2. Slides Show Summary AGEC 432 Spring 2007

3. Basic Structure of the Balance Sheet Assets: Liabilities and Net Worth: Current assets Current liabilities plus Intermediate assets plus Intermediate liabilities plus Long term assets plus long term liabilities (residual value) plus Net worth (residual value) equals Total assets equals Total liabilities and net worth Assets: Liabilities and Net Worth: Current assets Current liabilities plus Intermediate assets plus Intermediate liabilities plus Long term assets plus long term liabilities (residual value) plus Net worth (residual value) equals Total assets equals Total liabilities and net worth

4. Basic Structure of Income Statement Value of farm production Minus Farm expenses Equals Income from operations Plus Gain (loss) on sale of intermediate and long term assets Equals Net farm income Plus Non-farm income Equals Income (loss) before taxes and extraordinary items Minus Provision for income taxes Equals Income before extraordinary items Plus Extraordinary items Equals Net income Value of farm production Minus Farm expenses Equals Income from operations Plus Gain (loss) on sale of intermediate and long term assets Equals Net farm income Plus Non-farm income Equals Income (loss) before taxes and extraordinary items Minus Provision for income taxes Equals Income before extraordinary items Plus Extraordinary items Equals Net income

5. Basic Structure of Cash Flow Statement Cash available MinusCash required Equals Cash available less cash required Plus Savings withdrawals Equals Cash position Plus Net borrowing Minus Other uses of cash Minus Additions to savings Equals Ending cash balance Cash available MinusCash required Equals Cash available less cash required Plus Savings withdrawals Equals Cash position Plus Net borrowing Minus Other uses of cash Minus Additions to savings Equals Ending cash balance

6. Monthly Cash Position January February March Cash available Less Cash required Plus Savings withdrawal Equals Cash position A monthly cash flow statement indicates months of cash flow and surpluses or deficits before borrowing on a LOC… The value of the LOC to request is at least equal to the highest monthly cash flow deficit. A monthly cash flow statement indicates months of cash flow and surpluses or deficits before borrowing on a LOC… The value of the LOC to request is at least equal to the highest monthly cash flow deficit. ? ? ?

7. Repayment Capacity from Operations Debt Repayment Capacity Report Farm sources of term debt repayment capacity: Net income Adjustments to net income: PlusDepreciation Less Gain (loss) on sale of assets Less Non-farm income Less Family living withdrawals Less Gifts to others Subtotal Term debt repayment capacity from operations $0 + Repayment margin = repayment capacity – scheduled payments Coverage ratio > 1.0 if repayment margin is positive

8. Slides from Show #2

9. 2006 Cash Flow Statement Sources of cash: Beginning cash balance Cash receipts from product sales Other sources of cash Total sources of cash Uses of cash: Cash operating expenses Interest payments Principal payments Capital expenditures Withdrawals of cash Other selected uses of cash Ending cash balance Total uses of cash Basic structure: Total sources = total uses 2006 Income Statement Cash receipts from product sales Other income Total income Cash operating expenses Interest payments Other cash expenses Depreciation Total expenses Net income from operations Allowance for taxes Net income Basic structure: EBIT = total income – total expenses + interest payments Interrelationships Between Financial Statements Balance Sheet 12/31/06 Ending cash balance Other current assets Total current assets Machinery and equipment Buildings and improvements Land Total assets Accounts payable Current loan payment Allowance for taxes Other current liabilities Total current liabilities Remaining balance on loans Total liabilities Equity Basic Structure: Equity = total assets – total Liabilities  Equity = Retained net Income + asset revaluations Other statements and schedules: Statement of Change in Owner Equity Depreciable asset schedules

10. In Class Problem See Problem #1 under Quizzes and Exams link on Website

11. Slides from Show #3 None… Demonstrated impacts of price and yield shocks to financial statements and financial indicators.

12. Slides from Show #4

13. Lessons from Beaver Study Indicators of growth/survival:Indicators of growth/survival: –Increasing liquidity –Increasing solvency –Increasing debt repayment capacity –Increasing profitability Indicators of potential failure:Indicators of potential failure: –Declining liquidity –Declining solvency –Decreasing debt repayment capacity –Decreasing profitability

14. Trends in Indicators Failed Source: W. H. Beaver, “Financial Ratios and Predictors of Failure”, Journal of Accounting Research

15. Historical Analysis A look backwards like the Beaver study. Comparison of current performance with past performance. Recommend doing this at the enterprise level as well as for the farm as a whole. declines in last two years?Reasons underlying unwanted trends such as the declines in last two years?

16. Comparative Analysis Comparing current performance with similar operations like the Beaver study. Benchmark analysis at enterprise level when possible. Similar firms Your firm

17. Comparative Analysis Comparing current performance with similar operations like the Beaver study. Benchmark analysis at enterprise level when possible. before it is too lateAddress reasons why your firm is performing more poorly than other comparable operations before it is too late.

18. Comparative Analysis Comparing current performance with similar operations like the Beaver study. Benchmark analysis at enterprise level when possible. before it is too lateAddress reasons why your firm is performing more poorly than other comparable operations before it is too late.

19. Comparative Analysis Comparing current performance with similar operations like the Beaver study. Benchmark analysis at enterprise level when possible. before it is too lateAddress reasons why your firm is performing more poorly than other comparable operations before it is too late.

20. Comparative Analysis Comparing current performance with similar operations like the Beaver study. Benchmark analysis at enterprise level when possible. before it is too lateAddress reasons why your firm is performing more poorly than other comparable operations before it is too late.

21. Comparative Analysis Comparing current performance with similar operations like the Beaver study. Benchmark analysis at enterprise level when possible. before it is too lateAddress reasons why your firm is performing more poorly than other comparable operations before it is too late.

22. Sources of Uncertainty Global trends in production and consumption Energy prices and core inflation trends Interest rates and exchange rates WTO and the 2007 farm bill

23. Slides from Show #5

24. Comparison of Cost Systems Features Job Order Cost System Process Cost System Work in process accounts One work in process account Multiple work in process accounts Documents usedJob cost sheetsProduction cost reports Determination of total manf. costs Each jobEach period Unit-cost computations Cost of each job/ units produced for the job Total manf. costs/ units produced during the period

25. Comparison of Cost Systems Features Job Order Cost System Process Cost System Work in process accounts One work in process account Multiple work in process accounts Documents usedJob cost sheetsProduction cost reports Determination of total manf. costs Each jobEach period Unit-cost computations Cost of each job/ units produced for the job Total manf. costs/ units produced during the period

26. AB Overhead Rate AB Overhead rate = Overhead per activity ÷ Cost driver per activity Initial status: Activity Cost PoolOverhead Driver AB overhead activity rate Setting up machines$300,000 1,500 setups $200/setup Machining$500,000 50,000 hours $10/hour Inspecting$100,000 2,000 inspection $50/inspection Total$900,000 Step 1: Assigning overhead driver activity to products: Activity Cost PoolCost driver Driver Product 1 Product 2 activity 500 1,000 Setting up machines# setups 1,500 500 1,000 30,000 20,000 MachiningHours 50,000 30,000 20,000 500 1,500 Inspecting# inspections 2,000 500 1,500

27. AB Overhead Rate Step 1: Assigning overhead driver activity to products: Activity Cost PoolCost driver Driver Product 1 Product 2 activity Setting up machines # setups 1,500 500 1,000 Machining Hours 50,000 30,000 20,000 Inspecting# inspections 2,000 500 1,500 Step 2: Partitioning of overhead: Overhead Product 1 Product 2___ Setting up machines$300,000 (33%) $100,000 (67%) $200,000 Machining$500,000 (60%) $300,000 (40%) $200,000 Inspecting$100,000 (33%) $25,000 (67%) $75,000 33% = 500/1,500 and 67% = 1,000/1,500

28. AB Overhead Rate Step 2: Partitioning of overhead: Overhead Product 1 Product 2 Setting up machines$300,000 $100,000$200,000 Machining$500,000 $300,000$200,000 Inspecting$100,000 $25,000 $75,000 Total$900,000 $425,000 $475,000 Step 3: Overhead costs per unit: Units produced25,000 5,000 Overhead cost per unit $17 $95 Traditional overhead cost per unit* $30 $30 * $900,000 divided by 30,000 units Avoids overstating profitability of some enterprises and understating profitability of others

29. AB Overhead Rate Product 1 Product 2 COP unit costs with ABC costing: Direct materials $40 $30 Direct labor $12 $12 ABC overhead $17 $95 Total unit costs $69 $137 COP unit costs with traditional costing: Direct materials $40 $30 Direct labor $12 $12 Traditional overhead * $30 $30 Total unit costs $82 $72 * $900,000 divided by 30,000 units which is not true! Traditional overhead costing suggests that Product 2 is cheaper to produce than Product 1, which is not true!

30. Slides from Show #6

31. Annual Budget Preparation Annual operating budgetsAnnual operating budgets –Sales budget: number of units sold –Production budget: output and inventory –Direct materials budget: materials used –Direct labor budget: labor used –Other budgets: selling and administrative –Prepare cash budget Other annual budgets and statementsOther annual budgets and statements –Capital expenditure budget –Prepare budgeted cash flow statement –Prepare budgeted income statement –Prepare budgeted year end balance sheet

32. Sales Budget Production Budget Direct Materials Budget Direct Materials Budget Direct Labor Budget Direct Labor Budget Overhead Budget Overhead Budget Selling and Administrative Expense Budget Selling and Administrative Expense Budget Budgeted Income Statement Budgeted Income Statement Capital Expenditure and Cash Budgets Capital Expenditure and Cash Budgets Budgeted Cash Flow Statement Budgeted Balance Sheet Budgeted Balance Sheet

33. Slides from Show #7 None … showed sensitivity of break even prices and yields to changes in unit costs of production

34. Slides from Show #8

35. PASTFUTURE PRESENT  Historical analysis  Comparative analysis  Historical price and yield trends  Pro forma analysis  Forming expectations about future prices, costs and productivity  Ad hoc extrapolations  Projections based upon available outlook data  Projections based upon econometric analysis

36. Ad Hoc Modeling Approaches Naïve model – using last year’s prices, costs and yields Simple linear trend extrapolation of historical prices, costs and yields Using assumptions made by others

37. Econometric Model Approach Capturing future supply/demand impacts on prices and unit costs Linkages to commodity policy Linkages to domestic economy Linkages to the global economy

38. 2000 2001 2002 2003 2004 2005 2006 Timeline Required for Capital Budgeting… Assume it is the year 2000 and John Deere wants to project farm machinery and equipment sales over the next six years to determine if plant expansion is necessary. farm Capital budgeting models of investment decisions require projections of the annual farm revenue and cost values over the entire 2001 to 2006 time period.

39. Crop Market Equilibrium D S D S Quantity Price PePe QeQe D S Demand consists of: -Food use -Feed use -Exports -Ending stocks Demand consists of: -Food use -Feed use -Exports -Ending stocks Supply consists of: -Beginning stocks -Production -Imports Supply consists of: -Beginning stocks -Production -Imports

40. Steps to Forecasting Crop Price Develop econometric equations for domestic uses, exports and ending stock demand. Develop econometric equations for production and import supply. (Q D =Q S ) excess demand equals zero Substitute the estimated equations into the market equilibrium definition (Q D =Q S ) and solve for the price where excess demand equals zero.

41. Conclusions Econometric models are preferred over naïve models and linear time trend models. Much more accurate. elasticities Provide much more information (e.g., elasticities). sensitivity analysis potential variability Allow for sensitivity analysis with independent (exogenous) variables when evaluating potential variability about expected trends.

42. 23 Key Terms to Know

43. Some Key Terms 1. Three types of liquidity (HO #1) 2. Solvency (HO #1) 3. Debt repayment capacity (HO #1) 4. Explicit and implicit cost of capital (HO #5) 5. Optimal capital structure (HO #1,5) 6. Historical and comparative analysis (HO #1) 7. Long run planning curve (HO #2) 8. Financial risk (HO #2,5) 9. Payback period (HO #3) 10. Internal rate of return (HO #3)

44. More Key Terms 11. Economic life (HO #3) 12. Terminal value (HO #3) 13. Pro forma analysis (HO #4) 14. Structural econometric simulation (HO #4) 15. Coefficient of variation (HO #5) 16. Required rate of return (HO #5) 17. Business risk premium (HO #5) 18. Financial risk premium (HO #5)

45. More Key Terms 19. Leverage (HO #1 and #5) 20. Portfolio effect (HO #5) 21. Negatively correlated cash flows (HO #5) 22. Weighted average cost of capital (HO #5) 23. Capital budget constraint (HO #5)