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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 statement1
Net Worth Statement Condition

  • 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 Condition

  • Net Worth

  • Assets

  • Liabilities

Assets Condition

  • Items that have a market value

  • 2 Categories

    • Current

    • Non-Current

Current assets
Current Assets Condition

  • 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 Condition

  • 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) Condition

  • 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) Condition

  • Permanent items

  • Examples

    • Land

    • Improvements on buildings

Liabilities Condition

  • All the debt obligations of the business

  • Two types

    • Current

    • Non Current

Current liabilities
Current Liabilities Condition

  • 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 Condition

  • Debts due past (or after) one year

  • Two categories

    • Intermediate

    • Long Term

Intermediate liability
Intermediate Liability Condition

  • 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 Condition

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

Net worth
Net Worth Condition

  • 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
3 Kinds of Financial Analysis Condition

  • Comparative

  • Projected

  • Ratio

Comparative analysis
Comparative Analysis Condition

  • 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 Condition

  • Used to estimate future changes in equity

Making a projected analysis
Making a Projected Analysis Condition

  • 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 Condition

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

Ratio analysis maybe difficult because
Ratio Analysis Maybe Difficult Because…. Condition

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

  • Liquidity

  • Solvency

  • Equity

Liquidity Worth Statement

  • 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 Worth Statement

  • Current

  • Working

  • Debt Structure

How current ratio measure s liquidity
How Current Ratio Measure’s Liquidity Worth Statement

  • Current Ratio=Current Assets/Current Liabilities

How working capital measures liquidity
How Working Capital Measures Liquidity Worth Statement

  • Total Current Farm Assets – Total Current Farm Liabilities

What debt structure reveals about farm liabilities
What Debt Structure Reveals About Farm Liabilities Worth Statement

  • 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 Worth Statement

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

Calculations to measure solvency
Calculations to Measure Solvency Worth Statement

  • Debt-to-Asset Ratio

  • Debt-to-Equity Ratio

  • Equity-to-Asset Ratio

Debt to asset ratio
Debt-to-Asset Ratio Worth Statement

  • 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 Worth Statement

  • 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 Worth Statement

  • 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 Worth Statement

  • Give the figure of either income or figure loss

Income Worth Statement

  • 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 Worth Statement

  • Money paid out to operate the business

Calculation for net cash income
Calculation for Net Cash Income Worth Statement

  • 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 Values for…

  • Net cash income and the adjustments added together

Financial efficiency ratios1
Financial Efficiency Ratios Values for…

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

Four financial efficiency ratios
Four Financial Efficiency Ratios Values for…

  • 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 Values for…

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

Depreciation expense ratio
Depreciation Expense Ratio Values for…

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

Interest expense ratio
Interest-Expense Ratio Values for…

  • 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 Values for…

  • 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
Net Worth Statements Look At Values for…

  • The financial picture at a point in time.

Income statements indicate the performance of
Income Statements Indicate the Performance of Values for…

  • 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 Values for…

  • 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 Values for…

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

Not shown on income statements
Not Shown on Income Statements Values for…

  • 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 Values for…

  • Determined from a 2,080 hour work year

Return to equity capital and management
Return to Equity Capital and Management Values for…

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

Profitability ratios
Profitability Ratios Values for…

  • 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 Values for…

  • 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 Values for…

  • 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 Values for…

  • 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 Values for…

  • 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 Values for…

  • 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

3 reasons valuing fixed assets is difficult
3 Reasons Valuing Fixed Assets is Difficult Values for…

  • 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 Values for…

  • 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 Values for…

  • 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