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Financial Analysis

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  1. Financial Analysis Ag Management Chapter 3

  2. Financial Statements Necessary to Determine Financial Condition • Net worth Statement • Income Statement • Cash Flow

  3. Net Worth Statement

  4. Net Worth Statement • A “snapshot” of a financial situation that lists assets, liabilities, and net worth

  5. 3 Parts of Net Worth Statement • Net Worth • Assets • Liabilities

  6. Assets • Items that have a market value • 2 Categories • Current • Non-Current

  7. Current Assets • Cash or other assets which can be converted to cash through normal operations of business during the year • Examples • Checking and/or Savings Accounts • Receivables • Inventory held for sale • Other near-cash items such as securities, stocks and bonds and the cash value of life insurance

  8. Non Current Assets • All assets controlled by the farm or ranch business having a useful life greater than 1 year • 2 categories • Intermediate • Fixed

  9. Intermediate Assets (Non Current) • Resources or production items with a useful life of 1-10 years • Include most assets used to support production or in the production process • Examples • Equipment • Machinery • Breeding Livestock

  10. Long Term Assets (Non Current) • Permanent items • Examples • Land • Improvements on buildings

  11. Liabilities • All the debt obligations of the business • Two types • Current • Non Current

  12. Current Liabilities • Debts due within the operating year, normally a 12 month period • Examples • Notes & accounts payable • Rents • Taxes • Interest plus principle payments due on intermediate or long-term debt within the next 12 months

  13. Non Current Liabilities • Debts due past (or after) one year • Two categories • Intermediate • Long Term

  14. Intermediate Liability • Non real estate debt that corresponds to intermediate assets • Loan terms are normally for a period of 12 months or more but less than 10 years • Examples • Loans for • Improvements to Real Estate • Equipment Purchases • Breeding livestock and dairy stock • Capital requirements for major adjustments in farm operations

  15. Long Term Liabilities • Mortgages and land contracts on real estate minus principle due within 12 months

  16. Net Worth • The amount of money you can put in your pocket before taxes if you were to sell all your assets and pay off all your liabilities • Net Worth = Assets-Liabilities • See p. 3-5

  17. Kinds of Financial Analysis

  18. 3 Kinds of Financial Analysis • Comparative • Projected • Ratio

  19. Comparative Analysis • Measuring and analyzing the trends found in net worth statements over a period of months & years. • Important to compare the same dates each year • Looks at Assets, Liabilities & Net Worth

  20. Projected Analysis • Used to estimate future changes in equity

  21. Making a Projected Analysis • Making balance sheets for the future for expected farm situations and analyzing them to see problem trends • Usually made when cash flow statements are made

  22. Ratio Analysis • Used to measure the financial condition of one farm against other farms

  23. Ratio Analysis Maybe Difficult Because…. • Ratio’s showing strengths and weaknesses may not be clearly defined • What is good for one business may not be good for another

  24. Financial Analysis from the Net Worth Statement

  25. 3 Financial Indicators that can be Calculated from the Net Worth Statement • Liquidity • Solvency • Equity

  26. Liquidity • The ability of a business to generate enough cash to pay bills without disrupting business

  27. 3 Formulas to Measure Liquidity • Current • Working • Debt Structure

  28. How Current Ratio Measure’s Liquidity • Current Ratio=Current Assets/Current Liabilities

  29. How Working Capital Measures Liquidity • Total Current Farm Assets – Total Current Farm Liabilities

  30. What Debt Structure Reveals About Farm Liabilities • Measured by dividing current liabilities by total liabilities • Current Liabilities/ Total Liabilities • The higher this percentage the more assets would be needed to service debt.

  31. Solvency • Measures the ability of all assets if sold at market value to cover all debts

  32. Calculations to Measure Solvency • Debt-to-Asset Ratio • Debt-to-Equity Ratio • Equity-to-Asset Ratio

  33. Debt-to-Asset Ratio • Measures the amount of risk in regard to debt against the farm or ranch • Calculated by • Total Farm Liabilities/Total Farm Assets • Lenders prefer to provide loans which are equal to or less than 50 percent of assets.

  34. Debt-to-Equity Ratio • Shows the relationship between owned and borrowed capital • Measured by • Total Liabilities/Net Worth • Lenders prefer a debt-to-equity ratio of less than 1 because this shows that the owner’s net worth or contribution is more than the borrowed funds

  35. Equity-to-Asset Ratio • Measures the relationship of the farm’s net worth and total farm assets • Measured by • Total Farm Net Worth/Total Farm Assets • Allows you to see if total assets exceed total liabilities

  36. Income Statements are Used • Give the figure of either income or figure loss

  37. Income • Money received from the sale of crops, livestock, and livestock products during the year. • Receipts should also include government payments and miscellaneous sources of farm income

  38. Expenses • Money paid out to operate the business

  39. Calculation for Net Cash Income • Net Cash Income =Cash Income – Cash Expense • Net Cash Income is what remains after subtracting Operating and Fixed Expenses

  40. Non Cash Adjustments Must Be Made by Comparing and Ending Values for… • Expenses payable • Prepaid expense • Adjustments in inventories • Change in interest payable

  41. Net Farm Income • Net cash income and the adjustments added together

  42. Financial Efficiency Ratios

  43. Financial Efficiency Ratios • Ratio’s that compute what percent of total revenue is attributed to the relevant category

  44. Four Financial Efficiency Ratios • Operating-Expense Ratio= • Total Expenses-Depreciation and Interest/Total Income • Depreciation-Expense Ratio= • Total Depreciation Expense/ Total Income • Interest-Expense Ratio= • Total Interest Expense/Total Income • Net Farm Income From Operations Ratio= • Net Farm Income From Operations/Total Income • See p.3-12 fig. 21 for examples

  45. Operating Expense Ratio • Percent of income that consist of operating expenses. (excluding interest and depreciation expenses)

  46. Depreciation Expense Ratio • Total depreciation expense divided by total revenue. Indicates the percentage of total income allocated to depreciation.

  47. Interest-Expense Ratio • Total interest expense (cash interest paid plus change in interest payable) divided by total income. Ratio show the percentage of income devoted to interest.

  48. Net Farm Income From Operations Ratio • Net farm income from operations divided by total income . Show the percentage or ratio of total income that actually ends up as net farm income from operations. • Good check is to ensure that all four ratios total to 100%.

  49. Net Worth and Income Statement Relationships

  50. Net Worth Statements Look At • The financial picture at a point in time.