1. Financial Statement Analysis
Understanding and Using Financial Ratios

2. Financial Management in Agriculture
9/18/2018
Introduction
The four financial statements contain much of the information need to make business decisions
How can this information be used to analyze a farm or a business?
Decision making can be improved through financial planning in five ways
Identify and learn from past mistakes
Make fewer mistakes
Take timely and appropriate action to correct mistakes that are made
Identify strengths and weaknesses
Spot opportunities

3. Financial Analysis Techniques
Financial Management in Agriculture
9/18/2018
Financial Analysis Techniques
Business over time
Evaluate direction the business is heading
Historical trends
Cost vs. Market
Cash vs. Accrual
Pro forma or Projected Analysis
Analyze historical performance and make adjustments to reflect future plans and expectations
Scenarios
What if analysis

4. Financial Analysis Techniques
Financial Management in Agriculture
9/18/2018
Financial Analysis Techniques
Monitoring and Control
Continuous comparison of actual performance to projected performance
Helps management to stay in control
Spot problems quickly
Spot opportunities quickly
Ratio Analysis
Used to express a relationship

5. Ratio Analysis Can be analyzed on
Financial Management in Agriculture
9/18/2018
Ratio Analysis
Can be analyzed on
Historical trends
Monitored on current basis
Based on projections
Lenders, researchers, and management consultants have relied heavily on ratios because
Selected ratios can direct attention to specific financial information
Particularly helpful if ratio information is available for multiple years

6. Ratio Analysis Three standards of comparison for ratios
Financial Management in Agriculture
9/18/2018
Ratio Analysis
Three standards of comparison for ratios
Compare the business against itself
Past performance to present
Present performance to budgeted performance
Able to identify trends
Compare the business to a set of benchmarks
Benchmarks must be first determined
Compare the business to an average for firms of similar size and type
Regional databases

7. Notes of Caution Apples to Apples Income calculation Business form
Financial Management in Agriculture
9/18/2018
Notes of Caution
Apples to Apples
Income calculation
Before or after tax
Cash or accrual
Business form
Balance Sheet
Cost basis valuation or market based

8. Financial Measures Five criteria
Financial Management in Agriculture
9/18/2018
Financial Measures
Five criteria
Liquidity
Solvency
Profitability
Repayment capacity
Financial efficiency
All measure financial position or financial performance

9. Liquidity Measures Liquidity ratios Analyzed two ways
Financial Management in Agriculture
9/18/2018
Liquidity Measures
Liquidity ratios
Measures the ability of the farm business to meet financial obligations as they come due, without disrupting the normal, ongoing operations of the business
Analyzed two ways
Structural liquidity
Balance sheet measures
Relationship between assets and liabilities
Operational liquidity
Cash flow measures

10. Liquidity Measures Working Capital Equation
Financial Management in Agriculture
9/18/2018
Liquidity Measures
Working Capital
Measure of the amount of funds that would be available to purchase inputs after the sale of current farm assets and payment of all current farm liabilities
Equation
Working Capital = Total Current Farm Assets – Total Current Farm Liabilities

11. Issues of Working Capital
Financial Management in Agriculture
9/18/2018
Issues of Working Capital
Absolute dollar amount
Difficult to make comparisons between businesses
Unable to establish one standard
Dependent upon size of firm
Future projections
Reflects amount at one point in time
Does not reflect timing of future cash flows

12. Financial Management in Agriculture
9/18/2018
Current Ratio
Used to evaluate the relationship between total current farm assets and total current farm liabilities
Equation

13. Current Ratio Relative measure
Financial Management in Agriculture
9/18/2018
Current Ratio
Relative measure
Higher the ratio, the more liquid the business
Acceptable values vary with business type
Not dependent on size of firm, can be used for comparisons

14. Cash Flow Coverage Ratio
Financial Management in Agriculture
9/18/2018
Cash Flow Coverage Ratio
Assesses the business’s ability to meet cash obligations
Calculated from the cash flow statement
Equation

15. Cash Flow Coverage Ratio
Financial Management in Agriculture
9/18/2018
Cash Flow Coverage Ratio
The higher the ratio, the higher the liquidity
Can be used for scenario

16. Solvency
Measures the amount of borrowed capital or debt, leasing commitments and other expense obligations relative to the amount of owner’s equity invested in the business.
Solvency measures provide an indication of the firm’s ability to repay all financial obligations if all assets were sold, and an indication of the ability to continue operations as a viable business after a financial adversity.

17. Financial Management in Agriculture
9/18/2018
Solvency Measures
Concerned with long-term as well as short-term assets and liabilities
Evaluates what would happen if all assets were sold and converted to cash and all liabilities were paid
Indicates the business’s ability to withstand risks and to continue operations after financial adversity
The most straightforward measure
Owner equity
Difficult to measure
Depends on size of firm

18. Solvency Measures Debt to Asset Debt to Equity Equity to Asset
Financial Management in Agriculture
9/18/2018
Solvency Measures
Debt to Asset
Debt to Equity
Equity to Asset

19. Financial Management in Agriculture
9/18/2018
Debt to Asset Ratio
Expresses total farm liabilities as a proportion of total farm assets
One way to express financial risk exposure
Equation

20. Debt to Asset Ratio Three main issues
Financial Management in Agriculture
9/18/2018
Debt to Asset Ratio
Three main issues
Greatly influenced by the value placed on farm assets
Market based
Cost based
Impact of deferred taxes
Reasonable standard will vary from one type of enterprise to another
No single standard
Depends on how debt is being used

21. Financial Management in Agriculture
9/18/2018
Debt to Equity Ratio
Reflects the extent to which farm debt is being combined with farm equity capital
If the ratio is less than 1:1 the creditors have less money in the business than the owner
Equation

22. Financial Management in Agriculture
9/18/2018
Equity to Asset Ratio
Expresses the proportion of total assets financed by the owner’s equity capital
Mirror image of debt to asset ratio
Equation

23. Profitability Measures
Financial Management in Agriculture
9/18/2018
Profitability Measures
Measures the extent to which a business generates profit from the use of labor, management, and capital
Relationship between revenues and expenses
Net Farm Income
Represents the returns to the farm for unpaid operator and family labor, management and owner’s equity.
Absolute dollar amount
Difficult to make comparisons
Before tax amount
Organizational form

24. Return on Farm Assets (ROA)
Financial Management in Agriculture
9/18/2018
Return on Farm Assets (ROA)
Used an overall index of profitability
Most meaningful for comparisons
Equation

25. ROA Issues Family withdrawals
Financial Management in Agriculture
9/18/2018
ROA Issues
Family withdrawals
Realized and unrealized capital gains are not included
May distort the ratio
Method of valuation
Pre-tax basis
Non-farm assets should be excluded

26. Rate of Return on Farm Equity (ROE)
Financial Management in Agriculture
9/18/2018
Rate of Return on Farm Equity (ROE)
Measures the rate of return on the owner’s equity in the farm business
Differs from ROA because of ROA considers both owned and borrowed capital
Equation

27. Financial Management in Agriculture
9/18/2018
ROE Issues
Same as ROA
Higher the ratio, the more profitable the business
If ROE is less than ROA
Business is paying more interest on borrowed money than is being earned

28. Operating Profit Margin Ratio
Financial Management in Agriculture
9/18/2018
Operating Profit Margin Ratio
Measures the returns to capital per dollar of gross revenue
Two ways to increase profit
Increase profit per unit produced
Increasing the volume of production
This ratio is concerned with the first
Equation

29. Financial Management in Agriculture
9/18/2018
Repayment Capacity
Measures the ability to repay debt from both farm and non-farm income
Evaluates the capacity of the business to service additional debt

30. Debt to Income Ratio Measures the amount by which debt exceeds income
Financial Management in Agriculture
9/18/2018
Debt to Income Ratio
Measures the amount by which debt exceeds income
Recognizes that equity is not the only thing a borrower can leverage
Useful for tracking the overall financial health of the farm sector.
Equation

31. Financial Efficiency Measures
Financial Management in Agriculture
9/18/2018
Financial Efficiency Measures
Measures in the intensity with which a business uses its assets to generate gross revenues and the effectiveness of production, purchasing, pricing, and financing, and marketing decisions.