Farming Is Big Business Dr. Norm Dalsted Department of Agricultural and Resource Economics Colorado State University

What is the current financial situation for Colorado Agriculture? 2

Colorado Farm Income and Production Expenses Crops $2.74 $2.58 $2.84 $2.41 $2.06 Livestock Total Other Income Including govt $1.42 $1.20 $1.58 $1.34 $1.17 Payments Gross Value$8.48 $8.27 $9.10 $9.09 $ % ↓

Total Farm Production Expenses and Net Income Expenses Net Farm Income Net Income – 56% decline ( ) Expenses increased 13.5% in same time period

Projected Net Income, Colorado 2011$1.9 billion 2015$824 million (lowest since $763 million) 2016 $719 million

Reasons for drop in net income: -lower livestock prices -lower corn, wheat, hay, potatoes, and other crops -higher input costs -lower milk prices

Outcome is from weakening commodity prices. Net income is forecast to decline to $719 million in 2016 – less than the $763 million for 2009.

What does your business look like?

9 Objectives Gain an understanding of the need for adequate “financial business performance analysis” What is the key factor for long term financial survival of the farm/ranch operation Gain a basic understanding of the interaction of financial statements Why it is critical (for some businesses) to prepare a complete set of financials Gain understanding of the interaction/impact the family has on the business

10 Key Producer Items/Concerns Adequate funds for family living For all families that might be involved Alternative enterprises, enterprise mix Debt Load and Structure Expansion plans/capabilities Dependence on government payments Managing cost of production, financial info, marketing, labor (family) Tight profit margins – Simply Surviving

11 What Key Factors Determine Prosperity? A positive Cash Flow A large Net Worth Reduce tax liabilities to reduce cash outflows Lots of family labor (good hard work) Location Positive Net Income Good management plan Succession plan ?

12 What is Required? Reconciled set of Financial Statements Prepared at least annually at the same time every year. Shared with your management team and all others concerned with the operation Family, lenders, partners, etc.

13 Just Like Balancing a Check Book Beginning Cash Balance + Inflows - Outflows = Ending Cash Balance Your business performance is measured the same way using a complete set of financial statements These are Linked

14 Complete Set of Financial Statements Beginning and Ending Balance Sheets Statement of Cash Flow/Cash Flow Statement Accrual Adjusted Income Statement Statement of Owner Equity All cash inflows are not income All cash outflows are not expenses You can have non-cash expenses You can have non-cash income Expense Versus Expenditure

15 Balance Sheets Left Side Right Side Current Assets Current Liabilities Long Term Assets Long Term LiabilitiesIntermediateLong Term Total Assets Total Liabilities (Assets - Liabilities) = Net Worth

16 Cash Flow Statement Cash Inflows Cash Outflows Cash Income Cash Expense + Other Inflows + Other Outflows = Total Cash Inflows = Total Cash Outflows (Inflows - Outflows) = Net Cash Flow        Profit Critical: Some inflows are not income and some outflows are not expenses

17 Accrual Adjusted Income Statement Cash Income + Non-cash Income = Gross Income/Revenue Cash Expense + Non-cash Expense = Total Expense Net Income (Gross Income - Total Expense) = Profit Profit  Net Cash Flow or Taxable Income

18 Statement of Owner Equity Beginning Owner Equity + Net Income - Withdrawals + Contributions - Distributions +/- Change in Valuation = Ending Owner Equity Balancing a Checkbook Beginning Equity +/- Activity = Ending Equity

19 Topics for Examination Withdrawals Government Payments Cost of Production Debt Load (asset and liability structure) Contributed capital Distributed capital Asset revaluation Capital asset purchase Non-business income Non-cash income Non-cash expense (not depreciation)

20 Withdrawals Note the: Net worth (equity) on the balance sheet and the change is equity from beginning to end of year Note net income (Accrual Adjusted Income Statement) The relationship between cash flow and the balance sheet, follow the red arrows. What is relationship of Net Income and change in equity What does this tell us about how equity growth in the business MUST occur

21 Government Payments Note current profit levels and cash flow position Reduce/eliminate government payments on crops Effects on cash flow, net income, equity Implications for profit Stop – What is Profit? Implications for the size of the business Where is the risk?

22 Cost of Production Implications for this operation Do you know your cost of production?????? If you can not measure it, you can not manage it Enterprise record keeping system with Quicken or Quickbooks Spreadsheets that allow you to allocate income and expenses to enterprises

23 Debt Load What is the debt load that can be carried by an operation this size? What about debt structure? Short vs long term debt How does family living withdrawal effect debt carrying capacity? Crop vs Livestock operations

24 Contributed Capital What is contributed capital? Capital not generated by the operation but given to the operation to support our farming habit Off farm income (wages/salary) Nonbusiness income (dividends, etc.) Gifts, inheritances, etc. Effects of contributed capital on: Equity Profits Cash Flow

25 Distributed Capital What is distributed capital? Capital taken out of the operation Effects of distributed capital on: Equity - Short term vs long term Profits - Short term vs long term Cash flow - Short term vs long term

26 Asset Revaluation Assets are occasionally revalued to reflect inflationary pressures Machinery, land, buildings, improvements, breeding livestock This is necessary to accurately reflect the true value of these assets Caution: Do not let yourself misinterpret this increase in equity Is not due to business performance Can be very misleading to those unaware

27 Capital Asset Purchase Question: Will purchasing a new capital asset increase your net worth? Pickup, new bull, combine, center pivot, etc. What is affected Ending asset balance, ending liabilities, cash inflows and cash outflows, net income Bottom line, You CAN NOT buy equity Equity or growth in equity must be earned The only way to do this is make the new asset earn additional revenue and/or save costs Increase net income

28 Non Business Income Income not generated by business assets Types of non business income Off farm wages Non farm earnings (interest, dividends, etc) Interest earned on a farm business checking account would be considered business income.

29 Non-Cash Income Non-cash income adjustments are made on the Accrual Adjusted Income Statement to reflect changes in Current Asset values on the beginning and ending balance sheet. Include changes in: Crops Held for Sale Market Livestock Other Current Assets Cash Invested in Growing Crops

30 Non-Cash Expense (Not Depreciation) Non-cash expense adjustments are made on the Accrual Adjusted Income Statement to reflect changes in Current Asset and Current Liabilities section of the beginning and ending balance sheet. On the Current Asset side Crops Held for Feed, Cash Invested in Growing crops and Supplies & Prepaid Expenses are adjusted as expense On the Current Liability side Accounts payable, Other current Liabilities

31 Summary You MUST know how to measure your Financial Business Performance Must be efficient Maximize output per unit of input Often we try to maximize just output Low cost producer The right size producer (minimum size) Family matters Manage marketing, production, family risk Financial analysis measures the impact of these

32 Business Performance? What do we use to measure this? What are the best tool(s) to use? What is the key to your survivability? Profits Profits  Net Cash Flow (Positive or Negative) Profits  Taxable Income If you can’t measure it, you can’t manage it!!

33 Your Business Must Produce Net Worth Internally Every dollar of income goes towards increasing net worth Every dollar of expense goes towards decreasing net worth If you only have external growth in Net Worth; puts you on shaky ground You must be profitable Profitable enough to pay for: Family Living, Debt Principal, Savings, Reinvestment, Retirement

34 Accrual Adjusted Financials: Catch problems with: Inventory sell down to manage cash needs Selling capital asset base, your manufacturing plant (livestock, machinery, land, etc.) Capital distributions Unearned equity increases Allows accurate business performance evaluation for each time period Just simply keeps you out of trouble Will not be easy the first time through

35 How To Get There What is your business plan Do you have a management team to help with Production decisions Marketing decisions Financial analysis Communication among team members? Are there team members missing that are critical to the overall success of the business?

Dr. Norm Dalsted Extension Farm/Ranch Management Economist Colorado State University