1. Financial Analysis
Ag Management
Chapter 3

2. Financial Statements Necessary to Determine Financial Condition
Net worth Statement
Income Statement
Cash Flow

3. Net Worth Statement

4. Net Worth Statement
A “snapshot” of a financial situation that lists assets, liabilities, and net worth

5. 3 Parts of Net Worth Statement
Assets
Liabilities

6. Assets
Items that have a market value
2 Categories
Current
Non-Current

7. Current Assets
Cash or other assets which can be converted to cash through normal operations of business during the year
Examples
Checking and/or Savings Accounts
Receivables
Inventory held for sale
Other near-cash items such as securities, stocks and bonds and the cash value of life insurance

8. Non Current Assets
All assets controlled by the farm or ranch business having a useful life greater than 1 year
2 categories
Intermediate
Fixed

9. Intermediate Assets (Non Current)
Resources or production items with a useful life of 1-10 years
Include most assets used to support production or in the production process
Examples
Equipment
Machinery
Breeding Livestock

10. Long Term Assets (Non Current)
Permanent items
Examples
Land
Improvements on buildings

11. Liabilities All the debt obligations of the business Two types Current
Non Current

12. Current Liabilities
Debts due within the operating year, normally a 12 month period
Examples
Notes & accounts payable
Rents
Taxes
Interest plus principle payments due on intermediate or long-term debt within the next 12 months

13. Non Current Liabilities
Debts due past (or after) one year
Two categories
Intermediate
Long Term

14. Intermediate Liability
Non real estate debt that corresponds to intermediate assets
Loan terms are normally for a period of 12 months or more but less than 10 years
Examples
Loans for
Improvements to Real Estate
Equipment Purchases
Breeding livestock and dairy stock
Capital requirements for major adjustments in farm operations

15. Long Term Liabilities
Mortgages and land contracts on real estate minus principle due within 12 months

16. Net Worth
The amount of money you can put in your pocket before taxes if you were to sell all your assets and pay off all your liabilities
Net Worth = Assets-Liabilities
See p. 3-5

17. Kinds of Financial Analysis

18. 3 Kinds of Financial Analysis
Comparative
Projected
Ratio

19. Comparative Analysis
Measuring and analyzing the trends found in net worth statements over a period of months & years.
Important to compare the same dates each year
Looks at Assets, Liabilities & Net Worth

20. Projected Analysis
Used to estimate future changes in equity

21. Making a Projected Analysis
Making balance sheets for the future for expected farm situations and analyzing them to see problem trends
Usually made when cash flow statements are made

22. Ratio Analysis
Used to measure the financial condition of one farm against other farms

23. Ratio Analysis Maybe Difficult Because….
Ratio’s showing strengths and weaknesses may not be clearly defined
What is good for one business may not be good for another

24. Financial Analysis from the Net Worth Statement

25. 3 Financial Indicators that can be Calculated from the Net Worth Statement
Liquidity
Solvency
Equity

26. Liquidity
The ability of a business to generate enough cash to pay bills without disrupting business

27. 3 Formulas to Measure Liquidity
Current
Working
Debt Structure

28. How Current Ratio Measure’s Liquidity
Current Ratio=Current Assets/Current Liabilities

29. How Working Capital Measures Liquidity
Total Current Farm Assets – Total Current Farm Liabilities

30. What Debt Structure Reveals About Farm Liabilities
Measured by dividing current liabilities by total liabilities
Current Liabilities/ Total Liabilities
The higher this percentage the more assets would be needed to service debt.

31. Solvency
Measures the ability of all assets if sold at market value to cover all debts

32. Calculations to Measure Solvency
Debt-to-Asset Ratio
Debt-to-Equity Ratio
Equity-to-Asset Ratio

33. Debt-to-Asset Ratio
Measures the amount of risk in regard to debt against the farm or ranch
Calculated by
Total Farm Liabilities/Total Farm Assets
Lenders prefer to provide loans which are equal to or less than 50 percent of assets.

34. Debt-to-Equity Ratio
Shows the relationship between owned and borrowed capital
Measured by
Total Liabilities/Net Worth
Lenders prefer a debt-to-equity ratio of less than 1 because this shows that the owner’s net worth or contribution is more than the borrowed funds

35. Equity-to-Asset Ratio
Measures the relationship of the farm’s net worth and total farm assets
Measured by
Total Farm Net Worth/Total Farm Assets
Allows you to see if total assets exceed total liabilities

36. Income Statements are Used
Give the figure of either income or figure loss

37. Income
Money received from the sale of crops, livestock, and livestock products during the year.
Receipts should also include government payments and miscellaneous sources of farm income

38. Expenses
Money paid out to operate the business

39. Calculation for Net Cash Income
Net Cash Income =Cash Income – Cash Expense
Net Cash Income is what remains after subtracting Operating and Fixed Expenses

40. Non Cash Adjustments Must Be Made by Comparing and Ending Values for…
Expenses payable
Prepaid expense
Adjustments in inventories
Change in interest payable

41. Net Farm Income
Net cash income and the adjustments added together

42. Financial Efficiency Ratios

43. Financial Efficiency Ratios
Ratio’s that compute what percent of total revenue is attributed to the relevant category

44. Four Financial Efficiency Ratios
Operating-Expense Ratio=
Total Expenses-Depreciation and Interest/Total Income
Depreciation-Expense Ratio=
Total Depreciation Expense/ Total Income
Interest-Expense Ratio=
Total Interest Expense/Total Income
Net Farm Income From Operations Ratio=
Net Farm Income From Operations/Total Income
See p.3-12 fig. 21 for examples

45. Operating Expense Ratio
Percent of income that consist of operating expenses. (excluding interest and depreciation expenses)

46. Depreciation Expense Ratio
Total depreciation expense divided by total revenue. Indicates the percentage of total income allocated to depreciation.

47. Interest-Expense Ratio
Total interest expense (cash interest paid plus change in interest payable) divided by total income. Ratio show the percentage of income devoted to interest.

48. Net Farm Income From Operations Ratio
Net farm income from operations divided by total income . Show the percentage or ratio of total income that actually ends up as net farm income from operations.
Good check is to ensure that all four ratios total to 100%.

49. Net Worth and Income Statement Relationships

50. Net Worth Statements Look At
The financial picture at a point in time.

51. Income Statements Indicate the Performance of
The farm business within a period
The period can be defined as any period but it is typically between one net worth statement and the next (usually 1 year)

52. Asset-Turnover Ratio
Useful measure to show how effectively farm assets are being used
Calculated by
Gross Revenue/Average Total Farm Assets
Gross Revenue is gross receipts from farming plus (or minus) total non-cash adjustments
Average total farm assets is in year one plus year two divided by two.

53. Value Favorable for Asset-Turnover Ratio
The higher the asset turnover ratio, the quicker the turnover of assets and generally the greater the likelihood of profits

54. Distribution of Net Farm Income (Profitability)

55. Not Shown on Income Statements
1 category of labor not shown on income statements– A charge for unpaid operator and family labor

56. Operator and Family Labor Allowance
Determined from a 2,080 hour work year

57. Return to Equity Capital and Management
Return to Equity Capital and Management=Net Farm Income – Operator and Family Labor Allowance

58. Profitability Ratios Rate of Return on Borrowed Capital (COD)=
Return on Farm Assets-Return to Equity Capital and Management/Average Total Farm Assets-Average Net Worth
Rate of Return on Farm Assets (ROA)=
Net Farm Income + Total Interest Expense –Operator and Family Labor Allowance
Rate of Return on Farm Equity (ROE)=
Return to Equity Capital and Management/Average Farm Net Worth
Operating Profit Margin Ratio (OPMR)=
Net Farm Income + Total Interest Expense – Withdrawals for Operator and Family Labor/ Total Income
See p.3-14 to 3-16 for examples

59. Rate of Return on Assets Show Profitability by
Adjusting net farm income as if no interest has been paid, thus treating the total farm assets like equity capital

60. Rate of Returns on Equity Ratio Is
The rate of return on equity in the farm
The ratio show’s the farm’s return on net worth

61. How the Rate of Return on Borrowed Capital is Used
Evaluating whether returns are great enough to pay the cost of borrowing funds
Comparing return on borrowed capital with the return on equity capital

62. Operating Profit Margin Shows Profitability By
Defines profit as a percentage of total revenue
Formula
Net Farm Income + Total Interest Expense – Withdrawals for operator and family labor/ Total Income

63. 3 Components of Ending Net Worth Statement
Ending Assets
Beginning Assets + Non-Cash Reinvestment + Changes in Inventory – Depreciation = Ending Assets
Ending Liabilities
Beginning Liabilities + New Debt Added – Debt Repaid = Ending Liabilities
Ending Owner Equity
Beginning Owner Equity + Net Farm Income – Family Living and Income Taxes= Ending Owner Equity

64. Fixed Assets and Net Worth Statements

65. 3 Reasons Valuing Fixed Assets is Difficult
Fixed assets can’t easily be changed to capital like current and other noncurrent assets
Fixed assets are usually part of the business for many years; often they are part of the entire life of the business
Values on financial statements must be estimated in order to get credit and to plan for future enterprises
It is best to be conservative when valuing fixed assets, therefore it is best to use BOOK VALUE

66. Summary Financial statements are like a health report
There are 2 financial statements to consider
Net Worth
Income
Net worth statement and income statement provide financial measures of strengths and weaknesses of the farm business. They help pinpoint problems.
The Net worth statement provides information about what assets are owned and what liabilities are owed. It is a picture of the farm business at a point in time, usually annually.
The income statement show the financial performance of the farm business from one net worth statement to another.
The two financial statements together are powerful tools for farm and ranch business management.

67. Assignment Chapter 3 Assignment Sheets 1 and 2 p. 39-42
DUE--- Tuesday Sept 21
Chapter 3 Review Questions
DUE--- Thursday Sept 23
Chapter 3 Quiz– Thursday Sept 23