Fearless Farm Finances……

Organizing basic financial information: balance

sheet, income statement, understanding cash

flows…

Craig Chase, Field SpecialistFarm & Ag Business Management

Plan for this session

• Four reasons to develop a balance sheet, an income statement, and a statement of cash flows:– We are going to cover these four reasons in our

allotted time today.

– However, we are going to work toward those reasons by asking and then answering common questions I hear from producers and comments I hear from lenders and financial analysts…

Reason #1

• How is your farm doing financially?

• How much of your farm do you own?

• How much money are you actually making farming?

Financial Condition and Profitability

• Financial condition can be shown by the balance sheet (pp. 89-100).

• Profitability can be illustrated by the income statement (pp. 101-109).

• Understanding how cash comes in and out of the business can be illustrated by the cash flow statement (pp. 110-120).

Balance Sheet, as of 12/31/2012Assets

Current Assets Cash 15,000Prepaid expenses 10,000Accounts receivable 1,000Supplies 6,000Int/Long Term AssetsMachinery/equip 83,000Real estate 140,000Buildings/improve 35,000 Total Assets $290,000

LiabilitiesCurrent LiabilitiesOperating loan 10,000Accounts payable 2,000Current L/T debt 12,000Int/Long Term LiabilitiesMach/equip loans 64,000Real estate loans 82,000 Total liabilities 176,000 Net worth 114,000Total Liab/Net Worth $290,000

Income Statement; Yr ending 12/31/2012Sale of crops $140,000Other income 4,000 Gross Income 144,000Car and truck, gas and oil, repairs 12,200Depreciation 36,000Fertilizer, Seed, Crop Inputs 19,800Insurance, interest, repairs, taxes 18,400Labor 24,600Supplies 8,000Utilities 8,000 Total Expenses $127,000Net Income $ 17,000

Answers

• Did you make any money?– Net income of $17,000– Net income plus depreciation of $53,000

• How much of your farm do you own?– Net worth of $114,000

• What do you think about these numbers?– What if the farm is 20 vegetable acres?– What if the farm is 10 vegetable acres?

Limitations

• Balance sheet illustrates what is owned and owed at one point in time.

• Income statement presents what was made over one time period.

• Profitability and financial condition give you limited information regarding details of the farm.

Limitations

• Size (scale) of farm affects how the results are interpreted.

• Neither statement identifies potential problems with cash flow (pp. 110-120).

Exercises 1 and 2

• Take 10 minutes answering exercises 1 and 2 related to developing an income statement and balance sheet.

Balance Sheet, as of 12/31/2012Assets

Current Assets Cash 2,000Supplies 1,500

Int/Long Term AssetsMachinery/equip 8,500Real estate 25,000Buildings/improve 6,000

Total Assets $43,000

LiabilitiesCurrent LiabilitiesCurrent L/T debt 2,000

Int/Long Term LiabilitiesReal estate loans 12,000 Total liabilities 14,000

Net worth 29,000Total Liab/Net Worth $43,000

Income Statement; Yr ending 12/31/2012Sale of shares $37,500Other income (misc sales) 4,000 Gross Income 41,500

Direct cash operating expenses 25,000Indirect cash operating expenses 5,000Depreciation 4,500Total Expenses $34,500

Net Income $7,000

Reason #2

• How does your farm compare to other farms?

• What are the strengths and weaknesses of your farm?

• What could you do different to be more profitable?

Benchmarking• Benchmarking refers to comparing your

numbers to other farms similar to yours.• For example, if your cost to produce your

crops or livestock are high compared to others, then your budget should be evaluated carefully to determine where the costs are different and why.

• Developing and understanding financial ratios is an excellent way to track your financial progress (pp. 122-138).

Comparing Financials – A few ratios

Your farmCurrent ratio 2.6Debt-to-asset21%Operating profit ratio 1%Asset turnover ratio28%Operating expense ratio 76%Net income ratio 5%

Benchmark2.2439%26%38%59%25%

Comparing Financials• What are the strengths?

– Balance sheet is strong – current ratio and debt-to-asset.

• What are the weaknesses?– Operating profit ratio, operating expense ratio,

and net income ratio.• What could be done differently?

– Evaluate operating expenses. Probably could make product mix and production changes.

– Evaluate revenue compared to expenses.

Limitations

• Whole farm analysis can only tell you in general where your strengths and weaknesses are.– Your operating expenses are too high, your

overall production is too low. Works very well for simple farming operations (few enterprises).

• Financial ratios give you a limited view of your farm - what specific management decisions can be made?

Exercises 3

• Take 10 minutes answering exercise 3 related to developing ratios for your income statement and balance sheet.

Exercise 3 - Ratios

• 1. Current ratio – Ans. 1.75 ($3,500 / $2,000)

•  2. Debt-to-asset ratio – Ans. 32% ($14,000 / $43,000)

•  3. Operating profit ratio– Ans. -10.4% (($7,000 + $700 – $12,000) /

$41,500)

Exercise 3 - Ratios

• 4. Asset turnover ratio– Ans. 96.5% ($41,500 / $43,000)

• 5. Operating expense ratio– Ans. 70.6% ($41,500 – $7,000 – $700 - $4,500) /

$41,500•  6. Net income ratio

– Ans. 16.9% ($7,000 / $41,500)

Ratios

• Keep in mind there are 21 commonly-used farm financial ratios that can be used to evaluate your farm.

• Each has its place. For example when looking at increasing your debt (through a farm investment), you would want to analyze your term debt coverage ratios to determine how much debt your farming business can handle without increasing financial risk.

Reason #3

• How much money can you borrow?• What will a lender think of your idea?• What information should you pull together to

show your lender?

Risk Rating Scale• All lenders have a risk rating scale…• Components of that scale may include:

– Ability to service (pay-off) debt– Net worth trend (positive or negative)– Current ratio– Debt-to-asset or equity-to-asset ratio– Character– Management ability– Collateral– Payment history (credit report)– Length of relationship with lender

Risk Rating Scale• Each component is weighted.• Ask your lender what goes into his/her scale.• Know what your numbers are that he/she

uses.

A Tale of Two Farms…Farm ADebt service 5Net worth change 5 Current ratio 4Equity-to-asset ratio 4Character 5Management ability 5Collateral 5Payment history 5Relationship 5Weighted Average Score 96

“Premium”

Farm BDebt service 4Net worth change 3Current ratio 1Equity-to-asset ratio 3Character 3Management ability 3Collateral 5Payment history 4Relationship 4Weighted Average Score 72

“Average”

Answers – It Depends…• If you are a “Premium” it is much easier to find

a lender and get a better deal.• If your lender knows something about your

business, is willing to actively learn, and make a farm visit at least once per year.

• If you come prepared (financials completed), know financial terms, and ask questions about borrowing options.

• If you find out what you need to do to get a better deal – shop around.

Cash Flow Statement

• Cash flow statement is often the forgotten statement.

• Question to be answered is: is there enough cash flowing into your business to cover the expenses occurred by your business? If not, then what are you going to do about it?

• Remember that profitability and cash flow are not the same thing – you can be profitable and have a negative cash flow and vice versa (p. 112).

Cash Flow Statement

• Turn to page 114 of the Fearless Farm Finances book…

• Three sections:– Cash flow from operations– Cash flow from investing– Cash flow from financing

Cash Flow Statement

• How did Otto do?

• How did this year compare to earlier years and to the cash flow budget developed at the beginning of the year (cash flow budget is different)? Why would this be important?

• Did Otto replace the right amount of capital or did he intentionally not invest because it would put him in a negative cash flow?

Summary

• Income statements and balance sheets can make your decisions much easier.

• Cash flow statement indicates whether your farm is bringing in more cash than expending.

• They can also point to both strengths and weaknesses in your farm.

Summary Step 1 – A few ratiosYou start with a few ratios…

Current ratio 2.6 goodDebt-to-asset 21% goodOperating profit ratio 1% lowAsset turnover ratio 28% lowOperating expense ratio 76% highNet income ratio 5% low

You decide to see if you can lower your expenses and raise your revenues to improve your ratios related to the income statement.

Summary

• Spend the time to pull together some financial numbers; it will likely be the best investment you have ever made.

• Spend time understanding your numbers and looking at possible improvements (we all have strengths and weaknesses).

• Always keep in mind your financial farm goal and your questions and work through your records to find your answers…

And the Fourth Reason….

• Taxes…• But don’t make management decisions solely

on tax management. Make them because it is a good business decision and it will lead you toward your overall income goal.

Last Thoughts…

• You should develop an annual budget for your farm and then monitor it (pp. 199-218).

• You should go over factors to improve profits (pp. 139-144) for ideas on how to improve your profitability.

Questions…..Any questions or comments?

Thank You for This Opportunity!Craig A. Chase

Marketing Food System Initiative Program LeaderIowa State Local Food and Farm Program Coordinator

Farm Management – Local Food Systems and Alternative Enterprises209 Curtiss Hall

Iowa State UniversityAmes, IA 50011(515) 294-1854

cchase@iastate.eduhttp://www.extension.iastate.edu/agdm/fieldstaff/cchase.html