07 Fin Analysis

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Farm Management: Principles and Strategies, Kent Olson, 2003

Financial Analysis

Chapter 7


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Chapter OutlineUnderstanding Financial Statements

Measures of Financial Position and

Performance

Initial Analysis

Diagnostic Analysis


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Financial position:

The total resources controlled by a business and

the claims against those resources

Financial performance:

The results of decisions over time


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Understanding FinancialStatements


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Main concernsProfitability

Solvency

LiquidityRepayment capacity


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Main Financial StatementsIncome Statement

Income and expenses during a certain time period(usually, a year)

Also called a profit and loss statement

Balance SheetAssets and liabilities on a certain date

Also called a net worth statement

Cash Flow StatementFlow of cash IN and OUT

ONLY CASH


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Income StatementCash Farm Income

Cash Farm ExpensesNet Cash Income

= Cash income cash expenses

Inventory Change

Depreciation & Capital Adjustments

Net Farm Income= Net cash income

inventory change

depreciation


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Example Income Statement(from Fig. 7.1)

72,273Adjustments for Changes in Inventory

146,280Net Cash Farm Income417,181Total Cash Farm Expense

$563,461Gross Cash Farm Income

87,701Addition to Retained Earnings

68,016Proprietor Withdrawal

155,717Total Net Income

0Net Non-Farm Income

155,717Net Farm Income (NFI)

-62,836Depreciation & other Capital Adjustments


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Balance SheetASSETS

Current Assets

Intermediate Assets

Long-Term Assets

Total Assets (TA)

LIABILITIES

Current

Intermediate

Long-Term

Total Liabilities (TL)

Net Worth (NW) = TATLTL + NW


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Example Farm Balance Sheet (from Fig. 7.4)

Market

valueCost basis

Market

valueCost basis

1,278,241855,537Farm net

worth

482,755318,370TOTAL1,760,9961,173,907TOTAL

227,435131,866Long947,312605,993Long

152,44583,629Inter-mediate

350,207104,437Inter-mediate

$102,875$102,875Current$463,477$463,477Current

Farm LiabilitiesFarm Assets

Farm Management: Principles and Strategies, Kent Olson, 2003Farm Management: Principles and Strategies, Kent Olson, 2003


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Current AssetsCash, near-cash, or items normally used or

sold in the course of business during a yearCash, checking and savings accounts

Supplies, inventories, prepaid expensesFeed, grain, growing crops,

Market livestock

Crops under government loanAccounts receivable, and so on


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Non-current AssetsAll other assets which are not current

machinery and equipment, breeding livestock

shares in a cooperative

land, buildings, and other improvements to landIntermediate assets include machinery,

breeding livestock, and similarly aged

assetsLong-term assets include land, buildings,

and so on


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Current LiabilitiesLiabilities due within the next 12 months

Notes, operating loans, government crop loans

Accounts payable, accrued interest

Rents and lease payments due within 12 monthsThat portion of term debt due within 12 months


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Non-Current LiabilitiesLiabilities associated with non-current assets

Machinery loans and leases

Real estate loans and contracts

Leases on buildings (e.g., silos)And so on

But, the portion of term debt due within 12

months is a current liability and, thus, notlisted as a non-current liability


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Asset ValuationCost Basis

Original basis minus depreciation taken

Market Value

Current value in the market Minus cost of selling

Deferred taxes must be listed as a liability whenusing the market value approach

Why?: Gains (losses) are subject to taxation


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Cost or market?Cost basis

More solid data

GAAP method

But doesnt reflect current valuesMarket value

Provides better information on the current

resourcesMarket valuation is a softer value


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Cash Flow StatementCash Inflow

Product sales, insurance & government payments,capital sales

Cash Outflow

Expenses, capital purchases, proprietor withdrawals,term loan payments

Flow of Funds Summary

Beginning cash balance, borrowing & payment ofoperating loans, ending cash balance

Loan Balances


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Example Flow-of-Funds Summary(from Fig. 7.6)

3990Borrowing this period

5,0005,000Ending cash balance

9901,086Operating interest paid

05,282Operating principal paid

5,59111,368Cash difference

97,650184,292Total cash outflow

98,241182,140Total cash receipts$5,000$13,520Beginning cash balance

Apr-JunJan-Mar



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Measures of FinancialPosition and Performance


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Measures of ProfitabilityGross cash farm income

Net cash farm income

Net farm income from operations

Net farm income (NFI)

= gross cash farm income farm cash expenses

+ inventory change depreciation


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Profitability, cont.Labor & management earnings

Rate of return on farm equity (ROE)= (NFI from operations value of oper. labor & mgt)

(average farm net worth)

Rate of return on farm assets (ROA)= (NFI from oper. + int. paid value of oper. labor & mgt)

(average farm investment)

Financial leverage ratio = ROE / ROA

Operating profit margin ratio


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Measures of SolvencyNet Worth (NW) or Owners Equity

= total assets (TA) total liabilities (TL)

or: NW = TA - TL

Farm debt/asset ratio

= TL / TA * 100%

Farm equity/asset ratio

= NW / TA * 100%

Farm debt/equity ratio

= TL / NW * 100%


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Measures of LiquidityWorking capital

= current farm assets current farm liabilities

= CA - CL

Current ratio= CA / CL


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Measures of Repayment CapacityTerm debt and capital lease coverage ratio

(or: Term debt coverage ratio)

Capital replacement and term debt

repayment margin


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Measures of efficiencyAsset turnover ratio

= gross revenues / average total farm assets

Operational ratios (as a % of gross revenues)

Operating expense ratioDepreciation expense ratio

Interest expense ratio

Net farm income from operations ratio

Cost measures


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Initial Analysis


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Steps for an Initial Analysis1. Gain an overview of the farm

2. Identify the vision, goals, objectives, andstandards of the farm

3. Check the accuracy of the records4. Prepare the financial statements

5. Evaluate profitability

6. Evaluate solvency

7. Evaluate liquidity


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Steps for an Initial Analysis, cont.

8. Evaluate repayment capacity

9. Evaluate efficiencies

10. Examine marketing performance

11. Analyze livestock and crop enterprises12. Analyze internally, historically, vertically

and comparatively

13. Evaluate managerial ability & personalcharacteristics


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Diagnostic Analysis


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Questions for diagnostic analysis1. Is there an earnings problem?

2. Is the problem temporary or permanent?

3. Is it an operational or organizational

problem?

4. Should the resources be put to other uses?

07 Fin Analysis

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