Financial Management Returning To The Farm University of Nebraska- Lincoln

Assets Things Of Value Owned By The Business  Tangible (Real Estate, Inventory)  Intangible (Intellectual Property) Current Assets Are Assets That Can Be Converted To Cash Within A Year  Cash  Accounts Receivable (A/R)  Inventory

Current Assets

Assets Fixed Assets Provide Benefit To Business For More Than 1 Year  Buildings  Equipment  Land Liquidity = Speed & Ease An Asset Can Be Converted To Cash. (Intermediate or Long Term)  Ease Of Conversion vs. Loss Of Value Tractor vs. Custom Hog Finishing Unit vs. Land

Intermediate Term Assets

Long Term Assets

Non-Farm Assets

Liabilities Obligation To Pay A Debt Current Liabilities Generally Must Be Paid Within 1 Year  Accounts Payable  Current Year’s Principle Payment On Loan  Taxes Payable

Current Liabilities

Term Liabilities Are Obligations That Are Due After 1 Year Intermediate -Term Bank Notes 2 to 10 Year Long-Term Bank Notes 10 or more Contracts Liabilities

Term Liabilities Intermediate

Term Liabilities Long

Non-farm Liabilities

Owner’s Equity (Net Worth) Estimate Of The Business’ Value That Would Be Transferred To Owners If All Assets Were Liquidated & All Liabilities Paid Increased By $ Invested By Owners Or Made In The Business And Decreased By What Owners Withdraw From The Company Or The Business Lost

The Balance Sheet Summary Of Business’s Assets, Liabilities, & Net Worth  Assets Are Arranged From Most Liquid To Least Liquid Statement Of The Financial Condition Of A Business On A Specific Date Should Be Prepared At Least Once A Year, Usually At The End Of The Fiscal (Calendar) Year

The Balance Sheet Owner’s Equity (Net Worth)

Assets = Liabilities + Owner’s Equity Two Groups Can Make Claims Against The Business  Creditors  Owners Creditors, Legally, Are Entitled To The First Claim The Balance Is The Owner’s Equity If Liabilities Exceed Assets…  Owners Equity Is Negative  Firm Is Insolvent  Could File For Bankruptcy

Balance Sheet For Trend Analysis  Complete At Same Time Each Year  Value Assets Same Way Each Year Asset Valuation  Cost  Cost Less Depreciation  Market Value

Balance Sheet Trend Analysis Multi-year look at the Direction of progress In financial performance Measure progress in Net Worth

The Income Statement Summarizes Farm’s Revenues & Expenses Over A Given Period Of Time Provides Measurement Of Profit Should Be Prepared At Least Once A Year, Although May Prepare More Frequently

The Income Statement Revenue = Amount Received (Or To Be Received) From Selling Grain or Livestock, Government Program Benefits, or Services Provided Expenses = Amount Paid (Or To Be Paid) For Inputs Used In Production, Labor & Management Costs, & Noncash Items (e.g., Depreciation)

The Income Statement Net Income = What Is Actually Made By The Farm Business After All Expenses Are Paid Net Income = Revenue - Expenses

Comparative Statements Analysis Compare Documents From One Period To The Next, Or To Budgeted Amounts  Are There Major Changes?  What Caused The Changes? Calculate Difference In Absolute & Percentage Terms

Income and Expense Trend Analysis Net Farm Profit +/-

Working Capital Money Used To Meet Daily & Emergency Expenses Measure Of Liquidity WC = Current Assets – Current Liab. Guidelines:  Green: WC = or > than Current Liabilities  Yellow: WC 0  Red: WC < 0

Rationale for Ratio Analysis Financial Statements Are Only Numbers On Paper Measure Health Of The Business  Compare Over Time, One Farm To Another, Or Against Benchmarks Means To Control The Firm Easily Understood  Communicate To Interested Parties Outside Management (e.g., Lenders)

Ratio Analysis Easy To Calculate, Compare, & Understand Four Categories Of Financial Ratios:  Liquidity  Solvency  Efficiency  Profitability

Liquidity Ratios Measures The Ability To Pay Bills Or Short Run Obligations  Working Capital  Current Ratio

Current Ratio Formula: Current Assets Current Liabilities Function: Measure Of Short-Term Liquidity Guideline:  Green > 1.5  Yellow:  Red < 1.0 Improve By: Current Assets Or Current Liabilities

Solvency Ratios The Ability To Pay Debt Or Long Run Obligations  Debt To Asset Ratio  Equity To Asset Ratio  Debt To Equity Ratio (Leverage)

Debt To Asset Ratio Formula: Total Liabilities Total Assets Function: Measures How Much Of The Assets Lenders Are Capitalizing How much your lenders own of your business Guideline:  Green: < 0.3  Yellow:  Red: > 0.7 Improve By: Liabilities Or Total Assets

Equity To Asset Ratio Formula: Total Equity Total Assets Function: Measures How Much Of The Assets Are Funded By Owner Capital  How much you own of your business. Guideline:  Green: > 0.7  Yellow:  Red: < 0.4 Improve By: Equity Or Total Assets

Debt to Equity (Leverage) Ratio Formula: Total Liabilities Net Worth (OE) Function: Determine Size Of Debt, Measures Leverage Guideline:  Green: <0.43  Yellow:  Red: > 1.5 Improve By: Liabilities And Net Worth

Efficiency Ratios Relative Activity Of The Farm With Respect To Its Assets, Inventory Levels, Customer Credit Payments, & Its Own Bill Paying  Asset Turnover

Asset Turnover Ratio Formula: Gross Revenues Total Assets Function: Measure Intensity Of Asset Use Guideline:  The Higher The Better  Varies Across Industries & Even Farm Enterprises

Asset Turnover Ratio Benchmarks EnterpriseGreenYellowRed Cow-Calf> <0.07 Swine> <0.60 Cash Grain> <0.20 Feedlot> <0.90 Dairy> <0.85

Profitability Ratios Indicator Of Business’s Profitability & Performance Return On Equity Return On Assets Operating Profit Margin Ratio

Operational Ratios Operating Expense: Operating Exp Gross Revenues Depreciation Expense: Depreciation Exp Gross Revenues Interest Expense: Interest Exp Gross Revenues Net Income Ratio: Net Income Gross Revenues These Should Add Up to 1.0 Except depreciation & interest

Return on Equity (ROE) Formula: Net Profit Total Equity Function: Measures How Owners Fared During The Year In Exchange For Letting The Farm Use Their Money If The Return On Equity Is 10%, Then $.10 Of Profits Are Created For Each $1 That Was Invested. Guideline: Will Vary; Can Range From – To +

Return on Assets (ROA) Formula: (Net Profit + Interest) Total Assets Function: Measures How Owners & Lenders Fared During The Year In Exchange For Letting The Farm Use Their Money  Add Back Interest Because It Is Lender’s Payment Guideline:  Green: >0.05 (owned) >0.12 (rented)  Yellow: (owned) (rented)  Red: <0.01 (owned) <0.03 (rented)

Operating Profit Margin Ratio Formula: Net Income + Interest Exp – Unpaid Family Labor & Mgmt Gross Revenue Function: Measures Return To Farm After Operator & Family Labor & Mgmt Claims That Can Be Used For Growth

Summary Using These Ratios Will Aid Management In Understanding Their Farm’s Financial Health & Performance. Cannot Just Look At Ratios Alone  Treat Them As Indicators