Understanding Financial Performance Getting on Track Authors: Rodney L. Sharp, John P. Hewlett, Jeffrey E. Tranel 1
Introduction Meet Jack and Joanie The Business The Family Family farm with sheep and cut flower enterprises. In business 15 years. Run by Joanie with occasional hired help. Jack and Joanie; married 20 years. Two daughters; Jennifer, 16, and Julie, 14. Joanie s father is a retired loan officer who has provided Jack and Joanie with financial guidance and assistance in managing the business. 2
Introduction Financial Records Jack and Joanie know that their financial records are complete and accurate by: Keeping all business receipts. Recording business income and expenses in a journal. Summarizing all journal entries in a monthly ledger. Developing an income statement from the monthly ledger to estimate profitability. Categorizing the information by enterprise to determine which combination of enterprises provides the greatest opportunity for profitability. 3
Introduction Financial Statements The financial statements that Jack and Joanie created include: Cash flow statements Balance sheets Income statements Statements of owner equity These statements help them to determine whether the business is generating equity growth and net farm income. If you are not familiar with financial statements, you should review the course, Getting on Track: Better Management through Financial Statements. 4
Introduction Financial Analysis 5
Introduction In This Course You will learn: Five key indicators of financial health. How to assess financial health using financial ratios. How to calculate a variety of financial ratios. Ratios parameters that indicate strength or weakness. Actions for improving financial performance in the five key areas. 6
What is Financial Analysis? Are You Healthy? 7
What is Financial Analysis? Why Do Financial Analysis? Financial analysis provides information that can be used in different ways by different individuals. Click on the images below to see how these individuals use information from financial analysis 8
What is Financial Analysis? What Should We Measure? The Farm Financial Standards Council recommends five categories of measurement for financial analysis. Click the tabs to learn about each category. 9
What is Financial Analysis? Financial Ratios There are hundreds of different financial ratios. Each one indicates a different aspect of financial health. Smart business managers focus on only a few that are key to the success of their business. The Farm Financial Standards Council recommended 21 formulas for measuring the financial viability of farm and ranch operations You measure these things by calculating financial ratios. Financial ratios indicate the relationship between different values found on your financial statements. 10
Measures of Liquidity Liquidity Measures The Farm Financial Standards Council recommends three ratios for measuring liquidity: Current Ratio Working Capital Working Capital/Gross Revenues 11
Measures of Solvency Solvency Measures The Farm Financial Standards Council recommends three ratios for measuring solvency: Debt/Asset ratio Equity/Asset ratio Debt/Equity ratio 12
Measures of Profitability Profitability Measures The Farm Financial Standards Council recommends five ratios for measuring profitability: Rate of Return on Assets. Rate of Return on Equity. Operating Profit Margin. Net Farm Income. Earnings Before Interest, Tax, Depreciation, and Amortization (EBITDA). 13
Measures of Financial Efficiency Financial Efficiency Measures The Farm Financial Standards Council recommends five ratios for measuring financial efficiency: Asset Turnover Operating Expense Interest Expense Depreciation Expense Net Farm Income from Operations 14
Measures of Repayment Capacity Repayment Capacity Measures The Farm Financial Standards Council recommends five ratios for measuring repayment capacity: Capital Debt Repayment Capacity Term Debt and Capital Lease Coverage Ratio Capital Debt Repayment Margin Replacement Margin Replacement Margin Coverage Ratio 15
Measures of Repayment Capacity Capital Debt Repayment Capacity 16
Measures of Repayment Capacity Calculate the Ratios Download Jack and Joanie s financial statements. Then, calculate the capital debt repayment capacity. Click Submit to check your answers. 17
Measures of Repayment Capacity Calculate the Ratios, Cont. Calculating Capital Debt Repayment Capacity X Calculate Jack and Joanie s equity/asset ratio. Step Click 1: Submit to check your answers. Locate the net farm income value on Jack and Joanie s income Current statement. Ratio = 1.75 That s incorrect. Try again or click on the Hint icon for a little help. SUBMIT Next Slide 18
Measures of Repayment Capacity Evaluating the Results Financial ratios are most valuable when you have a value to compare them to. This might be your ratio calculations from previous years or industry benchmarks. Benchmarks: oxygen saturation Financial benchmarks work much the same way. Variations will occur between size of operations, owned versus leased, types of operation, location of operation, and other factors. 19
Measures of Repayment Capacity Financial Efficiency Benchmarks Possible Actions For Improvement: Increase the value of production, reduce production costs where prudent, control or reduce family living withdrawals, improve marketing practices, properly structure debt to revenue generation. 20
Measures of Repayment Capacity What Have You Learned? 21
Where Do We Go From Here? Trend Analysis 22
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