Mary Sobba Agriculture Business Specialist

1. Financial Statements in Agriculture Mary SobbaAgriculture Business Specialist

2. Accounting Better Farming (Canada) asked farm financial advisors and accountants about bookkeeping practices of farmers. 25-30% use accrual statements to track farm income and expenses and account for 80% of farm production in Ontario.

3. Why? Using a simple cash system it is possible a farmer could have expenses but no income because the crop was not sold prior to December 31. It makes it difficult to track crops and to know whether or not the enterprise is profitable

4. Accrual Simply means that a farmer is matching expenses to revenue and also keeps an inventory account for crops that are carried to the next year.

5. Financial Statements and Financial Ratios The Balance Sheet(s), Income Statement, Statement of Owner’s Equity, Statement of Cash Flows, and Measures of Financial Position and Performance

6. What is ahead…….. • Financial statements … purpose and use of the Balance Sheet(s), Income Statement, Statement of Owner’s Equity, and Statement of Cash Flows • Financial Ratios ……Define and understand measures of financial position and performance

7. Relationship between Financial Statements Statement of Owner’s Equity Income Statement Statement of Cash Flows (End of Year) Balance Sheet (Beginning of Year) Balance Sheet P L U S EQUA L S

8. Balance Sheet(s) • Prepared at the beginning of each year or business cycle • A “snapshot” of what your business has and owes OR • How funds are invested in your business (assets) and how they are financed (liabilities and equity) at a point in time

9. Balance Sheet(s) (cont’d) • Assets – everything owned or payable to the business as of the balance sheet date • Current and Non-current (Intermediate and Long Term) • Valued at cost and market • Liabilities – everything that is owed by the business as of the balance sheet date • Current and Non-current (Intermediate and Long Term) • Deferred liabilities

10. Income Statement • Prepared at the end of the year or business cycle • Also referred to as a profit - loss statement • Is a statement of earnings and comprehensive income (FFSC) • Required to do income taxes

11. Income Statement (cont’d) • Revenues – income from sales, direct payments, and other sources • Expenses – outlays in order to conduct business • Inventory Changes (ending minus beginning) • Depreciation – changes in capital values (ending minus beginning)

12. Statement of Owner’s Equity • Prepared at the end of the year or business cycle with the Balance Sheet and Income Statement • Shows sources of earned and unearned change in owner’s equity • Combined with Income Statement, reconciles Balance Sheets

13. Statement of Owner’s Equity (cont’d) • Beginning Net Worth + Earned changes (Retained Earnings) + Unearned changes (Market Value Changes) • = Ending Net Worth

14. Statement of Owner’s Equity (cont’d) • Sources of earned change in owners equity • Net farm income • Non-farm income (+) • Family living withdrawals (-) • Income and Social Security Taxes (-) • = Retained Earnings

15. Statement of Owner’s Equity (cont’d) • Sources of unearned change in owners equity • Change in market value of assets (+) • Change in deferred liabilities (-) • = Change in Market Values

16. Cash Flow Projections • Cash Flow Projections are a financial tool that looks at the past and projects into a future year. • It serves as a guide or blueprint for the coming year’s business operation.

17. Cash Flow Projections (cont’d) • Cash Flows are commonly confused with a profit & loss statement which they are not. • Cash Flows can be as simple or detailed as you want but must provide what information you need.

18. Cash Flow Projections (cont’d) • Most cash flows are done on a month by month basis but can be done on a quarterly as well. • The information you’ll need before you start are your last couple of year’s records, year end financial statement andnext year’s plans.

19. All income sources should be included, including non-farm. Don’t forget crops and livestock that were on hand the first of the year! Expenses may be easier to figure by looking over the last year or 2. Look for trends over the years so that projections are a little easier to do. Cash Flow Projections (cont’d)

20. Cash Flow Projections (cont’d) • Once you’ve completed it, go over it once more to be sure you haven’t missed anything. • Look it over a few times a year to see how close you’re coming to your projection. If you’re off a lot, figure out why.

21. Cash Flow Projections (cont’d) • Remember that the cash flow projection is for your use first. • However, it can also be very helpful for your lenders.

22. Cash Flow Projections (cont’d) • Many lenders now require a cash flow projection of their borrowers every year. • Government (FSA - Ag Credit, etc.) agencies will not loan money without it anymore.

23. Cash Flow Projections (cont’d) • While not an exact science, cash flows can assist you in planning the next year. • It can help you measure the financial risk of your operation.

24. Moving on…….to ratios • While not an exact science, cash flows can assist you in planning the next year. • It can help you measure the financial risk of your operation.

25. Financial Ratios • Measures of financial position and performance • Why? to anticipate and diagnose financial problems and identify financial strengths and or trends • Used in a vacuum are ABSOLUTELY meaningless ! ! !

26. Financial Ratios (cont’d) • Financial ratios are most useful to: • Compare past to present performance • Compare present to anticipated performance • Identify multi-year trends • Also may be used to compare to benchmarks or other farms

27. Financial Ratios (cont’d) • Five categories of financial ratios: • Liquidity – the ability to meet obligations as they come due (from the Balance Sheet) • Solvency– the ability to pay all debts (from the Balance Sheet) • Profitability – the difference between value and cost of goods produced (from the Income Statement)

28. Financial Ratios (cont’d) • Five categories of financial ratios (cont’d): • Repayment Capacity – the ability to repay term debts on time (from the Cash Flow Statement) • Financial Efficiency – how effectively assets are used to generate income (from all statements)

29. Financial Ratios (cont’d) • Liquidity Current ratio = total current farm assets . total current farm liabilities • The extent that current farm assets, if sold tomorrow, would pay off current farm liabilities.

30. Financial Ratios (cont’d) • Liquidity (cont’d) Working capital = total current farm assets – total current farm liabilities . • Operating capital available in the short term from within the business.

31. Financial Ratios (cont’d) • Solvency Debt to Asset ratio = total farm liabilities . total farm assets • Measures the lenders’ share of the business.

32. Financial Ratios (cont’d) • Solvency (cont’d) Equity to Asset ratio = total farm equity . total farm assets • Measures your share of the business.

33. Financial Ratios (cont’d) • Solvency (cont’d) Debt to Equity ratio = total farm liabilities . total farm equity • Compares the lenders’ share of the business to your share of the business. Measures how much you have leveraged your equity.

34. Financial Ratios (cont’d) • Profitability Net Farm Income = Gross cash farm income – total farm cash expenses + inventory changes + depreciation and other capital adjustments • Measures the return to your labor, management, and equity.

35. Financial Ratios (cont’d) • Profitability (cont’d) Rate of return on = (Net farm income farm assets + farm interest – unpaid family labor) . Average farm assets • Measures the average “interest rate” being earned on all (yours and lenders’) investments in the farm business.

36. Financial Ratios (cont’d) • Profitability (cont’d) Rate of return on = (Net farm income – unpaid farm equity family labor) . Average farm net worth • Measures the average “interest rate” being earned on all your investments in the farm business.

37. Financial Ratios (cont’d) • Profitability (cont’d) Operating profit = Return on farm assets . margin Gross farm income • Shows the operating efficiency of the farm business

38. Financial Ratios (cont’d) • Repayment Capacity Term debt = (Net farm operating income + net non-farm coverage income + scheduled interest on term ratio debt – family living & taxes paid) . Scheduled P&I on term debt • Did the farm business produce enough cash to cover all (farm & non-farm) non-current debt payments?

39. Financial Ratios (cont’d) • Repayment Capacity (cont’d) Capital Net farm operating income replacement = + net non-farm income margin – family living & taxes paid – scheduled principal payments on term debt • Is there money left to buy new capital?

40. Financial Ratios (cont’d) • Financial Efficiency Asset turnover = Gross farm income . ratio Average farm assets • Measures the efficiency of capital use.

41. Financial Ratios (cont’d) • Financial Efficiency(cont’d) Operating (Total farm operating expense = expense – farm interest) . ratio Gross farm income • Measures the portion of farm income used to pay operating expenses.

42. Financial Ratios (cont’d) • Financial Efficiency(cont’d) Depreciation (Depreciation and other expense = capital adjustments) . ratio Gross farm income • Indicates how fast capital is worn out. • What portion of farm income is needed to maintain business capital?

43. Financial Ratios (cont’d) • Financial Efficiency(cont’d) Interest expense = Farm interest expense . ratio Gross farm income • Indicates what portion of farm income is used to pay for borrowed capital.

44. Financial Ratios (cont’d) • Financial Efficiency(cont’d) Net farm income ratio = Net farm income . Gross farm income • Indicates what portion of gross income is left after all farm expenses, except unpaid labor and management, are paid.

45. Farm Finance Scorecard Developed by: Rick Wackernagel, Dennis Kauppila, and Glenn Rogers, Univ. of Vermont Extension (handout)

46. Farm Finance Scorecard (cont’d)

47. Farm Finance Scorecard (cont’d)

48. Farm Finance Scorecard (cont’d)

49. Farm Finance Scorecard (cont’d)

50. Questions? Mary Sobba(573) 581-3231sobbam@missouri.edu