1. Annie’s Project January 30, 2007 Coweta Oklahoma
Financial Statements
Annie’s Project
January 30, 2007
Coweta Oklahoma

2. What are financial statements?
Financial statements are the written reports on the financial condition of a business.
There are three major types of financial statements.

3. Types of Financial Statements
Balance Sheet
A statement that shows the wealth of the business at a given date.
Cash Flow Statement
A summary of the cash inflows and outflows for a business over a given time period.
Income Statement
A summary of income and expenses for a business over a given time period.

4. Balance Sheet
A balance sheet is a summary sheet of everything that is owned and owed by the operation.
A balance sheet should be done at the beginning and end of each fiscal time period.
A balance sheet can be done using the market value or cost basis methods.

5. Which Method to Use? Market Value Cost Basis
Typically used by most lending institutions
Easiest to determine
Easiest to over or under estimate
Due to rapidly changing markets, could overstate or understate net worth.
Cost Basis
Must have good records
Must know depreciation of assets
Probably gives a truer picture of the value of the business

6. Parts of a Balance Sheet
A balance sheet has three components
Assets – what is owned
Current and non-current
Liabilities – what is owed
Net Worth – Assets minus Liabilities

7. Current Assets
Current assets are assets that will be used up or sold during the next twelve months.
Examples include:
Cash, checking accounts, savings
Investments
Accounts receivable
Prepaid expenses
Cash investments in growing crops
Inventories
Market livestock, stored crops, purchased feed, supplies

8. Non-Current Assets
Non-current assets are assets that have a useful life of more than 1 year.
Examples include:
Breeding livestock
Machinery, equipment
Vehicles
Investments in capital leases
Land
Buildings and improvements

9. Current Liabilities Accounts payable Notes payable
Current portion of term debt
Accrued interest
Taxes payable
Deferred taxes

10. Non-current Liabilities
Notes payable, non-real estate
Notes payable, real estate
Deferred taxes

11. Net Worth
Net worth of the business is the difference between the total value of the assets and the total value of the liabilities.
Net (Current Assets + Non-current Assets)
Worth − (Current Liabilities + Non-current Liabilities) =

12. Balance Sheet Exercise

13. Cash Flow Statement
A cash flow statement is a summary of cash inflows and outflows divided into equal time periods usually monthly.
Cash Inflows
Operating receipts
Crop and livestock sales, government payments, other farm income
Capital sales
Contributed capital
Cash Outflows
Operating expenses (feed, fertilizer, etc.)
Capital purchases
Family living and other withdrawals

14. Uses of a Cash Flow Statement
Establishes target levels for income and expenses which can be used in monitoring progress towards goals
Points out potential problems in meeting financial obligations
Indicates when cash is available for new investments

15. Cash Flow Exercise

16. Income Statement There are two methods of doing an income statement.
Cash
Cash receipts and expenses are recorded when the they are paid.
Most non-cash expenses are not included.
Accrual
Records receipts and expenses when they occur.
Inventory changes are included.

17. Difference Between Cash Flow and Income Statement
Income statement does not include:
Capital sales and contributed capital
Principal payments
Family living expenses
Cash flow statement does not include:
Depreciation

18. The Accrual Adjusted Income Statement
Revenues
Livestock and crop sales
Changes in inventories
Government payments & other farm income
Gain/loss from sale of culled breeding stock
Change in value due to change in raised breeding livestock numbers
Accrual adjustments in asset accounts

19. Changes in Inventories
Market livestock
Raised crops/feed inventories

20. Gains/Losses on Sale of Culled Breeding Livestock
Purchased breeding stock: subtract cost basis from the sale proceeds
Raised breeding stock: subtract base value from the sale proceeds

21. Change in Value Due to Change in Raised Breeding Livestock Numbers
Number of head transferring from one classification to another, e.g., replacement heifers to cows
Differences in base values of the two classifications

22. Accrual Adjustments (Assets)
Change in:
Accounts receivable
Prepaid expenses
Cash investment in growing crops
Supplies
Contracts and notes receivable
Investment in cooperatives

23. The Accrual Adjusted Income Statement
Expenses
Purchased market livestock
Cash operating expenses
Changes in feed inventories
Accrual adjustments for liability accounts
Depreciation
Cash interest paid
Change in accrued interest

24. Accrual Adjustments Changes in: Purchased feed inventories
Accounts payable
Ad valorem taxes
Employee payroll withholdings
Accrued expenses
Accrued interest

25. Depreciation There are different methods of depreciation.
Modified Accelerated Cost Recovery System (MACRS)
General Depreciation System (GDS)
Alternative Depreciation System (ADS)
Which one depends type of property
Straight Line Depreciation
Cost – Salvage Value
Years of Life

26. The Accrual Adjusted Income Statement
Net Farm Income, Accrual Adjusted =
Gross Farm Revenues
- Total Operating Expenses
- Total Interest Expense
+/- Gain/Loss on Sale of Farm Capital
Assets

27. Gains/Losses on Sale of Farm Capital Assets
Difference between the value for which the items is sold and the adjusted basis (cost minus depreciation taken)

28. Look at an Income Statement

29. Measuring Financial Stress
Liquidity
Ability to pay bills as they come due and cover unanticipated events
Solvency
Ability to cover all debts if the business were sold
Profitability
Returns to labor and management generated by the operation
Financial efficiency
Efficiency with which assets generate income
Repayment capacity
Ability to repay term debt in a timely fashion

30. Measuring Liquidity Current ratio = Total current farm assets
Total current farm liabilities
Current farm assets are those expected to be converted to cash or used up in the current year. Examples include cash, supplies, market livestock, feed and hay inventories.
Current liabilities are those expected to be paid this year and include the principal due this year on longer term notes.
Lower current ratios can be supported by farms with income coming in regularly, such as dairies, rather than once a year as with a specialized grain farm.
If the current ratio is very low, a potential “fix” is to reschedule debt to reduce the amount of current farm liabilities. A portion of the debt is shifted from this year to future years, extending the length of indebtedness, but reducing the burden in the short term.
Low Stress
High Stress

31. Measuring Solvency Debt/asset ratio = Total farm liabilities
Total farm assets
Credit is like a buzzsaw, useful in the hands of a skilled craftsman, dangerous in the hands of others.
May also see 30 and 60% used as benchmarks for stress levels.
Having a high d/a ratio means a higher risk situation. A crop failure or other disaster can end the business.
For financial analysis purposes, better to use cost basis for value of assets as those values are more stable over time than market values.
How to improve the d/a ratio? Pay down debt.
50% is the threshold used to qualify for eligibility for an interest rate subsidy through the Oklahoma Ag Linked Deposit program.
Low Stress
High Stress

32. Measuring Profitability
Net Farm Income =
Gross farm revenue
- all farm operating expenses incurred to create those revenues
+/- gains/losses on sale of capital assets
Accrual adjusted measure is best. That means accounting for income that is generated but not realized, for instance, heifers born and raised for replacements. It also means recognizing non-cash expenses, such as changes in inventories of hay and depreciation.
Being profitable positively impacts all other measures.
Net farm income for tax purposes is not sufficient in a given year to indicate profitability. (Ten year record should however give an indication.)
How to improve profitability? Conduct a management audit. Look at enterprises to determine whether they are pulling their weight. Should you be producing hay or buying it? Growing wheat or renting pasture? Cost control is important.
Negative net farm income means equity is being eroded. Using up wealth built up over time.
Net farm income from operations (excluding gains/losses on assets sold) is even better as an indicator of profitability of the operation.
Low Stress
High Stress

33. Measuring Profitability
Rate of Return on Farm Assets =
(Net farm income from operations
+ farm interest expense
- value of unpaid labor & management)
(Average total farm assets)
ROA is an index. Compare this to the cost of capital, e.g. a 10% interest rate. If you are paying 10%, but only earning 3% the borrowed money is not being used profitably.
Family living expense is used as a proxy for the value of unpaid labor and management.
Average farm assets = (total value at beginning of year + total value at end of year)/2
For financial analysis purposes, better to use cost basis for value of assets as those values are more stable over time than market values.
ROA in ag is low compared to other industries. However, historically appreciation in the value of assets such as land has provided other compensation. This has not been as true in recent years however, particularly in rural areas in western OK.
How to improve it? Improve profitability, lower interest expense, lower family living withdrawals.
Low Stress
High Stress

34. Measuring Profitability
Rate of Return on Farm Equity =
(Net farm income from operations
- value of unpaid labor & management)
(Average total farm equity)
ROE is an alternative index, used to compare to rates of returns in alternative investments, such as CDs or stock market index funds. Probably want to earn as much on $ invested in farm as you could if it were in the bank.
Equity = Assets - debt = owner’s claim to assets.
For financial analysis purposes, better to use cost basis for value of assets as those values are more stable over time than market values.
Do red lights mean a wreck is inevitable? Most have run a red light and lived to tell about it. However, wouldn’t recommend it as a practice if you want to live a long life!
How to improve it? Improve profitability, lower interest expense, lower family living withdrawals.
Low Stress
High Stress

35. Measuring Efficiency and Repayment Capacity
Interest Expense Ratio =
Total farm interest expense
Gross farm revenues
20% threshold means 1/5 of sales are used to pay interest.
How to fix it? Pay down debt. Seek ways to reduce interest rate.
Low Stress
High Stress

36. Measuring Efficiency Asset Turnover Ratio = Gross farm revenues
Average total farm assets
How to improve it? Increase revenues relative to asset base by improving profitability, double-cropping (including using wheat pasture for livestock), rent rather than own assets.
Will be different for different types of operations. Stockers on wheat operations using rented land will have high turnover ratios relative to cow/calf operators with a lot of owned land.
Low Stress
High Stress

37. Stress Test Exercise