Financial Management For Small Farms

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Financial management concepts (FINPACK). – AgPlan Business Planning Software. – MN Organic Farm Business Management Project. – Interpreting Financial ...
Financial Management For Small Farms

© 2009, University of Minnesota

Dale Nordquist

Department of Applied Economics 800-234-1111 © 2009, University of Minnesota

www.cffm.umn.edu

Financial Management For Small Farms • Today’s agenda – Financial management concepts (FINPACK) – AgPlan Business Planning Software – MN Organic Farm Business Management Project – Interpreting Financial Statements and Measures workshop

© 2009, University of Minnesota

A comprehensive whole farm financial planning and analysis system © 2009, University of Minnesota

FINPACK Components • Balance sheets

Where Am I?

• FINAN

Annual Financial Analysis

• FINFLO

Monthly Cash Flow Planning

• Annual Plan

Annual Cash Flow Planning

• FINLRB

Financial Long Range Planning

© 2009, University of Minnesota

Financial Management For Small Farms

• Is there a difference?

© 2009, University of Minnesota

Financial Management For Small Farms • Small farms: – – – – – – –

Use less debt Rely more on labor than technology Manage risk through diversification Earn more off farm income Have more interests than just maximizing profit Tend to be more entrepreneurial Need to focus on margin (marketing and operating efficiencies)

© 2009, University of Minnesota

Financial Management For Small Farms • Is there a difference? – Yes and no – All want to be profitable – All want to be able to pay bills – All want to grow net worth

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Financial Management For Small Farms

• Commodity producers – Focus on producing at the lowest cost – Earn a small margin on sales – Make their money on volume

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Financial Management For Small Farms • Small farms – Focus on selling at a profitable margin – Need to earn a high margin on sales – Need to be entrepreneural to take advantage of niche markets and market opportunities

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Financial Analysis vs Business Management Financial Analysis • Uses the numbers • Diagnostic • Keep score (trends)

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Business Management • Uses knowledge of the business • Prescriptive • Decision-making

Financial Management For Small Farms

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Interpreting Financial Statements and Measures

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Farm Financial Standards Guidelines • Financial statements: – Balance sheet – Income statement – Statement of owner’s equity – Statement of cash flows or cash flow budget

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Farm Financial Standards Guidelines

• Financial ratios and measures: – Farm Financial Standards Sweet 16+

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Balance Sheet A snapshot of: – Assets – Liabilities – Net worth (owners equity)

• At a specific point in time

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Balance Sheet The accounting equation: Assets = Liabilities + Net worth (Equity)

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Balance Sheet • Assets – Everything owned or payable to the business

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Balance Sheet • Assets – Everything owned or payable to the business

• Liabilities – All obligations owed

© 2009, University of Minnesota

Balance Sheet • Assets – Everything owned or payable to the business

• Liabilities – All obligations owed

• Net worth/Owners Equity – Total assets minus total liabilities © 2009, University of Minnesota

Balance Sheet • Measures financial position:

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Balance Sheet • Measures financial position: – Liquidity •The ability of the business to generate cash when needed

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Balance Sheet • Measures financial position: – Liquidity •The ability of the business to generate cash when needed

– Solvency •The relation ship between total assets and total liabilities

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Balance Sheet Assets

Liabilities

Current (< 1 year)

Current

Intermediate (1–10 yrs)

Intermediate

Long term (> 10 years)

Long term Total liabilities Net worth

Total assets

© 2009, University of Minnesota

Total Liabs + Net worth

Balance Sheet Assets

Liabilities

Current (< 1 year)

Current

Intermediate (1–10 yrs)

Intermediate

Long term (> 10 years)

Long term Total liabilities Net worth

Total assets

© 2009, University of Minnesota

Total Liabs + Net worth

Balance Sheet Assets Current (< 1 year) Intermediate (1–10 yrs) Long term (> 10 years)

Liabilities

Cash accounts Crop inventories Current Livestock held for sale Intermediate Prepaid expenses LongSupplies term Accounts receivable Total liabilities Net worth

Total assets

© 2009, University of Minnesota

Total Liabs + Net worth

Balance Sheet Assets

Liabilities

Current (< 1 year)

Current

Intermediate (1–10 yrs)

Intermediate

Long term (> 10 years)

Long term Total liabilities Net worth

Total assets

© 2009, University of Minnesota

Total Liabs + Net worth

Balance Sheet Assets

Liabilities

Current (< 1 year)

Current

Intermediate (1–10 yrs)

Machinery & equipment Intermediate Breeding livestock Long term

Long term (> 10 years)

Total liabilities Net worth Total assets

© 2009, University of Minnesota

Total Liabs + Net worth

Balance Sheet Assets

Liabilities

Current (< 1 year)

Current

Intermediate (1–10 yrs)

Intermediate

Long term (> 10 years)

Long term Total liabilities Net worth

Total assets

© 2009, University of Minnesota

Total Liabs + Net worth

Balance Sheet Assets

Liabilities

Current (< 1 year)

Current

Intermediate (1–10 yrs)

Intermediate

Long term (> 10 years)

Landterm Long Buildings Total liabilities Net worth

Total assets

© 2009, University of Minnesota

Total Liabs + Net worth

Balance Sheet Assets

Liabilities

Current (< 1 year)

Current

Intermediate (1–10 yrs)

Intermediate

Long term (> 10 years)

Long term Total liabilities Net worth

Total assets

© 2009, University of Minnesota

Total Liabs + Net worth

Balance Sheet Assets Accounts Current ( 10 years)

Liabilities Current Intermediate Long term Total liabilities Net worth

Total assets

© 2009, University of Minnesota

Total Liabs + Net worth

Balance Sheet Assets

Liabilities

Current (< 1 year)

Current

Intermediate (1–10 yrs)

Intermediate

Long term (> 10 years)

Long term Total liabilities Net worth

Total assets

© 2009, University of Minnesota

Total Liabs + Net worth

Balance Sheet Assets

Liabilities

Current (< 1 year)

Current

Intermediate yrs) term Loans with an(1–10 original of from 1 to 10 years Long term (> 10 years)

Intermediate Long term Total liabilities Net worth

Total assets

© 2009, University of Minnesota

Total Liabs + Net worth

Balance Sheet Assets

Liabilities

Current (< 1 year)

Current

Intermediate (1–10 yrs)

Intermediate

Long term (> 10 years)

Long term Total liabilities Net worth

Total assets

© 2009, University of Minnesota

Total Liabs + Net worth

Balance Sheet Assets

Liabilities

Current (< 1 year)

Current

Intermediate (1–10 yrs)

Intermediate

Loans with(>an Long term 10original years) term of greater than 10 years

Long term Total liabilities Net worth

Total assets

© 2009, University of Minnesota

Total Liabs + Net worth

Balance Sheet Assets

Liabilities

Current (< 1 year) Non-current Current Intermediate (1–10 yrs)

Intermediate

Long term (> 10 years)

Long term Total liabilities Net worth

Total assets

© 2009, University of Minnesota

Total Liabs + Net worth

Balance Sheet Assets

Liabilities

Current (< 1 year)

Current

Intermediate (1–10 yrs)

Intermediate

Long term (> 10 years)

Long term

Personal

Personal Total liabilities Net worth

Total assets © 2009, University of Minnesota

Total Liabs + Net worth

Balance Sheet Assets

Liabilities

Current (< 1 year)

Current

Intermediate (1–10 yrs)

Intermediate

Long term (> 10 years)

Long term

Personal

Personal Total liabilities Net worth

Total assets © 2009, University of Minnesota

Total Liabs + Net worth

Balance Sheet Assets

Liabilities

Current (< 1 year)

Current

Intermediate (1–10 yrs)

Intermediate

Long term (> 10 years)

Long term

Personal

Personal Total liabilities Net worth

Total assets © 2009, University of Minnesota

Total Liabs + Net worth

Balance Sheet Assets

Liabilities

Current (< 1 year)

Current

Intermediate (1–10 yrs)

Intermediate

Long term (> 10 years)

Long term

Personal

Personal Total liabilities Net worth

Total assets © 2009, University of Minnesota

Total Liabs + Net worth

Balance Sheet • Management implication – Match financing to asset life

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Balance Sheet: When • A snapshot at a specific point in time

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Balance Sheet Analysis • Current position • Financial structure • Total solvency • Net worth change

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Balance Sheet Analysis • Current position – Current assets vs. current liabilities – Measures of liquidity

• Balance sheet structure • Total solvency • Net worth change

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Working Capital = Current assets minus current liabilities • Important in financial risk management • Reduced by cash capital purchases and family withdrawals

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Balance Sheet Analysis • Current position • Balance sheet structure – Where is the equity – Are assets matched with liabilities – No right or wrong answer

• Total solvency • Net worth change

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Balance Sheet Structure • High current debt to assets – Liquidity problems

• High intermediate debt to assets – Capital replacement problems

• High long term debt to assets – Limited expansion capacity

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Balance Sheet Analysis • Current position • Balance sheet structure • Total solvency – Net worth – Overall financial risk position of the business – Future borrowing capacity – Debt to asset ratio = Total Debt ÷ Total Assets

• Net worth change © 2009, University of Minnesota

Balance Sheet Analysis

Let’s look at a balance sheet.

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Balance Sheet Analysis • Current position • Balance sheet structure • Total solvency • Net worth change – Measures overall progress

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Balance Sheet Analysis • Current position • Balance sheet structure • Total solvency • Net worth change – Measures overall progress – Net worth growth can only happen if: •Earnings exceed consumption or

© 2009, University of Minnesota

Balance Sheet Analysis • Current position • Balance sheet structure • Total solvency • Net worth change – Measures overall progress – Net worth growth can only happen if: •Earnings exceed consumption or •Market values are increased

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Earned Net Worth Change Net farm income Non-farm income Family living/owner withdrawals Income taxes Earned net worth change

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+ =

$75,000 25,000 50,000 10,000 $40,000

Balance Sheet Challenge

Asset Valuation

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Balance Sheet Challenge Asset Valuation • Market Valuation – assets valued at estimated fair market value – a price that could be expected is sold at arms length to an unrelated buyer – after selling costs

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Market Value Balance Sheet Total estimated market value of assets - Total debts = Net worth

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Market Value Balance Sheet •Advantage – Best estimate of solvency - amount remaining if all assets were sold and all debts paid

© 2009, University of Minnesota

Market Value Balance Sheet •Advantage – Best estimate of solvency - amount remaining if all assets were sold and all debts paid

•Disadvantage – Mixes net worth changes from earnings with market value changes

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Market Value Balance Sheet • Uses – Evaluate solvency – Evaluation of debt capacity – Collateral analysis – External comparison with other farms – Estate planning

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Balance Sheet Challenge Asset Valuation • Cost (Book) Valuation – assets valued at original cost less depreciation – land value never changes

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Cost Value Balance Sheet Total depreciated value of assets - Total debts = Retained earnings

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Cost Value Balance Sheet •Advantage – Includes only net worth changes resulting from earnings

© 2009, University of Minnesota

Cost Value Balance Sheet •Advantage – Includes only net worth changes resulting from earnings

•Disadvantage – Does not provide accurate solvency picture

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Cost Value Balance Sheet •Uses – Monitor earned net worth change – Internal periodic performance – Calculation of periodic net income

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Balance Sheet Challenge Asset Valuation • Market – Assets valued at a conservative market value adjusted for selling costs

• Cost of book value – Assets valued at original cost minus depreciation

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Balance Sheet Challenge Asset Valuation • Be consistent • Depreciation – Machinery 10% – Buildings 5%

© 2009, University of Minnesota

Balance Sheet A snapshot of: – Assets – Liabilities – Net worth (owners equity)

• At a specific point in time

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FFSC Financial Guidelines Four financial statements: – Balance sheet – Income statement – Statement of owners equity – Statement of cash flows

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Income Statement Purpose – Measure profitability – How much money did we make

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Income Statement Types of income statements – Cash – IRS Schedule F

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Income Statement Types of income statements – Cash – IRS Schedule F – Accrual

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Income Statement Accrual method – Revenues recognized when earned – Expenses recognized when incurred – More accurately matches income with the expenses incurred to produce that income

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Income Statement Types of income statements – Cash – IRS Schedule F – Accrual – Accrual adjusted

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Accrual Adjusted Income Statement

Cash Accounting Records

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Accrual Adjusted Income Statement

Beginning Balance Sheet

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Cash Accounting Records

Ending Balance Sheet

Accrual Adjusted Income Statement Smith Farm

Jones Farm Gross income

$500,000

Gross income

$500,000

Cash expenses

-450,000

Cash expenses

-450,000

Net cash income

50,000

Depreciation

-40,000

Schedule F income

10,000

© 2009, University of Minnesota

Net cash income

50,000

Depreciation

-40,000

Schedule F income

10,000

Accrual Adjusted Income Statement Jones Farm

Smith Farm

Gross income

$500,000

Gross income

$500,000

Cash expenses

-450,000

Cash expenses

-450,000

Net cash income

50,000

Inventory change

+100,000

Depreciation

-40,000

Schedule F income

10,000

© 2009, University of Minnesota

Net cash income

50,000

Depreciation

-40,000

Schedule F income

10,000

Accrual Adjusted Income Statement Jones Farm

Smith Farm

Gross income

$500,000

Gross income

$500,000

Cash expenses

-450,000

Cash expenses

-450,000

Net cash income

50,000

Inventory change

+100,000

Depreciation

-40,000

Net farm income

110,000

© 2009, University of Minnesota

Net cash income

50,000

Depreciation

-40,000

Schedule F income

10,000

Accrual Adjusted Income Statement Jones Farm

Smith Farm

Gross income

$500,000

Gross income

$500,000

Cash expenses

-450,000

Cash expenses

-450,000

Net cash income

50,000

Net cash income

50,000

Inventory change

+100,000

Inventory change

-100,000

Depreciation

-40,000

Depreciation

-40,000

Net farm income

110,000

Schedule F income

10,000

© 2009, University of Minnesota

Accrual Adjusted Income Statement Jones Farm

Smith Farm

Gross income

$500,000

Gross income

$500,000

Cash expenses

-450,000

Cash expenses

-450,000

Net cash income

50,000

Net cash income

50,000

Inventory change

+100,000

Inventory change

-100,000

Depreciation

-40,000

Depreciation

-40,000

Net farm income

110,000

Net farm income

-90,000

© 2009, University of Minnesota