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Improving Financial Performance: What Is the Payoff?

This guide delves into the essentials of improving financial performance by analyzing operating performance (ROA) and financial performance (ROE). It explores the determinants affecting both metrics, such as operating profit margin and asset turnover ratio. Additionally, the text examines the implications of managerial decisions on financial outcomes while introducing the DuPont model for profitability analysis. Case studies, including MBC Farms, provide practical insights into strategies for enhancing performance, reducing costs, and leveraging debt effectively to maximize returns.

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Improving Financial Performance: What Is the Payoff?

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  1. Improving Financial Performance: What Is the Payoff?

  2. Objectives • Understanding determinates of operating performance (ROA) • Understanding determinates of financial performance (ROE) • Links between managerial decisions and financial performance

  3. Operating Profit Margin Turnover Ratio Return on Assets X = Determinants of Operating Performance (ROA) • Operating profit margin • Asset turnover ratio

  4. Return on Assets InterestAssets Leverage ROE - X = Determinants of Financial Performance (ROE) • Operating profit margin • Asset turnover ratio • Leverage

  5. Profitability Analysis AKA The DuPont Model

  6. Gross Revenue Fixed Costs Variable Costs Net Income - - = Operating Profit Margin Net Income Interest Expense Gross Revenue + ÷ = - Interest Assets ROA x Gross Revenue ÷ Turnover Ratio Total Assets = ROE x Financial Structure Total Assets Equity Financial Structure ÷ = DuPont Analysis Operating Performance

  7. Implications • If ROE > ROA • Interest rate less than ROA • Making money on borrowed money • Increase ROE by borrowing more (but be careful)

  8. Implications • If ROE < ROA • ROA less than interest rate • Losing money on borrowed money • Reduce interest cost • Reduce debt • Improve operating performance (ROA)

  9. Improving performance • Ways to enhance operating performance (ROA) • Increase operating profit margin • Increase volume per dollar invested or capital turnover • Ways to enhance equity return (ROE) • Enhance operating performance • Reduce financing costs • Leverage – more debt

  10. Income Statement Balance Sheet Data for Profit Analysis • Gross Revenue • Fixed Costs • Variable Costs • Interest Costs • Total Assets • Equity

  11. Example Case: MBC Farms • Operated by Mike, Betty, and Craig • Enterprises • Crops, dairy • Operate 3,000 acres, 250 milking cows • Own 1,800 acres, cash rent remainder • Six full-time employees

  12. Worksheet 1: Cost Basis Inputs

  13. Worksheet 4 Spreadsheet for MBC Farms Case

  14. Worksheet 4: MBC Farms (cost value)

  15. Complete Worksheet 4

  16. Worksheet 4: MBC Farms (cost value)

  17. Worksheet 4: MBC Farms (market value)

  18. Reduced interest • Opportunity to refinance term debt at a 1% lower interest rate • $91,648 in intermediate debt and $799,573 term • Saves about $8,913

  19. Complete Alternative on Worksheet 4

  20. Reduced Interest

  21. Reduced Interest Results

  22. Earlier soybean planting • Has been planting about half of soybeans after June 23 • Pushing harder would result in about a 10% increase in soybean revenue • No change in costs

  23. Earlier Planting

  24. Earlier Planting Results

  25. Summary • Measurement of performance • Operating: ROA • Financial: ROE • Determinants of rates of return • Operating profit margin • Asset turnover ratio • Cost of debt • Leverage • Links among managerial decisions & rates of return

  26. Key Points? • What are the 2 key elements of operating performance? • Overall financial performance is measured by what ratio? • With respect to financial performance, when is debt a good thing?

  27. References • Boehlje, Michael, Craig Dobbins, Alan Miller, Dawn Miller, & Freddie Barnard, Measuring and Analyzing Farm Financial Performance, Department of Agricultural Economics, Purdue University, EC-712, 1999 (pages 37-43), • Miller, Alan, Michael Boehlje, and Craig Dobbins, Key Financial Performance Measures for Farm General Managers, Department of Agricultural Economics, Purdue University, ID-243, June 2001.

  28. Strategic Business Planning for Commercial Producers

  29. Worksheet 4

  30. Reduced Interest Results

  31. Earlier Planting Results

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