1. Session 3 – Financial Analysis I and Human Resources

2. Session 3: Part I – Business Structure, Financial Statements, and Taxation

3. Program-at-a-glance Advanced Farm Management Program Schedule 2014/15 - An Overview DAY 1DAY 2DAY 3DAY 4DAY 5 9:00am to 9:30am Course Introduction Risk Management Review & MAP Update Review & MAP UpdateReview & MAP update Financial Analysis III (Scorecard) 9:30am to 10:00am Business Planning and MAP Introduction Financial Analysis I (Business Structure, Financial Statements, Taxation) Financial Analysis II (Ratios & Operating Efficiency) 10:00am to 10:30am 10:30am to 11:00am Case Study SWOT Personal Leadership (Kolbe A) 11:00am to 11:30am Management Action Plan Completion 11:30am to 12:00pm 12:00pm to 12:30pm Lunch Break 12:30pm to 1:00pm 1:00pm to 1:30pm Risk ManagementMobile Technology Human Resources Lean ManufacturingMAP Continued 1:30pm to 2:00pm 2:00pm to 2:30pm Farm Business Vision & Strategic Direction Core Values & Beliefs 2:30pm to 3:00pm Branding/Marketing Your Farm Case Study & Wrap-up 3:00pm to 3:30pm Building Your Management Team 3:30pm to 4:00pm Kolbe A PreparationCompletion

4. Course Flow

5. Remember the Rules of Engagement Class participation Work assignments Build your Management Action Plan (MAP) Instructor feedback/coaching

6. Session 3 Agenda 9:00 amReview and MAP Update 9:30 amFinancial Analysis I (Business Structure, Financial Statements and Taxation) 12:00 pmLunch 1:00 pmHuman Resources 3:45 pmEvaluations and Adjourn

7. Business Structure and Taxation Proprietorship Partnership Corporation

8. Proprietorship OWNED and operated by an individual No legal distinction between owner and the business Own name or a registered name

9. Partnership A business relationship between two or more individuals Legal entity Share in profits (losses) Share in risks Agree to advance mutual interests

10. Corporation Separate legal entity Rights and privileges of an individual Shareholders have a right to participate (dividends/appreciation) Has directors and officers

11. BUSINESS STRUCTURE Advantages and Disadvantages

12. Proprietorship Advantages Less regulation/administration Own name No need for registration Annual filings You own Tax simplicity

13. Proprietorship Disadvantages Asset exposure Personal liability Lack of tax flexibility

14. Partnership Advantages Less regulation/administration Complementary skills Own name Increased ability to raise funds Need for registration Attract new owners Annual filings You own Tax simplicity

15. Partnership Disadvantages Asset exposure Personal liability Lack of tax flexibility Joint and several liability

16. Corporation Advantages Perpetual existence Limited liability Ownership transfers Tax advantages (small business rates)

17. Corporation Disadvantages Greater regulations Costs to form Record keeping/compliance Director/shareholder liability

18. TAXATION

20. Numbers – They Give me a Migraine A Word About Taxes Manage assets not taxes The 15½% solution We don’t know what to ask

21. Personal Taxation Tax Rates - 2015

22. Corporate Taxation Active Business IncomeTax Rates Corporate – Active (Ontario) 0-500,00015.50% 500,000+26.50%

23. Corporate Taxation Investment Income Tax Rates Corporate - Investment 46.17% -Tax refundable 26.67% -Refundable 19.50% $1 refund for $3 of dividend

24. Capital Assets Asset additions Tax pools Asset dispositions

25. Capital Assests Asset pools Half-year rule Classes 1 and 6 - Buildings – 4% and 10% Class 8 - Equipment – 20% Class 10 - Automotive ECE - 75% to pool – 7% Tiling - 100%

26. Capital Assets Capital Gain Proceeds$100,000 Cost75,000 Capital gain$25,000 Taxable capital gain @ 50%$12,500

27. Capital Assets Recapture Sale proceeds$100,000(A) Original cost75,000(B) U.C.C.40,000(C) Recapture35,000(B) – (C) Capital gain25,000(A) – (B)

28. Capital Gains Exemption Land Building Quota Shares of small business corporation Shares of family farm corporation Interest in a family farm partnership

29. Capital Gains Exemption $800,000 ($400,000) Individuals not corporations Keeping farm corporations “pure”

30. Adjusted Cost Base Valuation Day – December 31, 1971 Land Buildings Shares Get the details Find those old returns

31. Capital Gains Exemption 1994 Elections $100,000 Old returns

32. Corporations Share Redemption Proceeds$100,000 Less paid up capital(1,000) Deemed dividend$99,000

33. Corporations Capital Dividend Account Capital gain Taxable capital gain Addition to CDA Capital gain Capital losses Prior tax-free dividends Get the old returns

34. Tools of the Trade 28(1)(b) Dividends vs. Salary Timing – manage the tax position Retiring allowance Dividends payable Death benefit Capital dividend account

35. Let’s take a stress test!

37. UNDERSTANDING FINANCIAL STATEMENTS

39. Three areas of a Family Farm Family / Personal ManagementOwnership Emotional Centre Empathy Support Wealth Centre Fair and Equitable Stewardship Wealth Engine Opportunity Competition Land of Confusion

40. Specific Learning Objectives When you leave, you will be able to: Analyze your financial statements Share tips and techniques for managing and monitoring your farm finances Provide financial management education for the next generation Understand accrual basis of accounting and the matching principle Recognize and understand what a balance sheet, income statement, and statement of cash flows are and how they are linked to each other Your farm financial statements are a valuable tool in running your farm operation

41. Understanding financial statements 1.Cash basis of accounting 2.Accrual basis of accounting 3.The matching principle 4.Basic financial statements Balance sheet Retained earnings Income statement Statement of cash flow Before you can use your financial statements in managing your operation, you need to understand:

42. Review Pellegrino Farms Inc. Owned and operated by the Brennan family Richard Brennan has been farming for nearly 40 years Corn, soybeans and wheat 1,845 acres; 800 acres or 40% of the farm is owned, remaining acres are rented Pellegrino financial statement – appendices A to L

43. Which method of accounting? Cash basis of accounting Revenues and expenses are recorded when cash is actually paid or received. A simple method of accounting that is used for tax purposes. Accrual basis of accounting Revenues and expenses are recorded in the period they are earned or incurred – this method is based on The Matching Principle. More complex than cash basis but a more accurate picture of what has happened in your operation. * The method you choose can affect the decisions you make

44. The Matching Principle Pay for purchase Mar 10 Purchase of $500 made Feb 3 Month-end Report Feb 28 Sold $1000 of goods Mar 25 Month-end Report Mar 31 Received payment Apr 12 Under what date should this transaction be recorded?

45. Key points about cash basis Incomplete record of what you owe or what is owed to you Only know what you receive and what you pay out Does not give you an accurate income statement for a period so unable to determine profitability of your operation No accurate record of what you own in terms of assets and inventory Not enough information to manage a complex farm business Used for tax purposes to allow manageability of taxable income Doesn’t conform to Generally Accepted Accounting Principles (GAAP)

46. Key points about accrual basis Continuous record of what you owe or what is owed to you A clear picture of what you own Complete picture of your farm’s financial position and owner’s equity at any point in time An accurate measure of profitability Based on the Generally Accepted Accounting Principles (GAAP) of matching revenues and expenses to the period in which they occurred Allows you to have the information on hand that lenders require

47. DEBITS ASSETS EXPENSES REVENUE LIABILITIES CREDITS LIABILITIES REVENUE EXPENSES ASSETS

48. Basic financial statements The balance sheet Measures the financial position at a specific point in time (e.g. year end) Contains a summary of what the business owns and owes at a specific point in time. Shows book value (historical cost) of assets and liabilities Shows retained earning – what earnings have been retained in the business Prepared using accrual basis - GAAP Can also be prepared on FMV basis

49. The balance sheet What the business owns What the business owes Value retained in the business xxx,xxx Future taxes payable $x,xxx,xxx TOTAL LIABILITIES & OWNER’S EQUITY x,xxx,xxxOWNER’S EQUITY x,xxx,xxxTOTAL LIABILITIES xxx,xxx Due to shareholders LIABILITIES xxx,xxx Current Liabilities $ x,xxx,xxxTOTAL ASSETS x,xxx,xxx Property, plant & equipment at cost less accumulated amort. (note 1) $ x,xxx,xxx Current Assets ASSETS Values at a specific point in time Long-term debt less current portion x,xxx,xxx

50. The balance sheet What is an asset? Tangible or intangible item of value owned by the business that has future/lasting value to the operation Current assets are tangible assets that are expected to be converted to cash within one year or one operating cycle e.g. accounts receivable Capital assets (long-term assets) –Property, plant and equipment assets are tangible assets of lasting value of longer than one year and not usually purchased for resale (e.g. land) –Intangible assets are those that lack physical substance but have a value or benefit to the farm over the longer term (e.g. quota)

51. The balance sheet What is a liability?  An obligation of the business that is the result of a past transaction that is to be paid in the future  Current liabilities are those that are expected to be paid within one year (e.g. accounts payable)  Long-term liabilities are those that have a maturity date beyond one year from the date of the balance sheet (e.g. mortgages)

52. The balance sheet What is the owner’s equity? The value of the assets that are left after the liabilities are paid Owner’s equity consists of shareholdings and retained earnings Retained earnings is the accumulation of the profits retained in the operation over the years The balance sheet uses the book value of assets A statement of net worth uses the fair market value of assets assets – liabilities = owner’s equity

53. Exercises Review the Pellegrino Farms Inc. financial statements

54. Balance Sheet Exercise 1.1 From Appendix C: 1.Locate and record the current assets$ 2.Locate and record the long-term assets $ 3.Locate and record the total assets$ 4.Locate and record the current liabilities $ 5.Locate and record the long-term liabilities $ 6.Locate and record the total liabilities$ 7.Locate and record the owner’s equity$ 8.Locate and record the current portion of long-term debt$ 9.Locate and record retained earnings$

55. Balance Sheet Exercise 1.1 – Answer Key From Appendix C: 1.Locate and record the current assets$ 1,168,269 2.Locate and record the long-term assets $ 6,171,851 3.Locate and record the total assets$ 7,340,120 4.Locate and record the current liabilities $ 383,806 5.Locate and record the long-term liabilities $ 2,656,882 6.Locate and record the total liabilities$ 3,040,688 7.Locate and record the owner’s equity$ 4,299,432 8.Locate and record the current portion of long-term debt$ 264,396 9.Locate and record retained earnings$ 4,299,215

56. Exercise 1.2 and 1.3 Adjustment to FMV Basic information Land values currently $16,000 per acre FMV of automotive and equipment - $850,000 Restate Pellegrino Farms Inc. balance sheet Use appendices C and H

57. Exercise 1.2 Assets: Current assets$ Land acres @ $ Residence Paving Building Equipment and automotive Computer Total acres$ (A) Liabilities: Current liabilities$ Future taxes payable Long-term debt less current portion Total debt$ (B) Net worth$ (A-B) Use appendices C, H and Facts

58. Exercise 1.2 – Answer Key Assets: Current assets$ 1,168,269 Land 800 acres @ $16,000 12,800,000 Residence 362,337 Paving 6,076 Building 328,050 Equipment and automotive 850,000 Computer 135 Total assets$ 15,514,867 (A) Liabilities: Current liabilities$ 383,806 Future taxes payable 170,875 Long-term debt less current portion 2,141,328 Total debt$ 2,696,009 (B) Net worth$ 12,818,858 (A-B)

59. The balance sheet What the business owns What the business owes Value retained in the business 170,875 Future taxes payable $7,340,120 TOTAL LIABILITIES & OWNER’S EQUITY 4,299,432OWNER’S EQUITY 3,040,688TOTAL LIABILITIES 344,679 Due to shareholders LIABILITIES 383,806 Current Liabilities $ 7,340,120TOTAL ASSETS 6,171,851 Property, plant & equipment at cost less accumulated amort. (note 1) $ 1,168,269 Current Assets ASSETS Values at a specific point in time Long-term debt less current portion 2,141,328

60. Fair Market Value Balance Sheet Exercise 1.3 Net book value: Shares$ Retained earnings Due to shareholders Sub-total $(A) Adjustments: FMV – Land x – BPQ x – Equipment and Automotive – Other Subtotal (B) Less: Net book value of: Land BPQ Equipment Automotive Subtotal ( )(C) Fair market value: $(A+B-C) Use appendices C, H and Facts

61. Fair Market Value Balance Sheet Exercise 1.3 – Answer Key Net book value: Shares$ 217 Retained earnings 4,299,215 Due to shareholders 344,679 Sub-total 4,644,111(A) Adjustments: FMV – Land 800 x16,000 12,800,000 – Quota 0 x 0 NIL – Equipment and Automotive 850,000 – Other - Subtotal 13,650,000(B) Less: Net book value of: Land 4,613,824 BPQ NIL Equipment 295,074 Automotive 566,355 Subtotal ( 5,475,253)(C) Fair market value: $ 12,818,858(A+B-C)

62. The operating cycle The cycle of the conversion of cash back into cash Cash Finished goods Inventory Accounts receivable The purchase cycle The sales cycle

63. Basic financial statements The income statement A statement of the operating activity of the farm Shows revenues and expenses and the resulting net income (profit or loss) for a specific period of time Profit/loss is added/subtracted to retained earnings which in turn effects owner’s equity on the balance sheet Can be prepared on cash or accrual basis – choosing the cash vs accrual can have a significant impact

64. The income statement What are revenues? The value of all goods and services rendered by a business as a result of its operations What are expenses? Goods and services incurred to earn the revenues What is net income? The amount left after all expenses have been deducted from the revenues revenues – expenses = net income

65. The income statement Use it to measure your performance –Understand your operating cycle –Understand the lock up of cash flow Use it to monitor profitability –Ratio analysis – Session 4

66. Statement of Income The statement of income is used to: –Assess the operation’s ability to generate a profit. –Quantify the amount of profit or loss. –Determine why the operation experienced a profit or loss. –Identify how to improve profit. –Track management changes to measure the profit. –Record earnings change to cost basis equity.

67. Income Statement Component Definitions Total Revenues Cost of Production Gross Margin Administrative Expenses Income Before Taxes Income Taxes Other Items (extraordinary items, gain on disposal) Net Income Refer to Appendix E

68. The income statement (xx,xxx) Gain on disposal of property, plant and equipment, taxes $ xxx,xxx NET INCOME (LOSS) x,xxx,xxxGROSS MARGIN x,xxx,xxxTOTAL EXPENSES $ x,xxx,xxxTOTAL REVENUE Revenues the business earned Values over a specific period e.g fiscal year Expenses the business incurred The profit of the business for period ADMINISTRATIVE EXPENSES INCOME BEFORE TAXES xxx,xxx

69. Statement of Income Exercise 1.4 (continued) From Appendix E and G: 10.Locate and record the total revenues$ 11.Locate and record the total expenses$ 12.Locate and record the net income $ 13.Locate and record interest & bank charges$ 14.Locate and record the amortization of tangible assets$

70. Statement of Income Exercise 1.4 (continued) – Answer Key From Appendix E and G: 10.Locate and record the total revenues$ 2,174,561 11.Locate and record the total expenses$ 1,938,058 12.Locate and record the net income $ 290,207 13.Locate and record interest & bank charges$ 130,881 14.Locate and record the amortization of tangible assets$ 368,625

71. The income statement 53,714 Gain on disposal of property, plant and equipment, taxes $ 290,217 NET INCOME (LOSS) 811,488GROSS MARGIN 1,363,073TOTAL EXPENSES $ 2,174,561TOTAL REVENUE Revenues the business earned Values over a specific period e.g fiscal year Expenses the business incurred The profit of the business for period ADMINISTRATIVE EXPENSES INCOME BEFORE TAXES 574,985 236,503

72. Exercise 1.5 Two Kinds of Revenue Presentation Total Income or Revenue$x,xxx,xxx Adjusted revenue Revenue per financial statements $ x,xxx,xxx Plus: Closing inventoryx,xxx,xxx Less: Opening inventory (x,xxx,xxx) Adjusted revenue $x,xxx,xxx Refer to Appendix E

73. Exercise 1.5 Two Kinds of Revenue Presentation Answer Key Total Income or Revenue $2,174,561 Adjusted revenue Revenue per financial statements $ 2,174,561 Plus: Closing inventory882,419 Less: Opening inventory (1,333,607) Adjusted revenue $1,723,373 Refer to Appendix E

74. Understand operating expenses There are different types of expenses: Fixed expenses - You incur the expense whether or not you make any sales Variable expenses - You don’t incur the expense unless you have production Mixed expenses - Expenses that have both a fixed and a variable component

75. Fixed expenses You incur the expense whether or not you have any production The expense is independent of your volume of sales or revenues Examples of fixed expenses: –Equipment insurance –Property taxes –Loan interest –Family member wages

76. Variable expenses You wouldn’t incur the expense if didn’t have any production The expense varies in relation to the volume of sales or revenues Examples of variable expenses: –Purchase of broiler feed (wouldn’t purchase this if didn’t have a crop of chickens) –Purchase of fertilizer (wouldn’t fertilize if didn’t have crops planted)

77. Mixed expenses There are some expenses that have both a fixed component and a variable component: –Heat and hydro For example, in the winter, one will incur the variable cost to add supplemental heat to a barn full of growing broilers –Fuel For example, one will incur an increase in cost to operate machinery during times of higher use such as harvesting

78. Monitor operating expenses Why bother? To better analyze your income statement To determine your profitability To plan for business growth (including expansion or diversification) – Which expenses will be affected?

79. Conducting a profitability analysis: profitability ratios What are they? The calculation of a business’ ability to generate profit from using its resources Gross margin / gross margin % Net income as a percentage of revenue Major expenses as a percentage of revenue

80. Understand your operating expenses Income statement Revenue X less Cost of goods sold X equals Gross margin less Overhead (fixed) costs equals Net income Variable expenses Fixed expenses Mixed expenses Quantity sold Selling price Quantity purchased Cost of inputs

81. Major expenses as a percent of revenue Each expense / revenue x 100 Provides a line by line comparison expenses to your Revenue A valuable ratio to use when comparing trends and industry benchmarks Revenue 100% Cost of sales 50% Gross margin 50% Overhead cost #1 10% Overhead cost #2 10% Overhead cost #3 10% Net income 20%

82. Exercise 1.6 - major expenses % Wages and benefits % Long-term interest% Fertilizer and Chemicals% Seed% Using adjusted revenue number to calculate percentage; and appendices E and G

83. Exercise 1.6 - major expenses % Answer Key Wages and benefits 4.18% Long-term interest6.91% Fertilizer and Chemicals13.8% Seed11.30% Using adjusted revenue number to calculate percentage; and appendix E

84. 1.Reduce lock up period Cash basis of accounting used for tax purposes may force you to: Manage the lock up Pay early Collect late How do you get off the treadmill? –Use accrual basis of accounting –Collect cash sooner Current lock up New lock up

85. Manage the lock up Pay for inputs Dec 10 Mar 11 Market crop Sep 11 Purchase of inputs Nov 10 Feb 11 Cash float Reduction in cash lock up to 7 months Plant Apr 11 Collect cash from sale Jan 12 Oct 11 Inventory holding

86. Remember! Remember that the income statement is key to measuring your performance and monitoring your profitability

87. The statement of cash flow Cash from operating activities Cash resulting from collecting receivables, paying expenses or purchasing inventory Cash from investing activities Cash resulting from the purchase or disposal of long term assets e.g. equipment Cash from financing activities Cash from borrowing or repaying debt or additional investments or distributions to owners

88. The statement of cash flow $(xxx,xxx)Cash – End of year (xxx,xxx)Cash – Beginning of year xxx,xxxINCREASE (DECREASE) IN CASH FLOW (xxx,xxx) Cash Flow used by financing activities (xxx,xxx) Cash Flow used by investing activities FINANCING ACTIVITIES INVESTING ACTIVITIES $ xxx,xxx Cash Flow used by operating activities OPERATING ACTIVITIES Values at a specific point in time Must match to cash balance on balance sheet Cash generated during the year OTHER ACTIVITIES Cash Flow used by other activities (x,xxx)

89. Statement of Cash Flow Exercise 1.7 From Appendix F: 15.Locate and record the cash generated (or consumed) in each area: a. Operating activities $ b. Investment activities $ c. Financing activities $ d. Other activities $ 16.Locate and record the total cash generated (or consumed) during this period $

90. Statement of Cash Flow Exercise 1.7 From Appendix F: 15.Locate and record the cash generated (or consumed) in each area: a. Operating activities $ 1,038,229 b. Investment activities $ (245,000) c. Financing activities $ (352,268) d. Other activities $ (16,293) 16.Locate and record the total cash generated (or consumed) during this period $ 424,668

91. The statement of cash flow $(57,249)Cash – End of year (481,917)Cash – Beginning of year 424,668INCREASE (DECREASE) IN CASH FLOW (352,268) Cash Flow used by financing activities (245,000) Cash Flow used by investing activities FINANCING ACTIVITIES INVESTING ACTIVITIES $ 1,038,229 Cash Flow used by operating activities OPERATING ACTIVITIES Values at a specific point in time Must match to cash balance on balance sheet Cash generated during the year OTHER ACTIVITIES Cash Flow used by other activities (16,293)

92. Linking the financial statements Source: Farm Financial Records, Page 55

93. Review of Section 3 Cash versus accrual method Matching principle Lock up Variable, fixed and mixed expenses Balance Sheet Statement of Income Statement of Cash Flow

94. ASSET TURNOVER (ROI) EBITDA (Efficiency) CASH CASH IS KING

95. AFTER LUNCH Human Resources - “On Solid Ground”