Surviving in Agriculture

1. Surviving in Agriculture What's your Plan?

2. Objectives For This Session • Gain an understanding of the need for adequate “financial business performance analysis” • What is the key factor for long term financial survival of the farm/ranch operation • Gain a basic understanding of the interactionof financial statements • Why it is critical (for some businesses) to prepare a complete set of financials • Gain understanding of the interaction/impact the family has on the business Montana State University

3. Survival Has a Time Frame • This presentation addresses the long run • Short run may also be a concern • Short run strategies may be quite different than long run strategies. • Many short run strategies are very detrimental to long run financial health of the firm • Selling down inventories; reduces working capital • Selling assets; reduces future income generation • Accumulate heavy short run debt load Montana State University

4. Some Brief History 21% decline 66% decline Montana State University

5. Some Brief History • What was happening in Ag during this time? • Industrial revolution • Mechanization of Agriculture • Establishment of Land Grant University System to conduct Ag research • Tremendous improvement in yields (grains and livestock) through enhanced genetics • Increased opportunities to educate our young • Government Farm Program Support • Expand World markets for US Ag products • List of positives goes on and on Montana State University

6. So What’s the Problem • Competitiveness of agricultural industry • Profits always tight • “Family Farm” not assured to be efficient • Still largely bulk commodity producers • Minimal chance for designer product prices • Increased access to world markets also means we must compete globally • Forces us to be very efficient Montana State University

7. What Key Factors Determine Survivability? • Is it a positive Cash Flow • A large Net Worth • Paying no taxes to reduce cash outflows • Lots of family labor (good hard work) • Location • Positive Net Income • ? • ? • ? Montana State University

8. Living With Past Mistakes • Allowed producers, lenders, others to prepare financial statements that were/are: • Inconsistent between operations • Inconsistent for a single operation through time • Aimed at only one particular objective - (Loan collateral analysis, i.e the lenders best interest) • Misleading for both the lender and owner/operator with respect to: • Business Performance, Profitability, Earned Growth in Equity, Repayment Capacity Montana State University

9. Living with past mistakes • Current statement formats utilized by lenders & producers do not answer enough questions about Short and Long run Viability • Balance Sheet and Cash Flow Statements • Must get away from equity lending • Must understand the critical nature of being or becoming profitable • You absolutely MUST have a plan • Management team to implement the plan • Prepare financial analysis to monitor progress Montana State University

10. Living with past mistakes • Record keeping for tax purposes • Is simple and straight forward • Typically cash based and on a calendar year Montana State University

11. Tax Records & Past Mistakes • Can be manipulated to show desired tax results • Does not measure business performance • Has instilled the belief that tax basis records are a measure of business performance rather than simply a measure of tax liability. • Has set the tone for the amount of record keeping required for agriculture operations. Montana State University

12. What is Required? • Reconciled set of Financial Statements • Prepared at least annually at the same time every year. • Shared with your management team and all others concerned with the operation • Family, lenders, partners, etc. 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 Montana State University

14. Complete Set of Financial Statements • Beginning and Ending Balance Sheets • Statement of Cash Flow/Cash Flow Statement • Accrual Adjusted Income Statement • Statement of Owner Equity All cash inflows are not income All cash outflows are not expenses You can have non-cash expenses You can have non-cash income Expense Versus Expenditure Montana State University

15. Balance Sheets Left SideRight Side Current Assets Current Liabilities Long Term Assets Long Term Liabilities Intermediate Intermediate Long Term Long Term Total Assets Total Liabilities (Assets - Liabilities) = Net Worth Montana State University

16. Cash Flow Statement Cash InflowsCash Outflows Cash Income Cash Expense + Other Inflows + Other Outflows = Total Cash Inflows = Total Cash Outflows (Inflows - Outflows) = Net Cash Flow       Profit • Critical: Some inflows are not income and some outflows are not expenses Montana State University

17. Accrual Adjusted Income Statement • Cash Income • + Non-cash Income • = Gross Income/Revenue • Cash Expense • + Non-cash Expense • = Total Expense Net Income (Gross Income - Total Expense) = Profit Profit  Net Cash Flow or Taxable Income Montana State University

18. 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 Montana State University

19. Topics for Examination • Withdrawals • Government Payments • Cost of Production • Debt Load (asset and liability structure) • Contributed capital • Distributed capital • Asset revaluation • Capital asset purchase • Non-business income • Non-cash income • Non-cash expense (not depreciation) Montana State University

20. Withdrawals • Note the: • Net worth (equity) on the balance sheet and the change is 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 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 • Stop – What is Profit? • Implications for the size of the business • Where is the risk? Montana State University

22. Cost of Production • Implications for this operation • Do you know your cost of production?????? • If you can not measure it, you can not manage it • Enterprise record keeping system with Quicken or Quickbooks • Spreadsheets that allow you to allocate income and expenses to enterprises Montana State University

23. Debt Load • Starting with approximately 20% 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 Montana State University

24. Contributed Capital • 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. • Effects of contributed capital on: • Equity • Profits • Cash Flow Montana State University

25. Distributed Capital • What is distributed capital? • Capital taken out of the operation • Effects of distributed capital on: • Equity - Short term vs long term • Profits - Short term vs long term • Cash flow - Short term vs long term Montana State University

26. Asset Revaluation • Assets are occasionally revalued to reflect inflationary pressures • Machinery, land, buildings, improvements, breeding livestock • This is necessary to accurately reflect the true value of these assets • Caution: Do not let yourself misinterpret this increase in equity • Is not due to business performance • Can be very misleading to those unaware Montana State University

27. 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 save costs • Increase net income Montana State University

28. 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. Montana State University

29. 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 Montana State University

30. Non-Cash Expense (Not Depreciation) • Non-cash expense adjustments are made on the Accrual Adjusted Income Statement to reflect changes in Current Asset and Current Liabilities section of the beginning and ending balance sheet. • On the Current Asset side • Crops Held for Feed, Cash Invested in Growing crops and Supplies & Prepaid Expenses are adjusted as expense • On the Current Liability side • Accounts payable, Other current Liabilities Montana State University

31. Summary • You MUST know how to measure your Financial Business Performance • Must be efficient • Maximize output per unit of input • Often we try to maximize just output • Low cost producer • The right size producer (minimum size) • Family matters • Manage marketing, production, family risk • Financial analysis measures the impact of these Montana State University

32. Business Performance? • What do we use to measure this? • What are the best tool(s) to use? • What is the key to your survivability? • Profits • Profits  Net Cash Flow (Positive or Negative) • Profits  Taxable Income • If you can’t measure it, you can’t manage it!! Montana State University

33. Your 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 you only have external growth in Net Worth; puts you on shaky ground • You must be profitable • Profitable enough to pay for: • Family Living , Debt Principal, Savings, Reinvestment, Retirement Montana State University

34. 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 • Just simply keeps you out of trouble • Will not be easy the first time through Montana State University

35. Must do your own detailed analysis • http://www.montana.edu/extensionecon Then click Farm Management Then click Software Downloads • “RDFinancial” = Readers Digest Version • “WFBudgets” = Intermediate version • “Financial Statements” = Very detailed • “Machines” = Enterprise budgeting for crops • “CCFS” = Cow-Calf, Feeder, Stocker enterprise budgeting Montana State University

36. How To Get There • What is your business plan • Do you have a management team to help with • Production decisions • Marketing decisions • Financial analysis • What are communications like among team members? • Are there team members missing that are critical to the overall success of the business? Montana State University

37. What is Your Plan? Production Financial Marketing Is it written? Has it been Shared? Montana State University

38. The End Montana State University

39. Part Two or separate show • Presenters • The next few slides can be used to • Sprinkle in the previous set of slides for emphasis or additional support material • As a stand alone presentation on the financial condition of ag and ag families • Who, why, what, where, how • As a “phase two” of the first set of slides in this presentation. Montana State University

40. Recent Research • Rural Population Growth, 1950 – 1990: The Roles of Human Capital, Industry Structure, and Government Policy, American Journal Ag Econ., August 2002 • Summarize key findings Montana State University

41. Key Factors for Shifting Rural Populations • Differential income levels between rural farm and nonfarm populations • Young farm population has a wider gap in urban-rural returns to human capital than older farm or nonfarm populations • Translations, young people can earn more over their lifetime in nonfarm employment Montana State University

42. Key Factors Continued • Increased rural education levels has retarded rural population growth. • Young working age population particularly sensitive • No evidence that rural investment in public services will attract new residents • Raising taxes, increase gov. debt for this activity may actually decrease rural population Montana State University

43. Other Recent Research Results • Income,Wealth, and the Economic Well-Being of Farm Households. ERS, July 2002 • Main Findings Summarized • See “Farm Household Earnings 2003.xls” to review recently reported data in ERS: Farm income and costs: farm income forecasts Montana State University

44. Finding #1 • Farm households are no different than other households in pursuing two careers and diversifying earnings. • More than half of all U.S. farm operators work off-farm • 80 percent of these working full-time jobs. • Nearly half of all spouses are also employed off the farm. • Off-farm work is no longer viewed as a transitional position between the agricultural and the industrial economy, but as a lifestyle choice, with farming as a second job or investment. Montana State University

45. Sources of Farm Household Income by Farm Typology 2001 - 2002 Montana State University

46. Farm Operators Reporting Off Farm Work Montana State University

47. Finding #2 • The farm business as a source of income has played an increasingly smaller role in determining the well-being of farm households. • Nearly 90 percent of total farm household income in 1999 originated from off-farm sources. • The contribution of earned income (off-farm) alone amounted to 53 percent of total farm household income. Montana State University

48. Sources & Share of Total Household Income Montana State University

49. Household Income Trend Montana State University

50. Finding #3 • While farm business income exhibits considerable variability, farm household income is relatively stable. • Fluctuations in farm output, commodity prices, business cycles, Government policy all contribute to the variability in farm income. • Since these factors are beyond any farmer’s control, many farm households have relied successfully on off-farm income to stabilize their total household income. Montana State University