Managing Risks With Financial Analysis What's Your Plan?
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Transcript of Managing Risks With Financial Analysis What's Your Plan?
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Managing Risks With Financial Analysis
What's Your Plan?
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Montana State University 2
What's Your Plan?
Production Financial Marketing Human Resource
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Montana State University 3
Are You a Risk Taker?????
Production
Financial
Marketing
Human Resource
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Montana State University 4
Do You Take Unnecessary Risks????
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Montana State University 5
Objectives For This Session
Gain an understanding of: Business’s 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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Montana State University 6
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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Montana State University 7
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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Montana State University 8
Net Farm Income
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Montana State University 9
Net Cash Farm Income
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Montana State University 10
Total Production Expenses
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Montana State University 11
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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Montana State University 12
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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Montana State University 13
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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Montana State University 14
Statement of Owner Equity
Beginning Owner Equity + Net Income - Withdrawals + Contributions - Distributions +/- Change in Valuation = Ending Owner Equity
Balancing a CheckbookBeginning Equity+/- Activity= Ending Equity
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Montana State University 15
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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Montana State University 16
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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Montana State University 17
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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Montana State University 18
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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Montana State University 19
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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Montana State University 20
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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Montana State University 21
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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Montana State University 22
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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Montana State University 23
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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Montana State University 24
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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Montana State University 25
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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Montana State University 26
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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Montana State University 27
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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Montana State University 28
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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Montana State University 29
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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Montana State University 30
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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Montana State University 31
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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Montana State University 32
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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Montana State University 33
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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Montana State University 34
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 can’t measure it, you can’t
manage it!!
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Montana State University 35
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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Montana State University 36
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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Montana State University 37
Must Do Your Own Detailed Analysis
http://www.montana.edu/extensionecon/softwaredownloads.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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Montana State University 38
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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Montana State University 39
Parting Comment
Do not risk the future of your operation (family and business) with frustration over preparing detailed financial statements. Just do it!