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 Branding & Marketing Your Farm 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 Commodity Marketing MAP Continued 1:30pm to 2:00pm 2:00pm to 2:30pm Farm Business Vision & Strategic Direction Core Values & Beliefs 2:30pm to 3:00pm Case Study & Wrap-up 3:00pm to 3:30pm Building Your Management Team 3:30pm to 4:00pm Kolbe A PreparationManagement Action PlanCompletion

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 Weak management potential

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 Weak management potential 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 Centralized management

18. TAXATION

20. The Advisor’s Black Box 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. The Advisor’s Black Box Tax Rates - 2014 Corporate – Active (Ontario) 0-500,00015.50% 500,000+26.50%

22. The Advisor’s Black Box Tax Rates - 2014

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

24. The Advisor’s Black Box Asset additions Tax pools Asset dispositions

25. The Advisor’s Black Box 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. The Advisor’s Black Box Capital Gain Proceeds$100,000 Cost75,000 Capital gain$25,000 Taxable capital gain @ 50%$12,500

27. The Advisor’s Black Box 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. The Advisor’s Black Box Share Redemption Proceeds$100,000 Less paid up capital(1,000) Deemed dividend$99,000

29. The Advisor’s Black Box Capital Gains Exemption Land Building Quota Shares of small business corporation Shares of family farm corporation Interest in a family farm partnership

30. The Advisor’s Black Box Capital Gains Exemption $800,000 ($400,000) Individuals not corporations Keeping farm corporations “pure”

31. The Advisor’s Black Box Valuation Day – December 31, 1971 Land Buildings Shares Get the details Find those old returns

32. The Advisor’s Black Box Capital Dividend Account Capital gain Taxable capital gain Addition to CDA Capital gain Capital losses Prior tax-free dividends Get the old returns

33. The Advisor’s Black Box 1994 Elections $100,000 Old returns

34. The Advisor’s Black Box 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: A valuable tool in running your farm operation How 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

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. 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

49. Exercises Review the Pellegrino Farms Inc. financial statements

50. 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$

51. 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

52. 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

53. 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

54. 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

55. 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

56. 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

57. 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.

58. 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

59. 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

60. 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$

61. 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

62. 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

63. 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

64. 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

65. 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%

66. 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

67. 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

68. 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

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

70. 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

71. 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)

72. 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 $

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

74. 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

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

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