$ Managing Capital /Financial Risk Craig Binkowski Southern Michigan Bank & Trust Coldwater

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$ Topics in Financial Section Financial Balance Sheet (What’s at risk?) Cost of Production / Revenue Requirements: –Total Economic costs –Cover Direct Cost –To Maintain Equity –Meet Cash Flow Demands “Cost of Production” Worksheet Incorporating Financial Information into Risk Management / Control Decisions

$ Financial Risk Management Increase Equity through Farm Profit –Net Worth increase without inflation in asset values Meet Cash Flow Demands Monitor cost & availability of Debt Capital –Interest Rate Risk –Sources of Capital Financial Information for measurement and monitoring is available and used

$ 3 Basic Financial Statements 1. BALANCE SHEET: Assets, liabilities, and net worth Annual Change in Net Worth 2. INCOME STATEMENT: Inventory Adjusted (Accrual) 3. Projected CASH FLOW: After Scheduled Term Debt Principal & Interest Payments, Family Living, Income Taxes

$ Example Farms for the Game: Designed to Simulate Today’s Market Environment Green = Low Debt Farm (Sorry)Green = Low Debt Farm (Sorry) Yellow = Moderate Debt FarmYellow = Moderate Debt Farm Red = High Debt FarmRed = High Debt Farm

$ Balance Sheet Current balance sheet tells you: –Financial position of your business/Self –Your capacity to withstand risk “Take a Hit” and remain solvent Three-five years of balance sheets tell you: –Trends in equity of your business –Need Both Cost Basis (Book Value) –And Market Value –Dual Column Balance Sheet

$ Balance Sheet Debt Levels Page 4 FINLRB output

$ Income Statement: History: –Did your business make or lose money last year? How much? Was your neighbor’s experience similar? –What has been the past performance of your business? Relative to your neighbors? Projections (pro-forma): –What will be different from the past? Why? –Do you “expect” the business to make a profit? –How much can revenue fall due to price and/or yield shortfalls before there is a loss?

$ Income Statement Page 2 of FINLRB output

$ Liquidity - Cash Flow Statement Ability of your business to meet its cash flow obligations Accounts for all sources and uses of cash including debt and capital activity Helps you assess how much room there is for “stuff going wrong” -- RISK! Helps you assess if adjustments need to be made in the financial structure of your business. Does NOT tell you if your business made a profit!

$ Liquidity- Cash Flow Statement Page 3 of FINLRB output

$ Change In Net Worth: Did Your Net Worth Increase last year? Or Decrease? Trend? Why? –From Retained Earnings out of Farm Profit? Asset Inflation –From Asset Inflation? Machinery? Land? Contributed Capital –From Contributed Capital? (Outside sources) Do you expect your net worth to increase next year? Or, decrease? How much room do you have for “stuff to go wrong” RISK!

$ Change in Net Worth Page 4 of FINLRB output Hand calculate the % Change in Equity

$ Working Capital Ratio What does it tell you about Risk? Ability to meet cash flow demands if there is a downturn Ignores unused borrowing capacity Weak = Less Than 0% –(I.E. Working Capital Margin = 0) Can be too high - I.E. Large inventory of crops and feed on hand –money tied up that could be used to pay down debt –Marketing ? Getting crops sold!

$ Working Capital Ratio Working Capital/Gross Farm Income Page 5 and 2 of FINLRB output

$ Financial Guidelines for RISK Management

$ Can’t Look at Just One Ratio! Operating expenses may be high, but are depreciation expenses low? If many of the measurements are just out of the “weak” area then the farm as a whole may be in serious trouble. Focus on: – Accrual Net Farm Income – Projected Cash Flow – Retained Earnings ( non-inflationary Net Worth Change in Balance Sheets)

$ Understand the Numbers for Your Understand the Numbers for Your Farm Business! Critical in today’s environment Understand what the numbers mean and signal Monitor Business EVERY year … routinely Use professional assistance if needed

$ Cost of Production Roger Betz District Extension Farm Management Agent SW Michigan

$ Cost of Production Worksheet Allocates Overhead cost to each acre and combines with Direct Cost to determine “Cost of Productions” for various crops “Cost of Productions”? –Economic –Direct Cost –Maintain Net Worth –Meet Cash Flow Demands Useful in Marketing and Crop Insurance Decisions

$ Cost of Production Worksheet - page 2

$ Cost of Production - Overhead Cost of Production Page 2- Medium Debt

$ Economic Cost of Production Cost of Production Worksheet Page 2 - Medium Debt Farm

$ Total Direct Cost Cost of Production Worksheet Page 2 Medium Debt Farm

$ Revenues to Maintain Net Worth Cost of Production Worksheet Page 2 Medium Debt Farm

$ Revenues to Meet Cash Flow Cost of Production Worksheet Page 2 Medium Debt Farm

$ Break Even Incomes & Prices “Cost of Production”

$ Break Even Income & Prices “Cost of Production”

$ Break Even Incomes & Prices “Cost of Production”

$ “Break Even Prices Needed” Make Sure You Have These Values

$ What Percent of Equity are You Willing to Risk?

$ Can I use Risk Management Tools to Minimize Equity Loss? Lines 49 and 50 Cost of Prod. Worksheet

$ Key Questions for Your Farm Business : 1. Appropriate Financial Information Available? Historical, Current, and Future 2. Adequate Understanding of Financial Conditions and Risk Positions? 3. Realistic Plans & Underlying Assumptions? 4. What level of Equity Protection can Risk tools provide? 5. Should you utilize Financial Risk Management Strategies?

$ STOP! What is the key financial information for your farm? What are the revenues required to: Meet Economic Cost Cover Direct Cost Maintain Net Worth Meet Cash Flow Demands Start to think through your crop insurance and marketing plans