AG UPDATE 2004

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AG UPDATE 2004

• Issues Affecting the Agricultural Industry

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Financial AnalysisHow to Identify a Successful
Farm

• Gregg Ibendahl

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Balance Sheet vs. Income Stmt

• Balance Sheet
• a point in time measurement
• snap-shot view
• Income Statement
• measurement over time
• movie camera view

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Valuation of assets

• Modified cost - original cost less any
  accumulated depreciation
• Market value - Current fair market value

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Cash v Accrual

• Cash
• recorded at time of payment
• Accrual
• recorded when transaction occurs
• Accrual adjusted
• use cash records to produce accrual adjustments

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Accrual adjustments

• Net Farm Income (Cash basis)
• change in inventory value of crops and livestock
• change in accounts receivable
• change in accounts payable
• change in prepaid expenses
• change in accrued interest
• Equals net farm income (accrual basis)

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Advise for users of financial measures

• Financial measures help in asking the right
  questions but they do not provide answers.
• Judgement and common sense should be linked to
  informed application of formulae
• Be selective in the choice of financial measures
• A benchmark is needed to assess a firms
  financial performance and financial position.
• Financial measures derived from incomplete or
  poorly prepared financial statements are usually
  misleading and will frequently lead to bad
  business decisions by the owner and bad credit
  decisions by the lender.

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Debt/Asset Ratio Solvency Ratio

• Computation Total farm liabilities Total farm
  assets
• Interpretationmeasures financial position it
  expresses the risk exposure of the business can
  be calculated using either cost or market value
  of assets.
• Limitations
• value is influenced by the value placed on farm
  assets.
• reasonable value vary by farm.

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Debt/Asset Ratio (cont.)

• Example
• Assets 1,442,475
• Debt 461,386
• This means Equity 981,089
• Calculation 461386/1442475 32
• Is this good or bad?
• Rule of thumb

30
60
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Rate of Return on Farm Assets (ROA)

• Computation (NFIFO interest expense - unpaid
  labor)
  Ave total farm assets
• Interpretation an overall index of
  profitability.
• Limitations
• withdrawals for family living are often used as a
  proxy for unpaid labor.
• low compared to non-farm investments
• valuation of assets affects value
• non-farm income and assets can affect ratio
• business structure can affect ratio

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Rate of Return on Farm Assets (ROA) (cont.)

• Example
• NFIFO 86,661
• Interest Expense 27,461
• Unpaid labor 30,000
• Assets 1,442,475
• Calculation (8644127461-30000)/1442475 5.8
• Is this good or bad?
• Rule of thumb

5
1
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Rate of Return on Farm Equity

• Computation (NFIFO - unpaid labor) farm equity
• Interpretation this ratio measures the rate of
  return on equity capital employed in the farm
  business.
• Limitations
• similar to ROA
• a high ratio is normally good but could indicate
  under-capitalization or highly leveraged farm
  business.

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Rate of Return on Farm Equity - (cont.)

• Example
• NFIFO 86,661
• Unpaid labor 30,000
• Equity 981,089
• Calculation (86441-30000)/981089 5.78
• Is this good or bad?
• Rule of thumb
• Check to see if ROE ROA

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5
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Interest Expense Ratio

• Interest expense ratio
• Interest expense Value of farm production
• Calculation
• 27461/385967 7.1
• Rule of thumb
• This ratio and the D/A ratio determine if your
  farm has too much debt
• Ideal 2 greens
• o.k. 1 green and 1 yellow
• Bad any other combination

10
20
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Operational Ratios

• Depreciation expense ratio
• Depreciation Value of farm production
• Operating expense ratio
• Total operating expenses less depreciation
  Value of farm prod
• Calculation example
• Dep. Exp ratio 30459/385967 7.9
• Op. Exp ratio (271845-30459)/385967 62.5

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Operational Ratios (cont.)

• Rules of thumb
• Depreciation expense ratio
• Operating expense ratio
• A high depreciation expense ratio implies newer
  equipment. Therefore, operating expense should be
  lower

10
20
60
80
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Profitability

• Consists of 2 parts
• Operating profit margin
• Asset turnover ratio

NFIFO interest unpaid labor

Operating Profit Margin
VFP
ROA
X

Asset Turnover Ratio
Total Assets
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Profitability (cont.)

• Ideals
• Operating profit margin
• Asset turnover ratio
• Improving one or both ratios will improve both
  ROA and ROE

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20
40
20
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Points to Consider

• 1. Use book value for assets to evaluate farm
  over time.
• 2. Is ROE ROA?
• 3. Are Interest expense ratio and Debt-to-Asset
  ratio both in green range?
• 4. Are Depreciation expense ratio and Operating
  expense ratio both in green range?
• 5. To improve profitability, either Operating
  profit margin or Asset turnover must be
  improved
• Does your farm have too many assets for its size?

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