Financial Analysis Ag Management Chapter 3
Financial Statements Necessary to Determine Financial Condition • Net worth Statement • Income Statement • Cash Flow
Net Worth Statement • A “snapshot” of a financial situation that lists assets, liabilities, and net worth
3 Parts of Net Worth Statement • Net Worth • Assets • Liabilities
Assets • Items that have a market value • 2 Categories • Current • Non-Current
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
Non Current Assets • All assets controlled by the farm or ranch business having a useful life greater than 1 year • 2 categories • Intermediate • Fixed
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
Long Term Assets (Non Current) • Permanent items • Examples • Land • Improvements on buildings
Liabilities • All the debt obligations of the business • Two types • Current • Non Current
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
Non Current Liabilities • Debts due past (or after) one year • Two categories • Intermediate • Long Term
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
Long Term Liabilities • Mortgages and land contracts on real estate minus principle due within 12 months
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
3 Kinds of Financial Analysis • Comparative • Projected • Ratio
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
Projected Analysis • Used to estimate future changes in equity
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
Ratio Analysis • Used to measure the financial condition of one farm against other farms
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
3 Financial Indicators that can be Calculated from the Net Worth Statement • Liquidity • Solvency • Equity
Liquidity • The ability of a business to generate enough cash to pay bills without disrupting business
3 Formulas to Measure Liquidity • Current • Working • Debt Structure
How Current Ratio Measure’s Liquidity • Current Ratio=Current Assets/Current Liabilities
How Working Capital Measures Liquidity • Total Current Farm Assets – Total Current Farm Liabilities
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.
Solvency • Measures the ability of all assets if sold at market value to cover all debts
Calculations to Measure Solvency • Debt-to-Asset Ratio • Debt-to-Equity Ratio • Equity-to-Asset Ratio
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.
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
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
Income Statements are Used • Give the figure of either income or figure loss
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
Expenses • Money paid out to operate the business
Calculation for Net Cash Income • Net Cash Income =Cash Income – Cash Expense • Net Cash Income is what remains after subtracting Operating and Fixed Expenses
Non Cash Adjustments Must Be Made by Comparing and Ending Values for… • Expenses payable • Prepaid expense • Adjustments in inventories • Change in interest payable
Net Farm Income • Net cash income and the adjustments added together
Financial Efficiency Ratios • Ratio’s that compute what percent of total revenue is attributed to the relevant category
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
Operating Expense Ratio • Percent of income that consist of operating expenses. (excluding interest and depreciation expenses)
Depreciation Expense Ratio • Total depreciation expense divided by total revenue. Indicates the percentage of total income allocated to depreciation.
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.
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%.
Net Worth Statements Look At • The financial picture at a point in time.