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Fearless Farm Finances

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Title: Fearless Farm Finances


1
Fearless Farm Finances
  • Organizing basic financial information balance
    sheet, income statement, understanding cash flows

Craig Chase, Field Specialist Farm Ag Business
Management
2
Plan for this session
  • Four reasons to develop a balance sheet, an
    income statement, and a statement of cash flows
  • We are going to cover these four reasons in our
    allotted time today.
  • However, we are going to work toward those
    reasons by asking and then answering common
    questions I hear from producers and comments I
    hear from lenders and financial analysts

3
Reason 1
  • How is your farm doing financially?
  • How much of your farm do you own?
  • How much money are you actually making farming?

4
Financial Condition and Profitability
  • Financial condition can be shown by the balance
    sheet (pp. 89-100).
  • Profitability can be illustrated by the income
    statement (pp. 101-109).
  • Understanding how cash comes in and out of the
    business can be illustrated by the cash flow
    statement (pp. 110-120).

5
Balance Sheet, as of 12/31/2012
  • Assets
  • Current Assets
  • Cash 15,000
  • Prepaid expenses 10,000
  • Accounts receivable 1,000
  • Supplies 6,000
  • Int/Long Term Assets
  • Machinery/equip 83,000
  • Real estate 140,000
  • Buildings/improve 35,000
  • Total Assets 290,000
  • Liabilities
  • Current Liabilities
  • Operating loan 10,000
  • Accounts payable 2,000
  • Current L/T debt 12,000
  • Int/Long Term Liabilities
  • Mach/equip loans 64,000
  • Real estate loans 82,000
  • Total liabilities 176,000
  • Net worth 114,000
  • Total Liab/Net Worth 290,000

6
Income Statement Yr ending 12/31/2012
  • Sale of crops 140,000
  • Other income 4,000
  • Gross Income 144,000
  • Car and truck, gas and oil, repairs 12,200
  • Depreciation 36,000
  • Fertilizer, Seed, Crop Inputs 19,800
  • Insurance, interest, repairs, taxes 18,400
  • Labor 24,600
  • Supplies 8,000
  • Utilities 8,000
  • Total Expenses 127,000
  • Net Income 17,000

7
Answers
  • Did you make any money?
  • Net income of 17,000
  • Net income plus depreciation of 53,000
  • How much of your farm do you own?
  • Net worth of 114,000
  • What do you think about these numbers?
  • What if the farm is 20 vegetable acres?
  • What if the farm is 10 vegetable acres?

8
Limitations
  • Balance sheet illustrates what is owned and owed
    at one point in time.
  • Income statement presents what was made over one
    time period.
  • Profitability and financial condition give you
    limited information regarding details of the
    farm.

9
Limitations
  • Size (scale) of farm affects how the results are
    interpreted.
  • Neither statement identifies potential problems
    with cash flow (pp. 110-120).

10
Exercises 1 and 2
  • Take 10 minutes answering exercises 1 and 2
    related to developing an income statement and
    balance sheet.

11
Balance Sheet, as of 12/31/2012
  • Assets
  • Current Assets
  • Cash 2,000
  • Supplies 1,500
  • Int/Long Term Assets
  • Machinery/equip 8,500
  • Real estate 25,000
  • Buildings/improve 6,000
  • Total Assets 43,000
  • Liabilities
  • Current Liabilities
  • Current L/T debt 2,000
  • Int/Long Term Liabilities
  • Real estate loans 12,000
  • Total liabilities 14,000
  • Net worth 29,000
  • Total Liab/Net Worth 43,000

12
Income Statement Yr ending 12/31/2012
  • Sale of shares 37,500
  • Other income (misc sales) 4,000
  • Gross Income 41,500
  • Direct cash operating expenses 25,000
  • Indirect cash operating expenses 5,000
  • Depreciation 4,500
  • Total Expenses 34,500
  • Net Income 7,000

13
Reason 2
  • How does your farm compare to other farms?
  • What are the strengths and weaknesses of your
    farm?
  • What could you do different to be more
    profitable?

14
Benchmarking
  • Benchmarking refers to comparing your numbers to
    other farms similar to yours.
  • For example, if your cost to produce your crops
    or livestock are high compared to others, then
    your budget should be evaluated carefully to
    determine where the costs are different and why.
  • Developing and understanding financial ratios is
    an excellent way to track your financial progress
    (pp. 122-138).

15
Comparing Financials A few ratios
  • Your farm
  • Current ratio 2.6
  • Debt-to-asset 21
  • Operating profit ratio 1
  • Asset turnover ratio 28
  • Operating expense ratio 76
  • Net income ratio 5
  • Benchmark
  • 2.24
  • 39
  • 26
  • 38
  • 59
  • 25

16
Comparing Financials
  • What are the strengths?
  • Balance sheet is strong current ratio and
    debt-to-asset.
  • What are the weaknesses?
  • Operating profit ratio, operating expense ratio,
    and net income ratio.
  • What could be done differently?
  • Evaluate operating expenses. Probably could make
    product mix and production changes.
  • Evaluate revenue compared to expenses.

17
Limitations
  • Whole farm analysis can only tell you in general
    where your strengths and weaknesses are.
  • Your operating expenses are too high, your
    overall production is too low. Works very well
    for simple farming operations (few enterprises).
  • Financial ratios give you a limited view of your
    farm - what specific management decisions can be
    made?

18
Exercises 3
  • Take 10 minutes answering exercise 3 related to
    developing ratios for your income statement and
    balance sheet.

19
Exercise 3 - Ratios
  • 1. Current ratio
  • Ans. 1.75 (3,500 / 2,000)
  •  2. Debt-to-asset ratio
  • Ans. 32 (14,000 / 43,000)
  •  3. Operating profit ratio
  • Ans. -10.4 ((7,000 700 12,000) / 41,500)

20
Exercise 3 - Ratios
  • 4. Asset turnover ratio
  • Ans. 96.5 (41,500 / 43,000)
  • 5. Operating expense ratio
  • Ans. 70.6 (41,500 7,000 700 - 4,500) /
    41,500
  •  6. Net income ratio
  • Ans. 16.9 (7,000 / 41,500)

21
Ratios
  • Keep in mind there are 21 commonly-used farm
    financial ratios that can be used to evaluate
    your farm.
  • Each has its place. For example when looking at
    increasing your debt (through a farm investment),
    you would want to analyze your term debt coverage
    ratios to determine how much debt your farming
    business can handle without increasing financial
    risk.

22
Reason 3
  • How much money can you borrow?
  • What will a lender think of your idea?
  • What information should you pull together to show
    your lender?

23
Risk Rating Scale
  • All lenders have a risk rating scale
  • Components of that scale may include
  • Ability to service (pay-off) debt
  • Net worth trend (positive or negative)
  • Current ratio
  • Debt-to-asset or equity-to-asset ratio
  • Character
  • Management ability
  • Collateral
  • Payment history (credit report)
  • Length of relationship with lender

24
Risk Rating Scale
  • Each component is weighted.
  • Ask your lender what goes into his/her scale.
  • Know what your numbers are that he/she uses.

25
A Tale of Two Farms
  • Farm A
  • Debt service 5
  • Net worth change 5
  • Current ratio 4
  • Equity-to-asset ratio 4
  • Character 5
  • Management ability 5
  • Collateral 5
  • Payment history 5
  • Relationship 5
  • Weighted Average Score 96
  • Premium
  • Farm B
  • Debt service 4
  • Net worth change 3
  • Current ratio 1
  • Equity-to-asset ratio 3
  • Character 3
  • Management ability 3
  • Collateral 5
  • Payment history 4
  • Relationship 4
  • Weighted Average Score 72
  • Average

26
Answers It Depends
  • If you are a Premium it is much easier to find
    a lender and get a better deal.
  • If your lender knows something about your
    business, is willing to actively learn, and make
    a farm visit at least once per year.
  • If you come prepared (financials completed), know
    financial terms, and ask questions about
    borrowing options.
  • If you find out what you need to do to get a
    better deal shop around.

27
Cash Flow Statement
  • Cash flow statement is often the forgotten
    statement.
  • Question to be answered is is there enough cash
    flowing into your business to cover the expenses
    occurred by your business? If not, then what are
    you going to do about it?
  • Remember that profitability and cash flow are not
    the same thing you can be profitable and have a
    negative cash flow and vice versa (p. 112).

28
Cash Flow Statement
  • Turn to page 114 of the Fearless Farm Finances
    book
  • Three sections
  • Cash flow from operations
  • Cash flow from investing
  • Cash flow from financing

29
Cash Flow Statement
  • How did Otto do?
  • How did this year compare to earlier years and to
    the cash flow budget developed at the beginning
    of the year (cash flow budget is different)? Why
    would this be important?
  • Did Otto replace the right amount of capital or
    did he intentionally not invest because it would
    put him in a negative cash flow?

30
Summary
  • Income statements and balance sheets can make
    your decisions much easier.
  • Cash flow statement indicates whether your farm
    is bringing in more cash than expending.
  • They can also point to both strengths and
    weaknesses in your farm.

31
Summary Step 1 A few ratios
  • You start with a few ratios
  • Current ratio 2.6 good
  • Debt-to-asset 21 good
  • Operating profit ratio 1 low
  • Asset turnover ratio 28 low
  • Operating expense ratio 76 high
  • Net income ratio 5 low
  • You decide to see if you can lower your expenses
    and raise your revenues to improve your ratios
    related to the income statement.

32
Summary
  • Spend the time to pull together some financial
    numbers it will likely be the best investment
    you have ever made.
  • Spend time understanding your numbers and looking
    at possible improvements (we all have strengths
    and weaknesses).
  • Always keep in mind your financial farm goal and
    your questions and work through your records to
    find your answers

33
And the Fourth Reason.
  • Taxes
  • But dont make management decisions solely on tax
    management. Make them because it is a good
    business decision and it will lead you toward
    your overall income goal.

34
Last Thoughts
  • You should develop an annual budget for your farm
    and then monitor it (pp. 199-218).
  • You should go over factors to improve profits
    (pp. 139-144) for ideas on how to improve your
    profitability.

35
Questions..
  • Any questions or comments?
  • Thank You for This Opportunity!
  • Craig A. Chase
  • Marketing Food System Initiative Program Leader
  • Iowa State Local Food and Farm Program
    Coordinator
  • Farm Management Local Food Systems and
    Alternative Enterprises
  • 209 Curtiss Hall
  • Iowa State University
  • Ames, IA 50011
  • (515) 294-1854
  • cchase_at_iastate.edu

http//www.extension.iastate.edu/agdm/fieldstaff/c
chase.html
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