Financial Management In Sheep Production

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1 Financial Management In Sheep Production Shepherd's Weekend Jan 3-4, 2009 Roger Betz Southwest Michigan Farm Management Michigan State University Extension 1

2 Roger Betz District Extension Farm Management Agent Southwest Michigan 2

3 Topics for Today Levels of Accounting and Business Records Balance Sheet or Net Worth Statement Ewe Flock Budgets Comparisons 3

4 Source: Arnold Oltmans. Farm Financial Statements. Century Communications. 4

5 Levels of Accounting and Record Keeping Level 1 - INCOME TAX for IRS Level 2 - FINANCIAL - Whole Farm Analysis Level 3 - MANAGEMENT - Enterprise or Cost Accounting Level 4 - PRODUCTION RECORDS 5

6 Level 1 - INCOME TAX for IRS Cash Income - Cash Expenses - Depreciation Sched F (farm) and Sched D (capital gains) Advantages: 1. Relatively Simple 2. Meets IRS Requirements 3. Important component of Analysis Tools Disadvantages: 1. Can be very poor indicator of profit or loss 2. Provides little information for decision making 3. Does not provide information for monitoring financial progress 6

7 Level 2 FINANCIAL Whole Farm Analysis Accrual Income Statement Trend Analysis of Balance Sheets Reconciliation of Net Worth A. Requires Level I (Income Tax) B. Beginning & Ending Balance Sheets (Dec. 31 each year or your Fiscal Year) 7

8 Farm Example Sheep Farm Cash Income... $80,000 Cash Expense... $65,000 Tax Depreciation... $5,000 Schedule F Farm Income $10,000 Make or Lose Money? Beginning Lamb & Crop Inventory.. $25,000 Ending Lamb & Crop Inventory...$ 10,000 Make or Lose Money? Beginning Prepaid Expenses...$5,000 Ending Prepaid Expenses...$15,000 Make or Lose Money? $10,000 minus $15,000 plus $10,000 = $5,000 Change in Unpaid Bills? 8

9 Assets on the Balance Sheets (Net Worth Statement) 1. Accurate Market Value Inventory of crops, feed, minerals, supplements 2. Livestock (lambs) on hand 3. Inventory Dollar Value of vet & livestock supplies, tags, drugs, 4. Prepaid Expenses, fuel, fertilizer, seed, chemicals 5. Money owed to you (including cash & savings) 6. Cost Basis (depreciation schedule) & Market Value of machinery, breeding livestock, buildings, land 9

10 Liabilities on the Balance Sheets 1. Unpaid bills and accounts payable 2. Accrued unpaid Income and Social Security taxes 3. Accrued Interest to December Verified Loan Balances - current versus non-current 10

11 Details on Balance Sheets Need quantities and prices used for each item 2,123 bu $4.07 = $8, Mkt Lambs, 98lbs 93.00/cwt = $22,512 Unpaid Bills Feed $543, Utilities $312 Repairs - Tractor = $1, Property Taxes = $2,367 Need detail to accrue individual expenses and determine other production measures 11

12 Level 2 FINANCIAL Whole Farm Analysis (contd.) Advantages: 1. Allows managers to understand their business as a whole 2. Can accurately monitor Financial Progress 3. Meet the needs of lenders and IRS 4. Provides financial information for Estate Planning 5. Useful in evaluating the feasibility of Expansion 6. Not as complicated as Enterprise analysis 7. Can be done without computer assistance 8. Better than 90% of farm businesses 12

13 Level 2 FINANCIAL Whole Farm Analysis (contd.) Disadvantages: 1. Does not indicate which enterprises Ewes vs Lambs vs Corn vs Hay is more profitable Crops vs livestock and Synergies? 2. Requires extra effort once per year to develop net worth statement & reconciliation statements 3. Requires some effort in learning and applying the concepts 13

14 Production Information From The BALANCE SHEET Feed Efficiency? What did the animals eat? lbs & $ Beginning Inventory + Production + Purchases - Sales - End Inv = Feed Use Lbs of Lamb Produced? Sales - Beginning Inventory Purchases + Ending Inventory = Lbs Lamb Produced Feed Use (divided by) Lamb Produced = Feed Efficiency 14

15 Level 3 MANAGEMENT Enterprise or Cost Analysis for Individual Crops and Livestock Species or Phase A. Requires LEVEL 2 to be effective B. Eventual allocation of all cash income and expenses to individual profit centers Can Be - individual crops, farms, fields and livestock production phases C. Must allocate non cash cost (depreciation, unpaid labor) 15

16 Level 3 MANAGEMENT Enterprise or Cost Analysis (cont'd.) Advantages: 1. Determine Profitability of Individual Crops and Livestock 2. Determine which enterprises to expand and contract 3. Multi dimensional analysis possible 4. Which Farms to rent/sell/buy 5. Production Phase - Ewes versus finishing lambs 16

17 Level 3 MANAGEMENT Enterprise or Cost Analysis (Contd.) Disadvantages: 1. Must allocate income and expenses with SUFFICIENT detail 2. Difficult without computerized system 3. Difficult to allocate and keep track of during the year 4. Must spend sufficient time in setting up system and learning concepts 5. Will the investment in time and expense payoff 17

18 Level 4 - Production Records Tied to Financial Records (contd.) Advantages: 1. Incorporates the production with the economics to help determine relationships Disadvantages: 1. Production information alone often does not give sufficient indication of profitability 2. Can be time consuming 18

19 Balance Sheet or Net Worth Statement Balance Sheet defined: A List of Assets Owned and Debts Owed -- At a Given Time, -- With Quantities & Dollar Values Attached 19

20 If the Question Is: Are my assets worth more than my liabilities? The Problem is SOLVENCY! If Net Worth is Positive, the Business is Solvent Definition: $ Assets - $ Liabilities (Debts) = $ Net Worth or Equity 20

21 Balance Sheet Analysis To remember... Basic equations Assets = Debt + Equity Assets minus Debts = Equity Assets minus Equity = Debt 21

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24 What is the Balance Sheet or Net Worth Statement? Picture in time -- a specific point, as in Midnight, 12/31/XX. Shows financial position -- ability to handle risk Net result of past Very important component to track and monitor financial progress Basic building block for financial analysis 24

25 The Balance Sheet Name -- What does this represent? Partnership, individual, combined Needs to be consistent over time Date -- This is as of what date? Listing of all assets and all liabilities Balances at the bottom of form Assets = Liabilities plus Equity 25

26 Balance Sheet Preparation Some Issues IDENTIFY clearly the person(s) or the business entity being described SEPARATE the business assets and liabilities from the personal Be CONSISTENT as to WHEN the Balance Sheet is prepared at a minimum, prepare a net worth statement when your accounting year ends Valuation of Assets -- costs and/or market recommend two column balance sheet The Balance Sheet is the Cornerstone to Financial Management 26

27 Parts of the Balance Sheet Assets = What you own; have control of Current assets Normally converted to cash in 12 months, like crops, market livestock, prepaid expenses, cash, savings Intermediate Assets Useful life of one to 10 years -- machinery, breeding livestock, equipment, stocks, some buildings Long Term Assets Normal useful life of more than 10 years -- land, buildings, stocks Selling would typically decrease volume or size of business 27

28 Parts of the Balance Sheet (Current) Liabilities What you owe someone else (against what you own) Current Liabilities Existing items scheduled to be paid in the next 12 months Unpaid bills, accrued interest, property taxes Operating loans Principal payments on term debts to be made in the next 12 months 28

29 Liabilities -- Parts of the Balance Sheet (Intermediate) -- What you owe to someone else (against what you own) Intermediate Liabilities What is scheduled to be paid in one to 10 years (subtract out the current position) Typically, machinery loans, breeding livestock, special use buildings Match up to the intermediate assets 29

30 Liabilities -- Parts of the Balance Sheet (Long Term) -- What you owe to someone else (against what you own) Long Term Liabilities What was scheduled originally as 11 or more years Land debt, house payments Match up to the long term assets 30

31 Parts of a Balance Sheet (Term Debts) Definition: Term Debts - paid over more than 1 year: Intermediate liabilities (Intermediate term) Long Term liabilities (Long term) Term debts are not current loans 31

32 Balance Sheet Specials 1. Rented assets Assets: 1) Belong on landlord s s balance sheet 2) Footnote on tenant s 3) Unpaid rent is short-term term debt 4) Growing crops and Inventory 32

33 Balance Sheet Specials Growing Crops 1) Date sets the list 2) Winter Wheat 3) Pastures 4) Alfalfa 5) Stockpiling 6) Turnips, Brasicas 7) Value = Cost of variable inputs 33

34 Balance Sheet Specials 3. Leased Items (tractors, pickups, buildings) Assets: A) On user s s balance sheet = lease payments due Market value if any above lease payments due Liabilities B) = lease payments due 34

35 Balance Sheet Specials 4. Government Commodity Loans 35

36 How To Build A Balance Sheet 1. Do a count: 1. Crops: bushels, tons, etc. 2. Animals: head and pounds 3. Supplies 4. Buildings 5. Land: acres 2. $ Prices for each of the above. 1. Recommend both cost and market value for term assets 36

37 How To Build A Balance Sheet 3. Machinery list (depreciation schedule?) Cost less depreciation = book value 4. Assemble the above into the format 5. Add up the assets 6. Add up the debts 7. Assets minus debts = net worth or equity 37

38 Z Farms Balance Sheet Trends example) Dec. 31, 20X1 Dec. 31, 20X Net Worth $400,000 $450,000 WHY? 38

39 Change in Net Worth due to: 1. Retained Earnings From profits earned and retained in business 2. Market Valuation Equity From change in market value of assets 3. From Contributed Capital 39

40 Retained Earnings (contributed capital) Dollars earned by the business that are kept or retained for reinvestment in the business Calculated by: $ Total Cost Value Basis $ Total Liabilities before Contingent Liabilities 40

41 Valuation Equity Dollars of asset value that are created because the market value of term assets is greater than the book value Calculated by: + $ Total Market Value basis - $ Total Liabilities including Contingent Liabilities - $ Retained Earnings (contributed Capital) 41

42 What a Balance Sheet is NOT Does NOT necessarily tell you if the business is making money Unless done with certain detail, it does NOT tell you where net worth came from 42

43 A Good Balance Sheet 1. One page summary 2. Name and date 3. Shows type of farm 4. Cost and market columns 43

44 A Good Balance Sheet 5. Indicates physical quantities of major items 6. Sequence of items Sale time: quick to long 7. Assets less debts equals net worth (Own - Owe = Equity) 44

45 The Balance Sheet: Building Block for Financial Analysis Financial Position Trend Analysis Feeds Into the Income Statement Communication to Self Communicating with those outside the business Needs Good Detail 45

46 Source: Arnold Oltmans. Farm Financial Statements. Century Communications. 46

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57 Questions? 57