Evaluating Farm Financial Performance Introducton

1. Evaluating Farm Financial Performance Introducton Rodney Jones Rodney.jones@okstate.edu 405 744 6173

2. Financial Analysis • Put Financial Statements “To Work” • Identify developing problems • Correct management errors, avoid mistakes • Limit losses due to problems • Identify strengths • See opportunities • “Run the farm” instead of “Farm running the farmer”

3. Three Basic Methods • Trend Analysis • Compare Actual Performance To Benchmarks • Financial Ratios

4. Trend Analysis Trend Comment

5. Internal Benchmarking • Internal Benchmarking: Historical Trends (previous example) • When using trend analysis, the manager records the various measures and ratios for the same farm for a number of years and observes any trends in the results. • The manager looks for improvement or deterioration in each measure over time. • Those areas showing a decline deserve further analysis to determine the causes.

6. Internal Benchmarking • Internal Benchmarking: Budgets • In budget analysis, various measures or ratios are compared against budgeted goals or objectives identified during the planning process. • When results in some area consistently fall short of the budgeted objectives, that area needs additional managerial effort or the budgets need to be more realistic.

7. External Benchmarking • External Benchmarking: Comparative Farms • A second source of useful standards for comparison is actual results from other farms of similar size and type, for the same year or years. • Comparative analysis helps indicate if the farm being analyzed was above or below average given the weather and price conditions that existed. • Kansas Farm Management Association program is an excellent source for Southern Plains farms

8. Financial Ratio Analysis • Farmers use ratios all the time • Bushels per acre • Feed per pound of gain, etc. • Financial ratios focus on key relationships between the various financial statements • Ratio analysis helps to identify strengths, weaknesses, and direction

9. Key Position and Performance Criteria • Liquidity • Ability to meet financial obligations, ability to pay bills when due, avoid short run financial disruptions • Solvency • Degree to which the market value of all the assets exceeds debt obligations. True “wealth” of the business

10. Key Position and Performance Criteria • Profitability • Returns over costs, ability to grow, replace machinery, maintain standard of living, afford a new pickup once in a while • Financial Efficiency • Ability to use assets and resources to produce income, the overall relationship between inputs and output • Repayment Capacity • Ability to meet principle and interest obligations from all income sources It Is Absolutely Essential That Every Farm Business Find And Use At Lease One Indicator In Each Of These Criteria Categories To Monitor Financial Position And Performance

11. Financial Ratios For Farm Businesses • Farm Financial Standards Council (FFSC) has endorsed a set of standardized measures for monitoring financial position and performance in agricultural businesses • In many cases the measures are the same as Generally Accepted Accounting Practices (GAAP), but there is a recognition of the need to address the uniqueness of ag

12. Example FFSC Liquidity Measure • Current Ratio • (current farm assets) / (current farm liabilities) • The needed information comes from the Balance Sheet • Most people use the “ending” balance sheet values, but some analysts use the average of beginning and ending values. Be consistent in how you do it for your own farm • Another common liquidity measure is absolute level of Working Capital (current farm assets minus current farm liabilities)

13. Example FFSC Solvency Measure • Debt-to-Asset Ratio • (total farm liabilities) / (total farm assets) • Needed information comes from the Balance Sheet • Other common solvency measures include Equity-to-Asset Ratio, Debt-to-Equity Ratio, and absolute level of Net-Worth or Wealth

14. Example FFSC Profitability Measure • Rate of Return on Farm Assets • {(net farm income from operations) + (interest expense) - (opportunity cost for unpaid labor)} / {total farm assets} • Total farm assets comes from the Balance Sheet, net farm income and interest expense come from the Accrual Income Statement, and unpaid labor is an opportunity cost that can be estimated a number of different ways • Other common profitability measures include simply the absolute level of Net Farm Income, and Rate of Return on Farm Equity

15. Example FFSC Financial Efficiency Measure • Asset Turnover Ratio • {gross farm revenue} / {total farm assets} • Gross revenue comes from the Accrual Income Statement, and farm asset value comes from the Balance Sheet • Other common financial efficiency measures include Operating Expense Ratio, Interest Expense Ratio, Depreciation Expense Ratio, and the Net Farm Income from Operations Ratio

16. Example FFSC Repayment Capacity Measure • Term Debt (and Capital Lease) Coverage Ratio • (Net Farm Income from Operations + Non-farm Income + Depreciation Expense + Interest on Term Debt (and Capital Leases) – Taxes Paid – Family Withdrawals) / (Principle and Interest Payments to Be made on All Term Debt Next Year) • Information comes from the Accrual Income Statement, and the Cash Flow Projection • Other similar measures are endorsed by the FFSC, and are commonly used