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Managing Capital /Financial Risk

This comprehensive guide focuses on managing capital and financial risk in farming operations. Topics covered include financial balance sheets, cost of production, incorporating financial information into risk management decisions, increase equity through farm profit, interest rate risk monitoring, and basic financial statements analysis. Specific tools such as the dual column balance sheet and liquidity-cash flow statements are discussed for better understanding of the financial health of farm businesses. Practical worksheets and key questions provide guidance on utilizing risk management strategies and optimizing financial outcomes.

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Managing Capital /Financial Risk

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  1. Managing Capital/Financial Risk Craig Binkowski Southern Michigan Bank & Trust Coldwater

  2. Topics in Financial Section • Financial Balance Sheet (What’s 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

  3. 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

  4. 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

  5. Example Farms for the Game:Designed to Simulate Today’sMarket Environment • Green = Low Debt Farm (Sorry) • Yellow = Moderate Debt Farm • Red = High Debt Farm

  6. 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

  7. Balance Sheet Debt Levels Page 4 FINLRB output

  8. Income Statement: • History: • Did your business make or lose money last year? • How much? • Was your neighbor’s 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?

  9. Income Statement Page 2 of FINLRB output

  10. 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!

  11. Liquidity- Cash Flow Statement Page 3 of FINLRB output

  12. 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!

  13. Change in Net Worth Hand calculate the % Change in Equity Page 4 of FINLRB output

  14. Understand the Numbers for Your Farm Business! • Critical in today’s environment • Understand what the numbers mean and signal • Monitor Business EVERY year … routinely • Use professional assistance if needed

  15. Cost of Production Roger Betz District Extension Farm Management Agent SW Michigan

  16. 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

  17. Cost of Production Worksheet - page 2

  18. Cost of Production - Overhead Cost of Production Page 2- Medium Debt

  19. Economic Cost of Production Cost of Production Worksheet Page 2 - Medium Debt Farm

  20. Total Direct Cost Cost of Production Worksheet Page 2 Medium Debt Farm

  21. Revenues to Maintain Net Worth Cost of Production Worksheet Page 2 Medium Debt Farm

  22. Revenues to Meet Cash Flow Cost of Production Worksheet Page 2 Medium Debt Farm

  23. Break Even Income & Prices “Cost of Production”

  24. Break Even Incomes & Prices“Cost of Production”

  25. What Percent of Equity are You Willing to Risk?

  26. Can I use Risk Management Tools to Minimize Equity Loss? Lines 49 and 50 Cost of Prod. Worksheet

  27. 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?

  28. 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

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