Financial Management For Small Farms. 2009, University of Minnesota

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1 Financial Management For Small Farms

2 Dale Nordquist Department of Applied Economics

3 Financial Management For Small Farms Today s agenda Financial management concepts (FINPACK) AgPlan Business Planning Software MN Organic Farm Business Management Project Interpreting Financial Statements and Measures workshop

4 A comprehensive whole farm financial planning and analysis system

5 FINPACK Components Balance sheets Where Am I? FINAN FINFLO Annual Plan FINLRB Annual Financial Analysis Monthly Cash Flow Planning Annual Cash Flow Planning Financial Long Range Planning

6 Financial Management For Small Farms Is there a difference?

7 Financial Management For Small Farms Small farms: Use less debt Rely more on labor than technology Manage risk through diversification Earn more off farm income Have more interests than just maximizing profit Tend to be more entrepreneurial Need to focus on margin (marketing and operating efficiencies)

8 Financial Management For Small Farms Is there a difference? Yes and no All want to be profitable All want to be able to pay bills All want to grow net worth

9 Financial Management For Small Farms Commodity producers Focus on producing at the lowest cost Earn a small margin on sales Make their money on volume

10 Financial Management For Small Farms Small farms Focus on selling at a profitable margin Need to earn a high margin on sales Need to be entrepreneural to take advantage of niche markets and market opportunities

11 Financial Analysis vs Business Management Financial Analysis Uses the numbers Diagnostic Keep score (trends) Business Management Uses knowledge of the business Prescriptive Decision-making

12 Financial Management For Small Farms

13 Interpreting Financial Statements and Measures

14 Farm Financial Standards Guidelines Financial statements: Balance sheet Income statement Statement of owner s equity Statement of cash flows or cash flow budget

15 Farm Financial Standards Guidelines Financial ratios and measures: Farm Financial Standards Sweet 16+

16 Balance Sheet A snapshot of: Assets Liabilities Net worth (owners equity) At a specific point in time

17 Balance Sheet The accounting equation: Assets = Liabilities + Net worth (Equity)

18 Balance Sheet Assets Everything owned or payable to the business

19 Balance Sheet Assets Everything owned or payable to the business Liabilities All obligations owed

20 Balance Sheet Assets Everything owned or payable to the business Liabilities All obligations owed Net worth/owners Equity Total assets minus total liabilities

21 Balance Sheet Measures financial position:

22 Balance Sheet Measures financial position: Liquidity The ability of the business to generate cash when needed

23 Balance Sheet Measures financial position: Liquidity The ability of the business to generate cash when needed Solvency The relation ship between total assets and total liabilities

24 Balance Sheet Assets Current (< 1 year) Intermediate (1 10 yrs) Long term (> 10 years) Liabilities Current Intermediate Long term Total liabilities Net worth Total assets Total Liabs + Net worth

25 Balance Sheet Assets Current (< 1 year) Intermediate (1 10 yrs) Long term (> 10 years) Liabilities Current Intermediate Long term Total liabilities Net worth Total assets Total Liabs + Net worth

26 Balance Sheet Assets Current (< 1 year) Intermediate (1 10 yrs) Long term (> 10 years) Liabilities Cash accounts Current Crop inventories Livestock held for sale Intermediate Prepaid expenses Long Supplies term Accounts receivable Total liabilities Net worth Total assets Total Liabs + Net worth

27 Balance Sheet Assets Current (< 1 year) Intermediate (1 10 yrs) Long term (> 10 years) Liabilities Current Intermediate Long term Total liabilities Net worth Total assets Total Liabs + Net worth

28 Balance Sheet Assets Current (< 1 year) Intermediate (1 10 yrs) Long term (> 10 years) Liabilities Current Intermediate Machinery & equipment Breeding livestock Long term Total liabilities Net worth Total assets Total Liabs + Net worth

29 Balance Sheet Assets Current (< 1 year) Intermediate (1 10 yrs) Long term (> 10 years) Liabilities Current Intermediate Long term Total liabilities Net worth Total assets Total Liabs + Net worth

30 Balance Sheet Assets Current (< 1 year) Intermediate (1 10 yrs) Long term (> 10 years) Liabilities Current Intermediate Long Land term Buildings Total liabilities Net worth Total assets Total Liabs + Net worth

31 Balance Sheet Assets Current (< 1 year) Intermediate (1 10 yrs) Long term (> 10 years) Liabilities Current Intermediate Long term Total liabilities Net worth Total assets Total Liabs + Net worth

32 Balance Sheet Assets Accounts Current (< payable 1 year) Accrued expenses Operating Intermediate loans (1 10 yrs) Principal due on term debt Long term (> 10 years) Liabilities Current Intermediate Long term Total liabilities Net worth Total assets Total Liabs + Net worth

33 Balance Sheet Assets Current (< 1 year) Intermediate (1 10 yrs) Long term (> 10 years) Liabilities Current Intermediate Long term Total liabilities Net worth Total assets Total Liabs + Net worth

34 Balance Sheet Assets Current (< 1 year) Loans Intermediate with an (1 10 original yrs) term of from 1 to 10 years Long term (> 10 years) Liabilities Current Intermediate Long term Total liabilities Net worth Total assets Total Liabs + Net worth

35 Balance Sheet Assets Current (< 1 year) Intermediate (1 10 yrs) Long term (> 10 years) Liabilities Current Intermediate Long term Total liabilities Net worth Total assets Total Liabs + Net worth

36 Balance Sheet Assets Current (< 1 year) Intermediate (1 10 yrs) Loans Long term with (> an 10 original years) term of greater than 10 years Liabilities Current Intermediate Long term Total liabilities Net worth Total assets Total Liabs + Net worth

37 Balance Sheet Assets Current (< 1 year) Non-current Liabilities Current Intermediate (1 10 yrs) Long term (> 10 years) Intermediate Long term Total liabilities Net worth Total assets Total Liabs + Net worth

38 Balance Sheet Assets Current (< 1 year) Intermediate (1 10 yrs) Long term (> 10 years) Personal Liabilities Current Intermediate Long term Personal Total liabilities Net worth Total assets Total Liabs + Net worth

39 Balance Sheet Assets Current (< 1 year) Intermediate (1 10 yrs) Long term (> 10 years) Personal Liabilities Current Intermediate Long term Personal Total liabilities Net worth Total assets Total Liabs + Net worth

40 Balance Sheet Assets Current (< 1 year) Intermediate (1 10 yrs) Long term (> 10 years) Personal Liabilities Current Intermediate Long term Personal Total liabilities Net worth Total assets Total Liabs + Net worth

41 Balance Sheet Assets Current (< 1 year) Intermediate (1 10 yrs) Long term (> 10 years) Personal Liabilities Current Intermediate Long term Personal Total liabilities Net worth Total assets Total Liabs + Net worth

42 Balance Sheet Management implication Match financing to asset life

43 Balance Sheet: When A snapshot at a specific point in time

44 Balance Sheet Analysis Current position Financial structure Total solvency Net worth change

45 Balance Sheet Analysis Current position Current assets vs. current liabilities Measures of liquidity Balance sheet structure Total solvency Net worth change

46 Working Capital = Current assets minus current liabilities Important in financial risk management Reduced by cash capital purchases and family withdrawals

47 Balance Sheet Analysis Current position Balance sheet structure Where is the equity Are assets matched with liabilities No right or wrong answer Total solvency Net worth change

48 Balance Sheet Structure High current debt to assets Liquidity problems High intermediate debt to assets Capital replacement problems High long term debt to assets Limited expansion capacity

49 Balance Sheet Analysis Current position Balance sheet structure Total solvency Net worth Overall financial risk position of the business Future borrowing capacity Debt to asset ratio = Total Debt Total Assets Net worth change

50 Balance Sheet Analysis Let s look at a balance sheet.

51 Balance Sheet Analysis Current position Balance sheet structure Total solvency Net worth change Measures overall progress

52 Balance Sheet Analysis Current position Balance sheet structure Total solvency Net worth change Measures overall progress Net worth growth can only happen if: Earnings exceed consumption or

53 Balance Sheet Analysis Current position Balance sheet structure Total solvency Net worth change Measures overall progress Net worth growth can only happen if: Earnings exceed consumption or Market values are increased

54 Earned Net Worth Change Net farm income $75,000 Non-farm income + 25,000 Family living/owner withdrawals - 50,000 Income taxes - 10,000 Earned net worth change = $40,000

55 Balance Sheet Challenge Asset Valuation

56 Balance Sheet Challenge Asset Valuation Market Valuation assets valued at estimated fair market value a price that could be expected is sold at arms length to an unrelated buyer after selling costs

57 Market Value Balance Sheet Total estimated market value of assets - Total debts = Net worth

58 Market Value Balance Sheet Advantage Best estimate of solvency - amount remaining if all assets were sold and all debts paid

59 Market Value Balance Sheet Advantage Best estimate of solvency - amount remaining if all assets were sold and all debts paid Disadvantage Mixes net worth changes from earnings with market value changes

60 Market Value Balance Sheet Uses Evaluate solvency Evaluation of debt capacity Collateral analysis External comparison with other farms Estate planning

61 Balance Sheet Challenge Asset Valuation Cost (Book) Valuation assets valued at original cost less depreciation land value never changes

62 Cost Value Balance Sheet Total depreciated value of assets - Total debts = Retained earnings

63 Cost Value Balance Sheet Advantage Includes only net worth changes resulting from earnings

64 Cost Value Balance Sheet Advantage Includes only net worth changes resulting from earnings Disadvantage Does not provide accurate solvency picture

65 Cost Value Balance Sheet Uses Monitor earned net worth change Internal periodic performance Calculation of periodic net income

66 Balance Sheet Challenge Asset Valuation Market Assets valued at a conservative market value adjusted for selling costs Cost of book value Assets valued at original cost minus depreciation

67 Balance Sheet Challenge Asset Valuation Be consistent Depreciation Machinery 10% Buildings 5%

68 Balance Sheet A snapshot of: Assets Liabilities Net worth (owners equity) At a specific point in time

69 FFSC Financial Guidelines Four financial statements: Balance sheet Income statement Statement of owners equity Statement of cash flows

70 Income Statement Purpose Measure profitability How much money did we make

71 Income Statement Types of income statements Cash IRS Schedule F

72 Income Statement Types of income statements Cash IRS Schedule F Accrual

73 Income Statement Accrual method Revenues recognized when earned Expenses recognized when incurred More accurately matches income with the expenses incurred to produce that income

74 Income Statement Types of income statements Cash IRS Schedule F Accrual Accrual adjusted

75 Accrual Adjusted Income Statement Cash Accounting Records

76 Accrual Adjusted Income Statement Beginning Balance Sheet Cash Accounting Records Ending Balance Sheet

77 Accrual Adjusted Income Statement Jones Farm Gross income $500,000 Cash expenses -450,000 Net cash income 50,000 Depreciation -40,000 Schedule F income 10,000 Smith Farm Gross income $500,000 Cash expenses -450,000 Net cash income 50,000 Depreciation -40,000 Schedule F income 10,000

78 Accrual Adjusted Income Statement Jones Farm Gross income $500,000 Cash expenses -450,000 Net cash income 50,000 Inventory change +100,000 Depreciation -40,000 Schedule F income 10,000 Smith Farm Gross income $500,000 Cash expenses -450,000 Net cash income 50,000 Depreciation -40,000 Schedule F income 10,000

79 Accrual Adjusted Income Statement Jones Farm Gross income $500,000 Cash expenses -450,000 Net cash income 50,000 Inventory change +100,000 Depreciation -40,000 Net farm income 110,000 Smith Farm Gross income $500,000 Cash expenses -450,000 Net cash income 50,000 Depreciation -40,000 Schedule F income 10,000

80 Accrual Adjusted Income Statement Jones Farm Gross income $500,000 Cash expenses -450,000 Net cash income 50,000 Inventory change +100,000 Depreciation -40,000 Net farm income 110,000 Smith Farm Gross income $500,000 Cash expenses -450,000 Net cash income 50,000 Inventory change -100,000 Depreciation -40,000 Schedule F income 10,000

81 Accrual Adjusted Income Statement Jones Farm Gross income $500,000 Cash expenses -450,000 Net cash income 50,000 Inventory change +100,000 Depreciation -40,000 Net farm income 110,000 Smith Farm Gross income $500,000 Cash expenses -450,000 Net cash income 50,000 Inventory change -100,000 Depreciation -40,000 Net farm income -90,000

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