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Financial Analysis

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  1. Financial Analysis

  2. Financial Analysis Ratios Comparison over time (trend analysis) Numeric criteria; e.g. current ratio >1 Comparable firm benchmarks (peer group analysis)
  3. Financial Analysis See Farm Analysis Solution Tools (FAST) at Farmdoc website http://www.farmdoc.uiuc.edu CD with FFSC Guidelines and ratio formulas may be purchased from FFSC http://www.ffsc.org/
  4. Financial Analysis Liquidity: Ability to convert assets into cash or cash equivalents… without significant loss a) meet maturing obligations promptly b) earn trade discounts c) establish good credit rating d) take advantage of marketing opportunities
  5. Financial Analysis 1. Current ratio = Current assets ÷ Current liabilities Stocks vs. flows Does not reflect impact of line of credit Does not reflect differences in liquidity of current assets Does not reflect when cash flows will occur
  6. Financial Analysis Current ratio Trend analysis Critical Value = 1 Benchmarks Ideal tool: monthly projected cash flow
  7. Financial Analysis 2. Working capital Current assets less Current liabilities Cushion of current assets over current liabilities Trend analysis Convert to working capital margin for across-firm comparisons Working capital ÷ Current assets
  8. Financial Analysis 3. Working capital / Gross revenue Relationship of working capital to size of farm business Computed from two stocks and one flow Trend analysis Larger ratio reflects higher liquidity What if gross revenue becomes smaller?
  9. Financial Analysis Solvency: Able to pay debts as they become due or assets exceed liabilities Insolvency (financial state) Liabilities exceed assets (balance sheet insolvency) Insufficient cash or cash equivalents to pay debts as they become due (cash flow insolvency) Bankruptcy: legal proceedings related to insolvency (legal concept)
  10. Financial Analysis 4. Debt/Assets % of assets funded by creditors 5. Equity/Assets % of assets funded by owners 6. Debt/Equity Commonly referred to as the financial leverage ratio Debt/Assets + Equity/Assets = 100%
  11. Financial Analysis Solvency ratios Trend analysis Assets > liabilities Benchmarks Stocks vs. flows As leverage increases, risk of loss increases Larger interest expense Larger amount of cash dedicated to loan payments
  12. Financial Analysis Profitability: Influences the ability of management to increase retained earnings in the long run
  13. Financial Analysis 7. Rate of return on farm assets NFIFO – Withdrawals for unpaid labor & mgmt + Interest exp. Ave. farm business assets Return to assets ÷ Ave. farm business assets
  14. Financial Analysis NFI = return to equity, unpaid labor, unpaid mgmt NFI- withdrawals for unpaid labor & mgmt = return to equity Interest (financing)expense = return to borrowed funds (liabilities) Return to equity + return to lia. = return to assets Trend analysis Benchmarks Alternative investments with similar risk, maturity
  15. Financial Analysis 8. Rate of return on farm equity NFIFO – withdrawals for unpaid labor & mgmt Ave. farm business equity Return to equity ÷ Ave. farm business equity Trend analysis Benchmarks Alternative investments with similar risk, maturity
  16. Financial Analysis ROE vs. ROA vs. COFD (cost of farm debt) COFD = Interest (financing)expense ÷ Ave. farm business liabilities Risk to equity providers vs. risk to debt providers Cost of borrowed money vs. return to borrowed money
  17. Financial Analysis ROE > ROA > COFD return to borrowed money > cost of borrowed money COFD > ROA > ROE cost of borrowed money > return to borrowed money
  18. Financial Analysis 9. Operating profit margin ratio Return to assets Gross revenue Trend analysis Benchmarks
  19. Financial Analysis 10. Net Farm income, accrual adjusted Dollar amount Trend analysis
  20. Financial Analysis 11. EBITDA (earnings before interest, taxes, depreciation and amortization) Net farm income from operations + interest (financing) expense +depreciation and amortization expense Related to repayment capacity Dollar amount Trend analysis
  21. Financial Analysis Repayment Capacity: Ability of the firm to repay term debt, cover capital lease payments, and replace fixed assets
  22. Financial Analysis 12. Capital debt repayment capacity 13. Capital debt repayment margin 14. Replacement margin Calculations on p. 74 in packet Dollar amounts Trend analysis
  23. Financial Analysis 15. Term debt and capital lease coverage ratio Calculations on p. 74 in packet A measure of the ability of the borrower to cover all term debt and capital lease payments before acquisition of unfunded assets Critical value = 1 Trend analysis
  24. Financial Analysis 16. Replacement margin coverage ratio Calculations on p. 74 in packet A measure of the ability of the borrower to cover all term debt and capital lease payments and recurring unfunded acquisitions Critical value = 1 Trend analysis
  25. Financial Analysis Financial Efficiency: Profitable use of firm’s assets Expense control
  26. Financial Analysis 17. Asset turnover ratio Gross revenue (GR) ÷ Ave. farm business assets Trend analysis Benchmarks
  27. Financial Analysis Variables: Enterprises Size of business Tenure (value of owned real estate/value of all real estate farmed) Age of operator(s)
  28. Financial Analysis 18. Operating expense ratio (total oper. exp. – depr. & amort. exp.) ÷ GR 19. Depreciation expense ratio 20. Interest expense ratio 21. NFIFO ratio 18 through 21 should sum to one (100%) Trend analysis Benchmarks
  29. Financial Analysis Asset turnover x Oper. profit margin = ROA Asset turnover reflects efficiency of resource use Oper. profit margin reflects profit per unit If ROA is subpar, turnover ratio, or oper. profit margin ratio, or both must be subpar