Department of Applied Economics and Management Cornell University Ithaca, NY Dr. Wen-fei Uva Senior Extension Associate What is Your Profitability? - Using Financial Records to Improve Business Performance Modified by Georgia Agricultural Education Curriculum Office July, 2002 Modified by Leanne Brown March 2007

What We Are Going to Do Today?  What Is in Financial Analysis?  Calculating Your Costs.  Evaluating Your Profitability

What Is in Business Management?  The ability to use resources in an efficient manner so as to maximize returns to meet:  Business goals  Personal goals  Achieving your goals requires Financial Management

What Is Financial Management?  The ability to allocate financial resources in the areas which generate the greatest returns.  Financial Management Decisions You Need to Make:

Making Business Decisions  Are your sales covering your costs?  Which product lines generate the most income?  Should you operate year-round or shut down in the winter?  Contributions to fixed costs  Optimum mix of product lines  Goal setting and increased efficiency

Do You Perform Financial Analysis?  Cost analysis - costs to operate the business and profitability  Ratio analysis - Gross Margin Return On Investment, Return on Asset, Inventory Turns  Enterprise analysis - What is your most profitability product line? Are Your Financially Healthy and Wise?

 Do you know how your business compare with industry benchmarks  How do you compare to other firms in the industry? - Gross Margin, Inventory Turns, Profit Margin  Set performance goals  Track your performance over time (trend analysis)  Repeat process annually Are Your Financially Healthy and Wise?

Calculating Production Costs  A Record Keeping System for You  Pricing for Profit

Expenses Records  Variable costs: cost items that vary with production volume (Direct and Indirect).  Costs of plant materials, pots, soil, hourly labor, advertising.  Fixed costs: cost items that do not vary with production volume (Overhead costs).  Costs of rent, property taxes, management salary and family living expenses.  Allocate these costs to each product could be tricky (by floor space, time in store, etc.)  25 to 50% of total costs.

Expenses Records - cont. Marketing costs:  Advertising, packaging, shipping, billing, and special promotion, display, etc.  It could also be assigned to variable and fixed costs, but why look at it separately?  Production efficiency vs. marketing efficiency  5 to 15% of total costs

Financial Statements and Performance Measures  Income statement, balance sheet, cash flow budget  Liquidity, solvency, profitability, financial efficiency, repayment capacity measures

Ownership Records Asset Inventory  Business assets, ownership type, control arrangement, opportunity costs Ownership Arrangement  Resource sharing, owner compensation, responsibilities Estate Plan  Exit/entry and retirement plans (will, trust, insurance, buy-sell agreements)

Profit Pricing for Profit Variable Costs Fixed Costs Price (Revenue) Contribution Break-even

Calculate Costs - Direct Variable Costs Calculate Costs - Direct Variable Costs

Calculate Costs - Indirect Variable Costs

Calculate Costs - Fixed Costs

Calculate Enterprise Profitability

Breakeven Analysis

= VOLUME (PRICE-COST) PROFIT Profit Equation  4,800 pots* ($3.25/unit - $2.78/unit) = $2,256  4,800 pots* ($3.00/unit - $2.78/unit) = $1,056  10,254  10,254 pots* ($3.00/unit - $2.78/unit) = $2,256  For $250,000 in sales, a 4% price increase (4 cent increase for every dollar) give you $10,000 more profit.

Evaluating Business Profitability  Financial Ratios  Efficiency Measures

Financial Ratios  Profitability Ratios  Gross Margin: (Revenue - Variable Costs)  Revenue -- (around 50%)  Profit Margin: (Revenue - Total Costs)  Revenue -- (around 10-15%)  Return on Assets  Net Business Income  Average Total Assets  How efficient are you using your resources to produce income.

Financial Ratios  Inventory Ratio (3.5)  Cost of Good Sold  Average Inventory  How fast are you turnover your inventory  Liquidity  Current Ratio: Current Liability  Current Assets  Your ability to cover current debt (liability)  Solvency  Debt-to Asset Ratio: Total Liability  Total Assets  The percentage of the business’s assets to which creditors have claim.

Efficiency Measures  Operating Efficiency  Sales per Full Time Worker Equivalent  Net Income pre FT Worker Equivalent  Sales per Square Foot  Cost Efficiency  Labor as percent of sales  Operating expenses as percent of sales  Costs per square foot (or square foot week)  Profitability  Net Income per Owner  Net Income per Owner Hour  Net Income per Square Foot