Managing Capital /Financial Risk

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Managing Capital/Financial Risk
Craig Binkowski Southern Michigan Bank Trust
Coldwater
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(No Transcript)
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Topics in Financial Section

• Financial Balance Sheet (Whats at risk?)
• Cost of Production / Revenue Requirements
• Total Economic costs
• Cover Direct Cost
• To Maintain Equity
• Meet Cash Flow Demands
• Cost of Production Worksheet
• Incorporating Financial Information into Risk
  Management / Control Decisions

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Financial Risk Management

• Increase Equity through Farm Profit
• Net Worth increase without inflation in asset
  values
• Meet Cash Flow Demands
• Monitor cost availability of Debt Capital
• Interest Rate Risk
• Sources of Capital
• Financial Information for measurement and
  monitoring is available and used

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3 Basic Financial Statements

• 1. BALANCE SHEET
• Assets, liabilities, and net worth
• Annual Change in Net Worth
• 2. INCOME STATEMENT
• Inventory Adjusted (Accrual)
• 3. Projected CASH FLOW
• After Scheduled Term Debt Principal
  Interest Payments, Family Living, Income Taxes

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Example Farms for the GameDesigned to Simulate
TodaysMarket Environment

• Green Low Debt Farm (Sorry)
• Yellow Moderate Debt Farm
• Red High Debt Farm

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Balance Sheet

• Current balance sheet tells you
• Financial position of your business/Self
• Your capacity to withstand risk
  Take a Hit and remain solvent
  
• Three-five years of balance sheets tell you
• Trends in equity of your business
• Need Both Cost Basis (Book Value)
• And Market Value
• Dual Column Balance Sheet

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Balance Sheet Debt Levels
Page 4 FINLRB output
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Income Statement

• History
• Did your business make or lose money last year?
• How much?
• Was your neighbors experience similar?
• What has been the past performance of your
  business? Relative to your neighbors?
• Projections (pro-forma)
• What will be different from the past? Why?
• Do you expect the business to make a profit?
• How much can revenue fall due to price and/or
  yield shortfalls before there is a loss?

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Income Statement
Page 2 of FINLRB output
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Liquidity - Cash Flow Statement

• Ability of your business to meet its cash flow
  obligations
• Accounts for all sources and uses of cash
  including debt and capital activity
• Helps you assess how much room there is for
  stuff going wrong -- RISK!
• Helps you assess if adjustments need to be made
  in the financial structure of your business.
• Does NOT tell you if your business made a profit!

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Liquidity- Cash Flow Statement
Page 3 of FINLRB output
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Change In Net Worth

• Did Your Net Worth Increase last year? Or
  Decrease? Trend? Why?
• From Retained Earnings out of Farm Profit?
• From Asset Inflation? Machinery? Land?
• From Contributed Capital? (Outside sources)
• Do you expect your net worth to increase next
  year? Or, decrease?
• How much room do you have for stuff to go wrong
  RISK!

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Change in Net Worth
Hand calculate the Change in Equity
Page 4 of FINLRB output
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Working Capital Ratio What does it tell you
about Risk?

• Ability to meet cash flow demands if there is a
  downturn
• Ignores unused borrowing capacity
• Weak Less Than 0
• (I.E. Working Capital Margin 0)
• Can be too high - I.E. Large inventory of crops
  and feed on hand
• money tied up that could be used to pay down debt
• Marketing ? Getting crops sold!

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Working Capital Ratio
Working Capital/Gross Farm Income
Page 5 and 2 of FINLRB output
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Financial Guidelines for RISK Management
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Cant Look at Just One Ratio!

• Operating expenses may be high, but are
  depreciation expenses low?
• If many of the measurements are just out of the
  weak area then the farm as a whole may be in
  serious trouble.
• Focus on
• Accrual Net Farm Income
• Projected Cash Flow
• Retained Earnings ( non-inflationary Net Worth
  Change in Balance Sheets)

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Understand the Numbers for Your Farm Business!

• Critical in todays environment
• Understand what the numbers mean and signal
• Monitor Business EVERY year routinely
• Use professional assistance if needed

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Cost of Production

• Roger Betz
• District Extension Farm Management Agent SW
  Michigan

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Cost of Production Worksheet

• Allocates Overhead cost to each acre and combines
  with Direct Cost to determine Cost of
  Productions for various crops
• Cost of Productions?
• Economic
• Direct Cost
• Maintain Net Worth
• Meet Cash Flow Demands
• Useful in Marketing and Crop Insurance Decisions

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Cost of Production Worksheet - page 2
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Cost of Production - Overhead
Cost of Production Page 2- Medium Debt
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Economic Cost of Production
Cost of Production Worksheet Page 2 - Medium
Debt Farm
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Total Direct Cost
Cost of Production Worksheet Page 2 Medium Debt
Farm
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Revenues to Maintain Net Worth
Cost of Production Worksheet Page 2 Medium Debt
Farm
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Revenues to Meet Cash Flow
Cost of Production Worksheet Page 2 Medium Debt
Farm
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Break Even Incomes PricesCost of Production
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Break Even Income Prices Cost of Production
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Break Even Incomes PricesCost of Production
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Break Even Prices Needed
Make Sure You Have These Values
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What Percent of Equity are You Willing to Risk?
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Can I use Risk Management Tools to Minimize
Equity Loss?
Lines 49 and 50 Cost of Prod. Worksheet
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Key Questions for Your Farm Business

• 1. Appropriate Financial Information Available?
  Historical, Current, and Future
• 2. Adequate Understanding of Financial Conditions
  and Risk Positions?
• 3. Realistic Plans Underlying Assumptions?
• 4. What level of Equity Protection can Risk tools
  provide?
• 5. Should you utilize Financial Risk Management
  Strategies?

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STOP!

• What is the key financial information for your
  farm?
• What are the revenues required to
• Meet Economic Cost
• Cover Direct Cost
• Maintain Net Worth
• Meet Cash Flow Demands
• Start to think through your crop insurance and
  marketing plans