1 / 38

Financial Check Up

Financial Check Up. John B. Penson, Jr. Regents Professor and Stiles Professor of Agriculture Texas A&M University. Seen the Doc Lately?. Benefits from an annual financial checkup. Treadmill stress test your financial strength. Get your vision examined. What is the status of your….

yardley-hanson
Download Presentation

Financial Check Up

An Image/Link below is provided (as is) to download presentation Download Policy: Content on the Website is provided to you AS IS for your information and personal use and may not be sold / licensed / shared on other websites without getting consent from its author. Content is provided to you AS IS for your information and personal use only. Download presentation by click this link. While downloading, if for some reason you are not able to download a presentation, the publisher may have deleted the file from their server. During download, if you can't get a presentation, the file might be deleted by the publisher.

E N D

Presentation Transcript

  1. Financial Check Up John B. Penson, Jr. Regents Professor and Stiles Professor of Agriculture Texas A&M University

  2. Seen the Doc Lately? • Benefits from an annual financial checkup. • Treadmill stress test your financial strength. • Get your vision examined.

  3. What is the status of your…. • Liquidity? • Solvency? • Profitability? • Efficiency? • Debt repayment capacity? • Survivability?

  4. Key Financial Indicators • Measures of liquidity • See equations 1 and 2; page 13 of booklet • Measures of solvency • See equations 3 – 6; page 14 • Measures of profitability • See equations 7 – 8; page 15 • Measures of economic efficiency • See equations 10 – 14; pages 16-17 • Measures of debt repayment capacity • See equations 15 – 17; page 17

  5. Measures of Liquidity • 1. Current ratio: • Current assets divided by current liabilities. • Demonstrates ability to cover scheduled current liabilities for the • coming year out current assets and still have “cash” left over. • Should exceed 1.0 to be technically liquid. • Some firms fail despite exceeding this hurdle.

  6. Measures of Liquidity • 1. Current ratio: • Current assets divided by current liabilities. • Demonstrates ability to cover scheduled current liabilities for the • coming year out current assets and still have “cash” left over. • Should exceed 1.0 to be technically liquid. • Some firms fail despite exceeding this hurdle. • 2. Working capital: • Current assets minus current liabilities. • Expresses liquidity in dollars rather than ratio. • Should be positive. • Cash is King!

  7. Liquidity Trends Survived Failed Page 13 Source: W. H. Beaver, “Financial Ratios and Predictors of Failure”, Journal of Accounting Research

  8. Liquidity Trends Survived Failed Minimum Page 13 Source: W. H. Beaver, “Financial Ratios and Predictors of Failure”, Journal of Accounting Research

  9. Liquidity Trends Desired level varies by type of firm Survived Failed Page 14 Source: W. H. Beaver, “Financial Ratios and Predictors of Failure”, Journal of Accounting Research

  10. Measures of Solvency • 1. Debt ratio: • Total debt divided by total liabilities. • Demonstrates ability to liquidate the firm, cover all liabilities out • of all assets, and still have “cash” left over. • Should not exceed 0.50 to minimize financial risk exposure. • Some firms fail however at lower levels.

  11. Measures of Solvency • 1. Debt ratio: • Total debt divided by total liabilities. • Demonstrates ability to liquidate the firm, cover all liabilities out • of all assets, and still have “cash” left over. • Should not exceed 0.50 to minimize financial risk exposure. • Some firms fail however at lower levels. • 2. Leverage ratio: • Total debt divided by equity or net worth. • Often a credit standard in loan approval decisions. • Should not exceed 1.0 to minimize financial risk exposure. • Effects of rising interest rates.

  12. Solvency Trends Failed Survived Page 15 Source: W. H. Beaver, “Financial Ratios and Predictors of Failure”, Journal of Accounting Research

  13. Solvency Trends Failed Maximum Survived Page 15 Source: W. H. Beaver, “Financial Ratios and Predictors of Failure”, Journal of Accounting Research

  14. Measures of Profitability • 1. Rate of return on assets: • Net farm income before interest divided by total assets. • Demonstrates the return to management and total capital invested • in the firm. • Should be positive; the higher the better.

  15. Measures of Profitability • 1. Rate of return on assets: • Net farm income before interest divided by total assets. • Demonstrates the return to management and total capital invested • in the firm. • Should be positive; the higher the better. • 2. Rate of return on equity: • Net farm income divided by total equity. • Demonstrates return to owner’s investment in the firm. • Should be positive; the higher the better.

  16. Profitability Trends Survived Failed Page 16 Source: W. H. Beaver, “Financial Ratios and Predictors of Failure”, Journal of Accounting Research

  17. Profitability Trends Survived Minimum Failed Page 16 Source: W. H. Beaver, “Financial Ratios and Predictors of Failure”, Journal of Accounting Research

  18. Measure of Debt Repayment Capacity • 1. Term Debt and Capital Lease Coverage Ratio: • Net cash incomedivided by scheduled principal payments • on term loans and capital leases • After provision for taxes and withdrawals. • Should be greater than 1.0.

  19. Measure of Debt Repayment Capacity • 1. Term Debt and Capital Lease Coverage Ratio: • Net cash incomedivided by scheduled principal payments • on term loans and capital leases • After provision for taxes and withdrawals. • Should be greater than 1.0. • 2. Debt burden ratio: • Total liabilities divided by net income • After provision for taxes and depreciation • Should be as low as possible to avoid financial risk exposure

  20. Debt Repayment Capacity Desired level varies by type of firm Survived Failed Page 18 Source: W. H. Beaver, “Financial Ratios and Predictors of Failure”, Journal of Accounting Research

  21. Indicators of growth/survival: Increasing liquidity Increasing solvency Increasing debt repayment capacity Increasing profitability Indicators of potential failure: Declining liquidity Declining solvency Decreasing debt repayment capacity Decreasing profitability Some Conclusions….

  22. Tale of Two Cities… Failed Source: W. H. Beaver, “Financial Ratios and Predictors of Failure”, Journal of Accounting Research

  23. Tale of Two Cities… Failed Failed Source: W. H. Beaver, “Financial Ratios and Predictors of Failure”, Journal of Accounting Research

  24. Tale of Two Cities… Failed Failed Failed Source: W. H. Beaver, “Financial Ratios and Predictors of Failure”, Journal of Accounting Research

  25. Tale of Two Cities… Failed Failed Failed Failed Source: W. H. Beaver, “Financial Ratios and Predictors of Failure”, Journal of Accounting Research

  26. Sample Question Same firm level data used in Slide Show #1 Is this firm liquid, solvent, profitable and can it cover its term debt and capital lease payments?

  27. Sample Question Step #1 Calculate the following: 1. Current assets and total assets 2. Current liabilities and total liabilities 3. Net income 4. Equity (or net worth) Total current assets = 10,000 + 11,000 + 22,000 = 43,000 Total current liabilities = 1,200 + 7,500 + 7,213 = 15,913 Total assets = total current assets + 76,500 +14,000 + 99,500 = 233,000 Total liabilities = total current liabilities + 29,500 + 1,200 = 46,613 Equity = 233,000 – 46,613 = 186,387 Cash receipts from product sales = 73,000 Total operating expenses = 51,200 + 2,500 + 7,400 = 61,100 Net income from operations = 73,000 – 61,100 = 11,900 Net income before taxes = 11,900 Net income = 11,900 – 7,213 = 4,687

  28. Sample Question Step #2 Calculate the following: 1. Current ratio 2. Debt and leverage ratio Asset liquidity analysis: Total current assets = 10,000 + 11,000 + 22,000 = 43,000 Total current liabilities = 1,200 + 7,500 + 7,213 = 15,913 Current ratio = 43,000/15,913 = 2.702 Working capital = 43,000 – 15,913 = 27,087 Solvency analysis: Total assets = total current assets + 76,500 +14,000 + 99,500 = 233,000 Total liabilities = total current liabilities + 29,500 + 1,200 = 46,613 Equity = 233,000 – 46,613 = 186,387 Debt ratio = 46,613/233,000 = 0.20 Leverage ratio = 46,613/186,387 = 0.25

  29. Sample Question Step #3 Calculate the following: 3. ROA and ROE Total assets = 233,000 Equity = 186,387 Cash receipts from product sales = 73,000 Total operating expenses = 51,200 + 2,500 + 7,400 = 61,100 Net income from operations = 73,000 – 61,100 = 11,900 Net income before taxes = 11,900 Net income = 11,900 – 7,213 = 4,687 Profitability analysis: ROA = (4,687 + 2,500)/233,000 = 0.0308 or 3.1% ROE = 4,687/186,387 = 0.025 or 2.5%

  30. Sample Question Step #4 Calculate the following: 4. Term debt and capital lease coverage ratio 5. Debt burden ratio Debt repayment capacity analysis: Net cash income = 4,687 + 7,400 = 12,087 Principal payments = 5,000 Coverage ratio = 12,087/5,000 = 2.42 Debt burden analysis: Net income = 4,687 Total liabilities = 46,613 Debt burden ratio = 46,613/4,687 = 9.95

  31. Historical Analysis • A look backwards like the Beaver study. • Comparison of current performance with past performance. • Recommend doing this at the enterprise level as well as for the farm as a whole. Page 19

  32. Historical Analysis • A look backwards like the Beaver study. • Comparison of current performance with past performance. • Recommend doing this at the enterprise level as well as for the farm as a whole. • Reasons underlying unwanted trends such as the declines in last two years? Page 19

  33. Comparative Analysis • Compare the firm’s current performance with the performance of similar operations like the Beaver study did. • Benchmark analysis at enterprise level should be done whenever possible. Benchmark Your firm Page 20

  34. Comparative Analysis • Compare the firm’s current performance with the performance of similar operations like the Beaver study did. • Benchmark analysis at enterprise level should be done whenever possible. • Address reasons why your firm is performing more poorly than other comparable operations before it is too late. Benchmark Your firm Page 20

  35. Pro Forma Analysis • Stress testing current expected cash flows by varying prices, unit costs and yields (Slide Show #3). • Look at implications of longer run price and unit cost trends on future financial health when making major decisions.

  36. Forces of change…. • Impacts of rising unit costs of production inputs. • Prices, costs and yields can all affect the financial health of the firm. • Failure to account for the risk associated with adverse trends can lead to failure of the firm.

  37. Sources of Uncertainty • Global trends in production and consumption • Energy prices and core inflation trends • Interest rates and exchange rates • WTO and the 2007 farm bill

  38. Any Questions?

More Related