Managing Risks With Financial Analysis

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Managing Risks With Financial Analysis

• What's Your Plan?

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What's Your Plan?

• Production
• Financial
• Marketing
• Human Resource

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Are You a Risk Taker?????
Production Financial Marketing Human Resource
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• Do You Take Unnecessary Risks????

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Objectives For This Session

• Gain an understanding of
• Businesss financial position performance
  analysis
• Interaction among financial statements
• Financial interaction/impact the family has on
  the business
• Different types of risk affecting the business.

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Key Producer Items/Concerns

• Adequate funds for family living (All Families)
• Alternative enterprises, enterprise mix
• Debt Load and Structure
• Expansion plans/capabilities
• Dependences
• Government payments
• Off Farm Inflows
• Managing cost of production, financial info,
  marketing, labor (family)
• Tight profit margins

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Financial Trends in Agriculture

• Suggest several slides reviewing Ag financial
  health
• Trends in
• Farm Net Income
• Debt Load and Structure
• Number of farms
• Sources of Ag Household income
• Use these as background information
• Three examples follow

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Net Farm Income
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Net Cash Farm Income
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Total Production Expenses
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Complete Financials Required

• Beginning and Ending Balance Sheets
• Cash Flow Statement
• New form Statement of Cash Flows
• Accrual Adjusted Income Statement
• Statement of Owner Equity

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Terminology Causes Us Problems

• All cash inflows are not income
• Loan proceeds from lenders
• All cash outflows are not expenses
• Principal payments to lenders
• Expense versus Expenditure
• You can have non-cash expenses
• Depreciation most common
• Also through accrual adjustments
• You can have non-cash income
• Accrual adjustments

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Just Like Balancing a Check Book

• Beginning Cash Balance
• Inflows
• - Outflows
• Ending Cash Balance
• Your business performance is measured the same
  way using a complete set of financial statements

These are Linked
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Statement of Owner Equity

• Beginning Owner Equity
• Net Income
• - Withdrawals
• Contributions
• - Distributions
• /- Change in Valuation
• Ending Owner Equity

Balancing a Checkbook Beginning Equity /-
Activity Ending Equity
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Some Topics for Examination

• Withdrawals
• Non-business income
• Government Payments
• Cost of Production
• Debt Load (asset and liability structure)
• Asset revaluation
• Capital asset purchase
• Risk Protection Tools (Insurance)
• Non-cash income
• Non-cash expense (not depreciation)
• Contributed capital
• Distributed capital

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Withdrawals

• Note the
• Net worth (equity) on the balance sheet and the
  change in equity from beginning to end of year
• Note net income (Accrual Adjusted Income
  Statement)
• The relationship between cash flow and the
  balance sheet, follow the red arrows.
• Change family withdrawals to zero
• What is relationship of Net Income and change in
  equity
• What does this tell us about how equity growth in
  the business MUST occur
• Change family withdrawals back to 30,000

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Continuation of Owner Withdrawals

• With a positive Cash Flow
• No operating loan carryover
• May be a negative net worth change
• If so, the system tells how much owner draw is
  impacting net worth
• Also indicates the amount of money from
  non-business sources that must be brought into
  the operation

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Continuation of Owner Withdrawals

• With a negative Cash Flow
• Will have an operating loan carryover
• Carryover amount indicates the dollar adjustment
  necessary from
• Off farm earnings
• Income and/or expense adjustements
• Combination of all the above
• If from Off-Farm, enter as a nonbusiness cash
  inflow.
• May still be a negative equity change
• Correct with more non-business inflow

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Family Living Form of Ownership

• Sole Proprietor versus Corporation
• Change family living withdrawal to a business
  expense
• Zero out Owner Withdrawals and enter total
  dollars of family living on the Other Cash
  Business Expense line of the Cash Flow
• Illustrates the effects of a corporate form of
  ownership
• Review effects on
• Income Statement,
• Cash Flow,
• Balance Sheets,
• Relationship between Net Income and Net Worth
  Change

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Non Business Income

• Income not generated by business assets
• Types of non business income
• Off farm wages
• Non farm earnings (interest, dividends, etc)
• Interest earned on a farm business checking
  account would be considered business income.

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Government Payments

• Note current profit levels and cash flow position
• Reduce/eliminate government payments on crops
• Effects on cash flow, net income, equity
• Implications for profit
• Profit ? Net Cash Flow ? Taxable Income
• Implications for the size of the business
• Where is the risk?

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Cost of Production

• Implications for this operation
• Do you know your cost of production??????
• Enterprise record keeping system
• Quicken or QuickBooks
• Spreadsheets that allow you to allocate income
  and expenses to enterprises
• If you can not measure it, you can not manage it

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Debt Load and Structure

• Example starts with approximately 16.5 debt load
• What is the debt load that can be carried by an
  operation this size?
• What about debt structure?
• Short vs long term debt
• How does family living withdrawal effect debt
  carrying capacity?
• Crop vs Livestock operations

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Asset Revaluation

• Assets are occasionally revalued to reflect
  inflationary pressures
• Machinery, land, buildings, improvements,
  breeding livestock
• Necessary to accurately reflect the market value
  of these assets
• Do not misinterpret this increase in equity
• Is not due to business performance
• Can be very misleading and can mask serious
  business performance issues

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Capital Asset Purchase

• Question Will purchasing a new capital asset
  increase your net worth?
• Pickup, new bull, combine, center pivot, etc.
• What is affected
• Ending asset balance, ending liabilities, cash
  inflows and cash outflows, net income
• Bottom line, You CAN NOT buy equity
• Equity or growth in equity must be earned
• The only way to do this is make the new asset
  earn additional revenue and/or reduce costs
• Increase net income

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Risk Protection Tools (Insurance)

• Example used here is limited to the Basic Unit
  coverage provided by MPCI
• Only three Basic Units are allowed in this
  example
• Enter example levels of MPCI coverage for up to
  three Basic Units.
• Set initial yields and prices at low levels to
  simulate bad year.
• Turn MPCI section on/off to show affects of using
  MPCI insurance.

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Non-Cash Income

• Non-cash income adjustments are made on the
  Accrual Adjusted Income Statement to reflect
  changes in Current Asset values on the beginning
  and ending balance sheet.
• Include changes in
• Crops Held for Sale
• Market Livestock
• Other Current Assets
• Cash Invested in Growing Crops
• See the AccrualAdj tab for complete details

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Non-Cash Expense (Not Depreciation)

• Non-cash expense adjustments are
• Made on the Accrual Adjusted Income Statement
• Reflect changes in Current Asset and Current
  Liabilities section of the beginning and ending
  Balance Sheet.
• See the AccrualAdj tab of the spreadsheet for a
  detailed review of these adjustments

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Three Types of Contributed/Distributed Assets

• Cash or Near Cash
• Listed on the Current Assets portion of the
  Balance Sheet
• Capital assets, which include
• Long term depreciable assets
• Breeding livestock
• Machinery and equipment
• Buildings and improvements
• Land

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What is Contributed Capital

• Capital not generated by the operation but given
  to the operation to support our farming habit
• Off farm income (wages/salary)
• Nonbusiness income (dividends, etc.)
• Gifts, inheritances, etc.
• Will have affects on
• Equity, Profits, Cash Flow
• Earned versus Unearned

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What is Distributed Capital

• What is distributed capital?
• Capital taken out of the operation
• Will have different affects on
• Equity - Short term vs long term
• Immediate reduction in asset value
• Profits - Short term vs long term
• Reduction in ability to produce income in the
  future
• Cash flow - Short term vs long term
• Swapping assets within a family structure run as
  one business?

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Income Taxes

• The RDFinancial spreadsheet is distributed with
  the Income and S.S. tax estimator turned off.
• It can be turned on in cell W8 on the Statements
  tab
• Users can enter additional cash business expenses
  in cell I22 of the Statements tab to show the
  affects on the financials
• Net Worth, Net Income, Cash Flow

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Summary

• You MUST measure your Financial Business
  Positions and Performance
• Must be efficient
• Maximize output per unit of input
• Often we try to maximize just output
• Low cost producer
• The right size producer (size matters)
• Family structure matters
• Manage marketing, production, family risk
• Financial analysis measures the impact of these

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Business Position Performance

• What is key to your ability to survive?
• Managing all forms of risk
• Production, Human, Marketing, Financial, Legal
• With respect to the financial end
• Profits are critical
• Profits ? Net Cash Flow ? Taxable Income
• Earned positive Cash Flow also helps a great deal
• If you cant measure it, you cant manage it!!

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Business Must Produce Net Worth Internally

• Every dollar of income goes towards increasing
  net worth
• Every dollar of expense goes towards decreasing
  net worth
• If growth in Net Worth comes only from external
  sources, your on shaky ground
• You must be profitable enough to pay for
• Family Living , Debt Principal, Savings,
  Reinvestment, Retirement
• Positive Cash Flow is good but

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Accrual Adjusted Financials

• Catch problems with
• Inventory sell down to manage cash needs
• Selling capital asset base, your manufacturing
  plant (livestock, machinery, land, etc.)
• Capital distributions
• Unearned equity increases
• Allows accurate business performance evaluation
  for each time period
• Shows strengths and weaknesses
• Will not be easy the first time through

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Must Do Your Own Detailed Analysis

• http//www.montana.edu/extensionecon/softwaredownl
  oads.html
• RDFinancial Readers Digest Version
• WFBudgets Intermediate version
• Financial Statements Very detailed
• Machines Enterprise budgeting for crops
• CCFS Cow-Calf, Feeder, Stocker enterprise
  budgeting

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How To Get There

• What is your business plan?
• Do you have a management team to help with
• Production decisions
• Marketing decisions
• Financial analysis
• Human resources
• Are communications good among team members?
• Are team members missing that are critical to the
  overall success of the business?

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Parting Comment

• Do not risk the future of your operation (family
  and business) with frustration over preparing
  detailed financial statements. Just
  do it!