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Measuring & Analyzing Financial Performance. ANALYZING FINANCIAL POSITION AND PERFORMANCE. Analyze Financial Statement information Learn two basic types of analysis Use five key financial criteria Learn how to calculate key financial measures. TWO TYPES OF ANALYSIS.

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analyzing financial position and performance
ANALYZING FINANCIAL POSITION AND PERFORMANCE
  • Analyze Financial Statement information
  • Learn two basic types of analysis
  • Use five key financial criteria
  • Learn how to calculate key financial measures
two types of analysis
TWO TYPES OF ANALYSIS
  • Comparative statement analysis
  • Financial ratio analysis

The purpose of both types of analysis is to:

FIND, LOCATE AND ISOLATE

ratios
RATIOS
  • Monitoring Tools
  • Used in conjunction with other information
  • Rules of thumb are only guidelines
  • Unlimited number of

- physical ratios

  • financial ratios
  • Take time to develop

- a “feel”

- understand

- internalize

ratio analysis
RATIO ANALYSIS
  • Trends over time
  • Compare to industry standards
  • Comparison to similar firms
  • Comparison to performance objectives
financial ratio analysis
FINANCIAL RATIO ANALYSIS

Types of ratios to look at:

Liquidity:

Measures ability to meet obligations when due without disrupting normal operations

Solvency:

Measures borrowed capital in relation to owner’s equity capital invested in the business

financial ratio analysis cont d
FINANCIAL RATIO ANALYSIS (cont’d)

Profitability:

Measures amount of profit from use of labor, management and capital

Repayment Capacity:

Measures ability to repay debts from both farm and non-farm income

Financial Efficiency:

Measures degree of efficiency in use of labor, management and capital

tests of liquidity
A. Working Capital =

B. Current ratio =

C. Acid test ratio =

Cash flow

coverage ratio =

Total current farm assets minus total current farm liabilities

Current assets

Current liabilities

Liquid assets

Current liabilities

Cash available1

Cash required2

TESTS OF LIQUIDITY

1Beginning cash + cash received from operating activities+ cash received from investing activities + proceeds from term loans + cash received from equity contributions

2Cash paid for operating activities + cash paid for investing activities + principal paid on term loans and capital leases + cash equity distributions

tests of solvency
A. Debt-to-assets =

B. Equity-to-assets ratio =

C. Debt-to-equity ratio =

total liabilities

total assets

total farm equity

total farm assets

total farm liabilities

total farm equity

TESTS OF SOLVENCY
tests of profitability
TESTS OF PROFITABILITY

A. Return on equity = net income from farm operations - value of unpaid labor/management

average owners equity

B. Return on assets =net income from farm operations interest expense

- value of unpaid labor/management

total farm assets

C. Operating profit margin ratio = net farm income from operations + farm interest

expense - value of unpaid labor/mgmt

gross farm revenues

repayment of capacity ratios
REPAYMENT OF CAPACITY RATIOS

Term debt and capital lease coverage ratio =

net farm income from operations + total non-farm income + depreciation/amortization expenses + interest on term debt + interest on capital leases - total income tax expense- withdrawals for family living annual scheduled principal and interest on term debt + annual scheduled principal and interest on capital leases

Debt-to-income ratio = average total farm liabilities

net farm income from operations

financial efficiency ratios
FINANCIAL EFFICIENCY RATIOS

A. Asset turnover ratio = gross farm revenue

average total assets

B. Operating expense ratio = total expenses (excl. int. & depr. expense)

gross farm revenues

C. Depreciation expense ratio = depreciation expense

gross farm revenue

D. Interest expense = total farm interest expense

gross farm revenue

E. Net farm income = net farm income from operations

from operations ratio gross farm revenues

other efficiency ratios
OTHER EFFICIENCY RATIOS

Labor productivity ratio =

gross farm revenues

labor and salary expense + value of unpaid

labor and management

Machinery and equipment productivity ratio =

gross farm revenues

avg. investment in farm machinery and equip.

other comparisons
OTHER COMPARISONS
  • Carrying charge on owned land

vs.

Cash rental rate on comparable loan

  • Family withdrawal as a percent of

- value of farm production

- total expenses

  • Machinery investment per acre
  • Nonproductive assets as a percent of total assets
comparing ratios
COMPARING RATIOS

1. Net income, is it

✧ before or after taxes

✧ cash or accrual

✧ farm or farm plus non-farm

✧ before or after family living withdrawls

2. Balance sheet and resulting net worth

✧ cost, market or something in between

✧ have accrued items been included or omitted

✧ are deferred tax liabilities included or omitted

  • Is the information based on the individual, the business or a combination of the two

4. Is the ratio based an average, beginning of the year or end of the year figures

comparing ratios cont d
COMPARING RATIOS (cont’d)

5. The legal structure of the entity

- corporation vs. proprietorship

- treatment of salaries vs. withdrawals

  • Same fiscal year or point in time

7. What are you comparing to

- industry, state average, or loan portfolio average...

- a specific farm category, size

  • Type of business

- dairy vs. grain vs. cattle

9. Are the firms from the same geographic area:

- production methods (seasonality, irrigated vs. dry land, confinement vs. pasture, double vs. single crop)

case study
CASE STUDY

Ahmed and Zainab own and farm 130 dunum. On 100 tilled dunum, they grow 65 dunum of wheat and 35 dunum of barley. They also cash rent 500 dunum (320 dunum of wheat and 165 dunum of barley) and rent 400 dunum (200 dunum of wheat and 200 dunum of barley) on a 50-50 share lease. So, in year 2004 they farmed 585 dunum of wheat and 400 dunum of barley. They also sold 550 goats. Ahmed and Zainab work full time on the farm and have one hired man who works for them full time.

slide25

Analyzing financial performance for

  • Ahmed and Zainab Farmer
  • Using information from Ahmed and Zainab’s 2003 and 2004 market-value balance sheets, 2003income statement, 2003statement of cash flows, 2003cash flow statement and reconciliation of owner equity, calculate the following measures of financial performance.
exercise cont d
Exercise (cont’d)
  • Compare Ahmed and Zainab’s working capital and current ratio on December 31, 2003, with those measures on December 31, 2004. Are Ahmed and Zainab Farmer more or less liquid in 2004 than in 2003?
  • Compare Ahmed & Zainab’s 1.2% rate of return on assets to your calculated rate of return on equity. What does the relationship imply about the Farmers’ use of borrowed capital?
exercise cont d31
Exercise (cont’d)

4. What are the Farmers’ debt-to-asset ratios on December 31, 2003, and December 31, 2004, using the cost method of valuing assets? Are the ratios higher or lower than the ratios calculated for 2003 and 2004 using the market-value method?

5. The total of Ahmed and Zainab’s operating, depreciation and interest expenses as a percentage of gross farm revenues in 2004 equals _____%. If that amount is added to net farm income from operations/gross farm revenues, the total equals _____%.

summary
Summary

TESTS OF LIQUIDITY

TESTS OF SOLVENCY

TESTS OF PROFITABILITY

TESTS OF REPAYMENT CAPACITY

TESTS OF EFFICIENCY

OTHER MEASURES PECULIAR TO THE TYPE OF OPERATION