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Financial Analysis. Ag Management Chapter 3. Financial Statements Necessary to Determine Financial Condition. Net worth Statement Income Statement Cash Flow. Net Worth Statement. Net Worth Statement. A “snapshot” of a financial situation that lists assets, liabilities, and net worth.

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Financial analysis

Financial Analysis

Ag Management

Chapter 3


Financial statements necessary to determine financial condition

Financial Statements Necessary to Determine Financial Condition

  • Net worth Statement

  • Income Statement

  • Cash Flow


Net worth statement

Net Worth Statement


Net worth statement1

Net Worth Statement

  • A “snapshot” of a financial situation that lists assets, liabilities, and net worth


3 parts of net worth statement

3 Parts of Net Worth Statement

  • Net Worth

  • Assets

  • Liabilities


Assets

Assets

  • Items that have a market value

  • 2 Categories

    • Current

    • Non-Current


Current assets

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

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

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

Long Term Assets (Non Current)

  • Permanent items

  • Examples

    • Land

    • Improvements on buildings


Liabilities

Liabilities

  • All the debt obligations of the business

  • Two types

    • Current

    • Non Current


Current liabilities

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

Non Current Liabilities

  • Debts due past (or after) one year

  • Two categories

    • Intermediate

    • Long Term


Intermediate liability

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

Long Term Liabilities

  • Mortgages and land contracts on real estate minus principle due within 12 months


Net worth

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


Kinds of financial analysis

Kinds of Financial Analysis


3 kinds of financial analysis

3 Kinds of Financial Analysis

  • Comparative

  • Projected

  • Ratio


Comparative analysis

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

Projected Analysis

  • Used to estimate future changes in equity


Making a projected analysis

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

Ratio Analysis

  • Used to measure the financial condition of one farm against other farms


Ratio analysis maybe difficult because

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


Financial analysis from the net worth statement

Financial Analysis from the Net Worth Statement


3 financial indicators that can be calculated from the net worth statement

3 Financial Indicators that can be Calculated from the Net Worth Statement

  • Liquidity

  • Solvency

  • Equity


Liquidity

Liquidity

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


3 formulas to measure liquidity

3 Formulas to Measure Liquidity

  • Current

  • Working

  • Debt Structure


How current ratio measure s liquidity

How Current Ratio Measure’s Liquidity

  • Current Ratio=Current Assets/Current Liabilities


How working capital measures liquidity

How Working Capital Measures Liquidity

  • Total Current Farm Assets – Total Current Farm Liabilities


What debt structure reveals about 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

Solvency

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


Calculations to measure solvency

Calculations to Measure Solvency

  • Debt-to-Asset Ratio

  • Debt-to-Equity Ratio

  • Equity-to-Asset Ratio


Debt 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

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

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

Income Statements are Used

  • Give the figure of either income or figure loss


Income

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

Expenses

  • Money paid out to operate the business


Calculation for net cash income

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

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 Farm Income

  • Net cash income and the adjustments added together


Financial efficiency ratios

Financial Efficiency Ratios


Financial efficiency ratios1

Financial Efficiency Ratios

  • Ratio’s that compute what percent of total revenue is attributed to the relevant category


Four financial efficiency ratios

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

Operating Expense Ratio

  • Percent of income that consist of operating expenses. (excluding interest and depreciation expenses)


Depreciation expense ratio

Depreciation Expense Ratio

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


Interest expense ratio

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 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 and income statement relationships

Net Worth and Income Statement Relationships


Net worth statements look at

Net Worth Statements Look At

  • The financial picture at a point in time.


Income statements indicate the performance of

Income Statements Indicate the Performance of

  • The farm business within a period

    • The period can be defined as any period but it is typically between one net worth statement and the next (usually 1 year)


Asset turnover ratio

Asset-Turnover Ratio

  • Useful measure to show how effectively farm assets are being used

  • Calculated by

    • Gross Revenue/Average Total Farm Assets

      • Gross Revenue is gross receipts from farming plus (or minus) total non-cash adjustments

      • Average total farm assets is in year one plus year two divided by two.


Value favorable for asset turnover ratio

Value Favorable for Asset-Turnover Ratio

  • The higher the asset turnover ratio, the quicker the turnover of assets and generally the greater the likelihood of profits


Distribution of net farm income profitability

Distribution of Net Farm Income (Profitability)


Not shown on income statements

Not Shown on Income Statements

  • 1 category of labor not shown on income statements– A charge for unpaid operator and family labor


Operator and family labor allowance

Operator and Family Labor Allowance

  • Determined from a 2,080 hour work year


Return to equity capital and management

Return to Equity Capital and Management

  • Return to Equity Capital and Management=Net Farm Income – Operator and Family Labor Allowance


Profitability ratios

Profitability Ratios

  • Rate of Return on Borrowed Capital (COD)=

    • Return on Farm Assets-Return to Equity Capital and Management/Average Total Farm Assets-Average Net Worth

  • Rate of Return on Farm Assets (ROA)=

    • Net Farm Income + Total Interest Expense –Operator and Family Labor Allowance

  • Rate of Return on Farm Equity (ROE)=

    • Return to Equity Capital and Management/Average Farm Net Worth

  • Operating Profit Margin Ratio (OPMR)=

    • Net Farm Income + Total Interest Expense – Withdrawals for Operator and Family Labor/ Total Income

  • See p.3-14 to 3-16 for examples


Rate of return on assets show profitability by

Rate of Return on Assets Show Profitability by

  • Adjusting net farm income as if no interest has been paid, thus treating the total farm assets like equity capital


Rate of returns on equity ratio is

Rate of Returns on Equity Ratio Is

  • The rate of return on equity in the farm

  • The ratio show’s the farm’s return on net worth


How the rate of return on borrowed capital is used

How the Rate of Return on Borrowed Capital is Used

  • Evaluating whether returns are great enough to pay the cost of borrowing funds

  • Comparing return on borrowed capital with the return on equity capital


Operating profit margin shows profitability by

Operating Profit Margin Shows Profitability By

  • Defines profit as a percentage of total revenue

  • Formula

    • Net Farm Income + Total Interest Expense – Withdrawals for operator and family labor/ Total Income


3 components of ending net worth statement

3 Components of Ending Net Worth Statement

  • Ending Assets

    • Beginning Assets + Non-Cash Reinvestment + Changes in Inventory – Depreciation = Ending Assets

  • Ending Liabilities

    • Beginning Liabilities + New Debt Added – Debt Repaid = Ending Liabilities

  • Ending Owner Equity

    • Beginning Owner Equity + Net Farm Income – Family Living and Income Taxes= Ending Owner Equity


Fixed assets and net worth statements

Fixed Assets and Net Worth Statements


3 reasons valuing fixed assets is difficult

3 Reasons Valuing Fixed Assets is Difficult

  • Fixed assets can’t easily be changed to capital like current and other noncurrent assets

  • Fixed assets are usually part of the business for many years; often they are part of the entire life of the business

  • Values on financial statements must be estimated in order to get credit and to plan for future enterprises

  • It is best to be conservative when valuing fixed assets, therefore it is best to use BOOK VALUE


Summary

Summary

  • Financial statements are like a health report

  • There are 2 financial statements to consider

    • Net Worth

    • Income

  • Net worth statement and income statement provide financial measures of strengths and weaknesses of the farm business. They help pinpoint problems.

  • The Net worth statement provides information about what assets are owned and what liabilities are owed. It is a picture of the farm business at a point in time, usually annually.

  • The income statement show the financial performance of the farm business from one net worth statement to another.

  • The two financial statements together are powerful tools for farm and ranch business management.


Assignment

Assignment

  • Chapter 3 Assignment Sheets 1 and 2 p. 39-42

    • DUE--- Tuesday Sept 21

  • Chapter 3 Review Questions

    • DUE--- Thursday Sept 23

  • Chapter 3 Quiz– Thursday Sept 23


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