Using financial records

1
Using financial records

• To answer all sorts of questions you or others
  may have

Craig Chase, Field Specialist Farm Ag Business
Management
2
Plan for today

• Quickly review goal setting and planning
• Six reasons to keep financial records
• We are going to cover these six 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
Goal Setting and Planning

• How much production do I need to have?
• How big do I need to be (number of acres, head of
  livestock, etc.)?

4
Issue of Scale

• Assume you want to grow vegetables.
• You also want to make 30,000 per year net
  income.
• Question How many acres do you need to have in
  production?

5
Issue of Scale

• Assume your goal is to have a net income ratio of
  30 percent.
• Gross revenue would need to be 100,000 (30,000
  / 30).
• Number of acres assuming 15,000 gross revenue
  per acre would need to be 6.7 (100,000 /
  15,000).
• (e.g. 15,000 50 shares/acre _at_ 300 / share)

6
Additional Planning Needs

• What will my labor, equipment, and land needs be
  as I expand?
• How do I decide where to invest my money first?
• What do I do when things dont go as planned (pp.
  31-42)?

7
Reason 1

• How is my farm doing financially?
• How much of my farm do I own?
• How much money am I actually making farming?

8
Financial Condition and Profitability

• Financial condition can be shown by the balance
  sheet.
• Profitability can be illustrated by the income
  statement.
• Both of these statements need to be for your
  entire farming operation.

9
Balance Sheet, as of 12/31/2011

• 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

10
Income Statement Yr ending 12/31/2011

• 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

11
Answers

• Did I make any money?
• Net income of 17,000
• Net income plus depreciation of 53,000
• How much of my farm do I 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?

12
Limitations

• Balance sheet illustrates what is owned and owed
  at one point in time (pp. 89-100).
• Income statement presents what was made over one
  time period (pp. 101-109).
• Profitability and financial condition give you
  limited information regarding details of the
  farm.

13
Limitations

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

14
Exercises 1 and 2

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

15
Balance Sheet, as of 12/31/2011

• 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

16
Income Statement Yr ending 12/31/2011

• 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

17
Reason 2

• How does my farm compare to other farms?
• What are the strengths and weaknesses of my farm?
• What could I do different to be more profitable?

18
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).

19
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

20
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.

21
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?

22
Exercises 3

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

23
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)

24
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)

25
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.

26
Reason 3

• How much money can I borrow?
• What will a lender think of my idea?
• What information should I pull together to show
  my lender?

27
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

28
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.

29
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

30
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.

31
Reason 4

• Can I do a better job of production (can I be
  more efficient)?
• Which crops (livestock) should I grow (raise)?
• How do I price my product(s)?
• Which market(s) makes the most sense?

32
Enterprise Budget

• An enterprise budget is an estimate of costs and
  returns to produce a product (pp. 160-172).
• For producers who grow a large number of
  different products.
• Develop budgets for those products that
  contribute the most to business goals.

33
Enterprise Budget

• Or start with an enterprise budget for each major
  part of your business.
• Example, CSA with poultry/livestock. Complete a
  CSA and livestock budget.
• CSA with multiple seasons and use of high
  tunnels/greenhouses. Complete an enterprise
  budget for each season (spring, summer, fall) or
  production system (open ground, high tunnel,
  greenhouse).
• The process is the same for all scale of farming
  operations.

34
Simplified Enterprise Budget

• Salad Greens (4x100 ft bed)
• Revenue 30 lbs _at_ 5.00/lb 150.00
• Crop inputs (Seed, fertilizer, etc.)
  7.00
• Labor 28.00
• Supplies 1.00
• Ownership (machinery, land, irrigation) 11.00
• Total cost 47.00
• Return over total cost 103.00

35
Simplified Enterprise Budget

• Green Beans (4x100 ft bed)
• Revenue 120 lbs _at_ 3.00/lb 360.00
• Crop inputs (Seed, fertilizer, etc.) 23.00
• Labor 182.00
• Supplies 4.00
• Ownership (machinery, land, irrigation) 11.00
• Total cost 220.00
• Return over total cost 140.00

36
Enterprise Budget Analysis

• Enterprise budgets can be used to
• Look at how changes in production practices could
  improve profits.
• Review your product mix.
• Price your product.

37
Changing Production Practices

• Use the budgets to calculate break-even prices
  and yields.
• For example, cost per lb. of beans sold was 1.83
  (220/120 lbs).
• Compare this number to other producers or
  published budgets to determine where costs are
  different and why.
• NOTE add marketing costs to your cost of
  production.

38
Changing Production Practices

• A second reason track key costs.
• Green bean example, 182 (or 83) of the total
  production cost is labor. Most of the labor is
  weeding and harvesting.
• Question - can labor be lowered without reducing
  yields (i.e., can labor be more efficient)?
• Crop inputs is a small percentage (10) of total
  production costs, a 10 reduction in costs wont
  affect total production costs significantly.
  Dont spend time on small items

39
Product Mix

• Enterprise budgets allow for a comparison of
  profitability and labor usage among the various
  crops grown.
• For example, green bean returns over total costs
  was 140. Labor usage was 18.25 hrs. Returns
  over total cost per hour was 7.69.

40
Product Mix
Returns over Total Costs Hours of Labor Returns over Total/Hr
Asparagus 35.47 2.95 12.02
Basil 164.19 6.90 23.80
Carrots 54.02 5.35 10.10
Cherry Tomatoes 181.11 11.20 16.17
Eggplant 85.02 6.45 13.18
Specialty Green Beans 140.27 18.25 7.69
Garlic 43.89 7.15 6.13
Greens 102.90 2.80 36.75
Heirloom Tomatoes 547.21 11.20 48.86
Potatoes 61.65 5.10 12.09
Red Raspberries 131.50 6.15 21.38
Snow Peas 58.45 7.65 7.64
Strawberries 55.46 1.55 35.78
41
Comparing Budgets

• A quick comparison of the crops in the previous
  slide indicates annual returns over total costs
  ranged from 35.47 to 547.21.
• Labor usage ranged from 1.55 to 18.25 hours.
• Returns over total costs per hour ranged from
  6.13 - 48.86.

42
Product Mix Summary

• Labor in most cases is your limited resource -
  limited number of hours for any farming
  operation.
• Analyze not only returns over total costs, but
  also returns over total costs per hour.
• Some products with lower returns over total costs
  may have higher returns over total costs per hour
  because of low labor requirements.

43
Pricing

• Number 1 questionwhat price should I sell my
  products at (pp. 191-197)?
• For an individual product, what does it cost me
  to produce AND market that product?
• If tomatoes cost me 1.90 per lb. to produce and
  market, what should my price be?

44
Pricing (side note)

• NOTE that we are not going over how to determine
  market costs today.
• Marketing costs are extremely important, however,
  as they can be 2-5 times the cost of production.
• Marketing costs are covered in the book on pp.
  180-190.

45
Pricing

• What are your consumers willing to pay and what
  is your competition allowing?
• How much above your breakeven cost are these
  prices?
• What is your net farm income ratio goal (10yr
  Iowa average for all kinds of farms was 20-25)?

46
Pricing

• So if you want to net 20 of your gross income
  and your break-even cost is 1.90 per lb., your
  sales price would be 2.38 per lb
  (2.38-1.900.48 20 of 2.38).
• Will your consumers and competition allow this
  price (maybe higher)? The goal is for the farm,
  not one product.

47
Pricing

• Same process regardless of what you are
  producing
• Example CSA share cost you 240 per share to
  produce and market, price it at 300.
• Chickens cost you 2 per lb to produce and
  market, price at 2.50 per lb.

48
Exercises 4 and 5

• Take 15 minutes answering exercises 4 and 5
  related to product mix and pricing using
  enterprise records.

49
Exercise 4 Product Mix

• What were your suggestions, if any?

50
Exercise 5 - Pricing

• What is her per share cost for production and
  marketing?
• Ans. 345 ((25,000 5,000 4,500) / 100)
•  
•  What does she need to charge to achieve her net
  income goal?
• Ans. 431.25 (345 / .80) if all income is to
  come from shares, if 10 of total gross income
  comes from other sources, then this number can be
  reduced by 10, or approximately 388 per share.

51
Partial Budget

• A partial budget allows you to analyze a portion
  of your farm to determine if minor adjustments
  should be made (pp. 173-179).
• For example, should you
• Add an enterprise
• Change your product mix or production practices
• Custom hire or purchase machinery
• Change marketing outlets
• Purchase transplants or grow from seed

52
Partial Budget

• Partial budgets allows you to compare two
  alternatives side-by-side.
• The analysis tells you one of the alternatives is
  comparatively better than the other.

53
Partial Budget Components

• There are seven components to a partial budget
  increased revenue, reduced cost, reduced revenue,
  increased cost, total positive effects, total
  negative effects, and net change.

54
Partial Budget Example
Change Product Mix from Snow Peas to Salad Mix Change Product Mix from Snow Peas to Salad Mix
Positive Effects Negative Effects
Increases in revenue (1) Decreases in revenue (3)
Sales of salad greens 150.00 Sales of snow peas 175.00

Decreases in cost (2) Increases in cost (4)
7.65 hrs labor _at_ 10/hr 76.50 2.8 hrs of labor _at_ 10/hr 28.00
Input packaging costs 29.48 Input and packaging costs 8.53
Total decrease in costs 105.98 Total increase in costs 36.53

Total positive effects (5) 255.98 Total negative effects (6) 211.53

Net change (7) 44.45
55
Partial Budget Example
Change Marketing Outlet from Farmers Market to Institutional Market Change Marketing Outlet from Farmers Market to Institutional Market
Positive Effects Negative Effects
Increases in revenue (1) Decreases in revenue (3)
Institutional market sales 3,600 Farmers market sales 4,500

Decreases in cost (2) Increases in cost (4)
Farmers market labor costs 1,200 Institutional market labor costs 800
Farmers mkt. supply, trans. costs 400 Instl mkt. supply, trans. cost 200
Total decrease in costs 1,600 Total increase in costs 1,000

Total positive effects (5) 5,200 Total negative effects (6) 5,500

Net change (7) -300
56
Answers

• Production change key question can you either
  increase yields without increasing costs or
  decrease costs while maintaining yields?
• Product mix compare products based on your most
  limiting factor. If labor, determine which
  products return the most to you per hour. The
  ranking will likely be different on a per hour
  basis (e.g. green beans).

57
Answers

• Pricing you need to know your costs or
  otherwise you are shooting in the dark. Add a
  desired return to your total cost of producing
  and marketing your product(s). Compare that price
  to customers willingness and competition.
• Market outlet compare outlets that are
  available to you. Dont focus on selling price
  (gross revenue), focus on net returns.

58
Limitations

• As always, the decisions you make are only as
  good as the numbers you used to make them. Some
  numbers are better than none more is better
• Partial budgets compare two alternatives, neither
  which may be the best alternative available to
  you.
• Partial budgets (all types of budgets) look at
  only , other factors come into play as well in
  your decisions (health, environment, etc.)

59
Reason 5

• Should I purchase a 1-row potato harvester?
• Should I purchase transplants or grow from seed?

60
Partial Budget Example
Analyze the purchase of a new 1-row potato harvester (2,000, 7-yr life) Analyze the purchase of a new 1-row potato harvester (2,000, 7-yr life)
Positive Effects Negative Effects
Increases in revenue (1) Decreases in revenue (3)

Decreases in cost (2) Increases in cost (4)
Labor (50 hrs) 500 Labor (1 hrs) 10
Capital recovery cost 180
Taxes, housing, insurance (1) 20
Repairs and maintenance (2) 40
Total decrease in costs 500 Total increase in costs 250

Total positive effects (5) 500 Total negative effects (6) 250

Net change (7) 250 (per half acre) Net change (7) 250 (per half acre)
61
Partial Budget Example
Purchase 100 transplants rather than growing from seed Purchase 100 transplants rather than growing from seed
Positive Effects Negative Effects
Increases in revenue (1) Decreases in revenue (3)

Decreases in cost (2) Increases in cost (4)
Labor developing transplants 10 Transplants (1.50 ea) 150
Crop inputs (soil mix, seed, etc) 5
Total decrease in costs 15 Total increase in costs 150

Total positive effects (5) 15 Total negative effects (6) 150

Net change (7) -135
62
Exercise 6

• Take 10 minutes answering exercise 6 related to
  changing marketing outlets using a partial budget.

63
Exercise 6 - Partial Budget
Change Marketing Outlet from Farmers Market to Institutional Market Change Marketing Outlet from Farmers Market to Institutional Market
Positive Effects Negative Effects
Increases in revenue (1) Decreases in revenue (3)
Institutional market sales 9,100 Farmers market sales 14,000

Decreases in cost (2) Increases in cost (4)
Farmers market labor costs 4,800 Institutional market labor costs 1,600
Farmers market trans costs 1,600 Institutional market trans costs 800
Farmers market supply costs 500 Institutional market supply costs 300
Total decrease in costs 6,900 Total increase in costs 2,700

Total positive effects (5) 16,000 Total negative effects (6) 16,700

Net change (7) -700
64
Summary

• Income statements, balance sheets, enterprise
  budgets, and partial budgets can make your
  decisions much easier.
• They can also point to both strengths and
  weaknesses in your farm.

65
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.

66
Step 2 Enterprise Analysis

• You realize labor is a constraint. You determine
  to focus on crops with a higher return per hour.
• Less More
• Green beans Salad greens
• Snow peas Carrots
• Garlic Potatoes
• Result of the shift would be more revenue per
  hour worked.
• You also look to see where production changes
  could be made to increase yields or lower costs.

67
Step 3 Partial Budget Comparisons

• With more potatoes, you will be crunched for time
  during harvest, you can gain efficiencies with a
  potato harvester.
• Other partial budget analyses that you completed
  indicate you should continue with farmers
  markets and grow your own transplants.
• However, with more of certain products you will
  look at alternative markets for the excess.

68
Step 4 Pricing

• You set your income goal at 20 of gross revenue.
• You look at individual enterprises to determine
  how close you are and evaluate possible increases
  where you are low.
• If customers or competition will not allow you to
  get close to your income goal you evaluate
  whether that crop is needed.

69
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

70
And the Sixth 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.

71
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.

72
Questions..

• Any questions or comments?
• Thank You for This Opportunity!
• Craig A. Chase
• Farm Management Local Food Systems
  Alternative Enterprises
• 312 Westbrook Lane
• Ames, IA 50662
• [phone]
• cchase_at_iastate.edu

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