Income Statement Are you making a profit?
Objectives • Understand and utilize an income statement: • Understand the purpose of an income statement • Be familiar with income statement terminology and structure • Be familiar with cost and accrual methods of determining Net Farm Income • Understand the relationship with the balance sheet • Be able to use the income statement for strategic purposes
Income Statement • Use the income statement to determine the profit or loss during an accounting period. • Tells you the financial position of the business over a period of time (generally your fiscal year). • Return to Assets and Equity • Return to Labor and Management • Operating Profit Margin
Income Statement Fundamentals • Profit = Revenue – Expenses • Definitions: • Revenue – Income earned during the accounting period • Commodity Sales, Inventories, Accounts Receivable • Expenses – Cash or noncash expenses during the accounting period • Input Expenses, Depreciation, Accounts Payable, Accrued Interest & Expenses
Accrual-Adjusted Net Farm Income • The Farm Financial Standards Committee recommends that anyone using cash accounting convert net farm income to accrual-adjusted net farm income. • More accurate • Better for management purposes
Income Statement Adjustments • Gross Revenues • Inventory -Beginning Inventory + Ending Inventory • Accounts Receivable -Beginning Accounts Receivable + Ending Accounts Receivable • Operating Expenses • Accounts Payable -Beginning Accounts Payable + Ending Accounts Payable • Accrued Expenses -Beginning Accrued Expenses + Ending Accrued Expenses • Prepaid Expenses +Beginning Prepaid Expenses – Ending Prepaid Expenses • Unused Supplies +Beginning Unused Supplies – Ending Unused Supplies • Investment in Growing Crops +Beginning Investment in Growing Crops – Ending Investment in Growing Crops
Accounts receivable balance 1/1/13 was $4,110; balance 12/31/13 was $4,785 Property taxes for the year of $5,650 Accounts payable balance 1/1/13 was $6,131; balance 12/31/13 was $7,800 Utilities expenses were $2,195 Sold 530 tons of hay for $235 per ton Depreciation expense for the year was $59,600 Change in interest payable for 2011 is +$650 Cash interest paid during the year $14,175 Received $12,400 in farm program payments Sold a tractor for $24,000, the book value was $23,400
$44, 736.00 - $10,000.00 - $10,000.00 $24,736.00 Return to Assets:Adjusted Net Farm Income from OperationsLess Opportunity Cost of Unpaid LaborLess Opportunity Cost of ManagementEquals Return to Assets ROA = ROA = Red: Ratio less than 0.01 Yellow: Ratio between 0.01 and 0.05 Green: Ratio greater than 0.05 Goal: ROA greater than 0.05.
$44, 736.00 - $10,000.00 - $10,000.00 $24,736.00 Return to Equity:Adjusted Net Farm Income from OperationsLess Opportunity Cost of Unpaid LaborLess Opportunity Cost of ManagementEquals Return to Equity ROE = 11 ROE = No rule of thumb. It is best to compare with similar operations. Want ROE > ROA. Goal: ROE greater than _____.
$44, 136.00 + $14,825.00 - $10,000.00 - $10,000.00 $39,961.00 Operating Profit Margin Ratio:Adjusted Net Farm Income from OperationsPlus Interest ExpenseLess Opportunity Cost of Unpaid LaborLess Opportunity Cost of ManagementEquals Operating Profit OPMR = OPMR = Red: Ratio less than 0.10 Yellow: Ratio between 0.10 and 0.25 Green: Ratio greater than 0.25 Goal: OPMR greater than 0.25.
Repayment Capacity • Capital Debt Repayment Capacity (CDRC) • Are earnings available to cover principal and interest on term debt and capital leases? CDRC = Net Farm Income + Depreciation + Interest on Term Debt • CDRC Margin • The amount of capital debt repayment capacity above actual or anticipated term debt and capital leases. CDRC Margin =
Grant County Farms, LLC. Objectives • Evaluate the company’s current financial health based on the income statement. • Based on your evaluation, what suggestions would you give Grant County Farms, LLC to better manage their profitability? • Based on you evaluation of Grant County Farms, LLC’s profitability, how do you feel about a growth strategy? What other information do you need to know? Operation and Background: You are the owner of Grant County Farms, LLC. It is the end of your fiscal year, and you want to measure the health of your business through profitability analyses. Grant County Farms owns 700 acres of non-irrigated cropland on which it runs a winter wheat/fallow rotation. You also run 300 cow/calf pairs on another 700 acres. You have an excellent reputation as a farmer, and you come from a well-establish family in the area. You are the second generation to own this farm.
Profit to Equity The relationship between your balance sheet and income statement
Profit from the Income Statement Paid in Capital from Owners Debt Capital - + - +
Managing Your Balance Sheet • Profit comes into the business: • Fund growth • Replace fixed assets • Leverage/deleverage • Increase liquidity • Distribute to owners • Increase risk bearing ability through equity distribution
Liquidity Ratios • Already learned Working Capital and Current Ratio. • Working capital as a percentage of expenses: compares adequacy of working capital to operations • How much of the year’s operation can you finance? • Sales as a percentage of working capital: gauges working capital in relation to a year’s sales Working Capital as a Percentage of Op. Ex.= Working Capital ÷ Operating Expenses If W.C. = $180,000 and Op. Ex. = $353,548 $180,000 ÷ $353,548 = 0.51 Sales as a Percentage of Working = Sales ÷ Working Capital If W.C. = $180,000 and Sales = $450,000 $450,000 ÷ $180,000 = 2.5
Liquidity Working Capital near 50% of Operating Expenses Current Ratio near 2:1 Working Capital near 30% to 40% of Operating Expenses Current Ratio near 1.2:1 to 1.3:1 Current Ratio near of 1:1 Adapted from Northwest Farm Credit Services
Solvency Ratios • Already learned Debt/Asset and Debt/Equity. • Debt Coverage Ratio (DCR): amount of cash flow available to meet annual interest and principal payments • Fixed Charge Coverage Ratio (FCCR): ability to meet fixed financing expenses First calculate adjusted EBITDA: Adj. EBITDA = Net Profit + Interest Expense + Taxes + Depreciation Expense – Taxes – Distribution/Draws Then calculate DCR and FCCR: DCR = Adjusted EBITDA ÷ (Interest Expense + Principal Payments Due) FCCR = Adjusted EBITDA ÷ (Interest Expense + Principal Payments Due + Unfunded Capital Expenditures)
Leverage Debt/Asset Ratio: Dairy 50% Orchards 50% Irrigated Crops 45% Dry Crops 40% Livestock 40% DCR 1:1 DCR 1.2:1 FCCR 1:1 FCCR 1.2:1 Debt/Asset Ratio: Dairy 35% Orchards 35% Irrigated Crops 35% Dry Crops 25% Livestock 25% Adapted from Northwest Farm Credit Services
Guidelines for Using Ratios • Compare, compare, compare… • Industry • Historical information • Business lifecycle • Consider the whole picture.
Jack & Jill Ranch Co. Objectives: • Evaluate the company’s current financial health based on the financial statements. • Understand the impact of growth on the company’s financial position. • Based on your evaluation of Jack & Jill Ranch Co.’s financial position, how do you feel about their growth strategy? How do you feel that can prepare for growth? Operation and Background: Jack & Jill Ranch Co. farm 400 acres of irrigated crop ground. They rent 100 acres and own 300 acres. 300 acres are planted to timothy hay, and the additional 100 acres are used to pasture their seedstock cattle operation. The owners of Jack & Jill Ranch Co. would like to expand their operation. They have the opportunity to purchase a neighboring 100 acres. Growth Opportunity: Jack & Jill Ranch have the opportunity to purchase an additional 100 acres of excellent hay ground. They would like to offer $4,000 per acre. If purchased, this ground would be used to expand their timothy hay enterprise.
Homework • Complete an income statement for your farm. • Calculate your ROA and ROE. • Set targets for ROA, ROE, and OPMR.
One Minute Takeaway • Take a minute to write down one or two ideas or takeaways from this lesson.
Sieverkropp Consulting LLC. Contact: Elizabeth Sieverkropp firstname.lastname@example.org (509) 398-6858 Website: www.sieverkroppconsulting.com Training Program Homepage: www.sieverkroppconsulting.com/fsa-borrower-training-program-homepage