation to make more money? How critical will off farm jobs be during the expansion times?
16 Net Income Farm Revenue (income) - Farm Expenses (costs) +/- Inventory Adjustments= Net Farm Income+ Non-farm Income= Total Net Income (before taxes)- Taxes Paid and Accrued= Net IncomeYou may wish to use this slide to get into the retirement planning income adjustments issue or the non-farm income adjustments issue. Or you may want to not use this slide.It may also be the entry point for a discussion on the expectation of Non-farm Income to make up the difference in Family Living Costs and Net Farm Income for the beginning farmer.It goes both ways, and it gets to the limitations when Net Farm Income is limited.
17 Efficiency Operating Expense Ratio Net Farm Income Ratio How much of revenue is used in production costs excluding principle and interest?Net Farm Income RatioHow much of revenue is left for you?As with ProfitabilityHere make sure you have the group. By that I mean make sure that you haven’t lost them with too much math or extrapolation. You may need to ask participants if they’ve had a discussion of these ratios with their lenders or not.As before, visit with them about what these ratios tell you and which ones you use when looking at a farm’s capacity to take on another family without significant changes.Operating Expense Ratio (from the two page summary of ratios) Shows the proportion of farm income that is used to pay operating expenses, not including principle or interest.For our farm that’s 62% . Is that good or bad? Look at the Farm Financial Performance Measures by Year (page 92 in 2011 MTT workbook)Net Farm Income Ratio (same source) Compares profit to gross farm income. It shows how much is left after all farm expenses, except for unpaid labor and management, are paid.For our farm that’s 35%. Again, good or bad? – Outstanding. Why, very little interest or depreciation.
18 Cash Flow (Timing of Money) A cash flow statement is a listing of cash flows that occurred during the past accounting period.A projection of future flows of cash is called a cash flow budget.Think of it as a “check book registry”.A business can have positive cash flow and make $A business can have positive cash flow and lose $A business can have negative cash flow and make $A business can have negative cash flow and lose $
19 Look up five years of data. Homework:Look up five years of data.Ask them to turn to page (96 in 2011 MTT workbook).
20 HomeworkLook at your most current Balance Sheet and calculate working capital, current ratio, debt to asset ratio and net worthTry to fill in a five year trend summary from past Balance SheetsIf you can’t find Balance Sheets try to find five years worth of income statements; if not, five years of income tax returns.