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Page 1: Managing Risks With Financial Analysis What's Your Plan?

Managing Risks With Financial Analysis

What's Your Plan?

Page 2: Managing Risks With Financial Analysis What's Your Plan?

Montana State University 2

What's Your Plan?

Production Financial Marketing Human Resource

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Are You a Risk Taker?????

Production

Financial

Marketing

Human Resource

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Do You Take Unnecessary Risks????

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Objectives For This Session

Gain an understanding of: Business’s financial position &

performance analysis Interaction among financial statements Financial interaction/impact the family has

on the business Different types of risk affecting the

business.

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Key Producer Items/Concerns

Adequate funds for family living (All Families)

Alternative enterprises, enterprise mix Debt Load and Structure Expansion plans/capabilities Dependences

Government payments Off Farm Inflows

Managing cost of production, financial info, marketing, labor (family)

Tight profit margins

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Financial Trends in Agriculture

Suggest several slides reviewing Ag financial health

Trends in Farm Net Income Debt Load and Structure Number of farms Sources of Ag Household income

Use these as background information Three examples follow

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Net Farm Income

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Net Cash Farm Income

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Total Production Expenses

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Complete Financials Required

Beginning and Ending Balance Sheets Cash Flow Statement

New form = Statement of Cash Flows Accrual Adjusted Income Statement Statement of Owner Equity

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Terminology Causes Us Problems

All cash inflows are not income Loan proceeds from lenders

All cash outflows are not expenses Principal payments to lenders Expense versus Expenditure

You can have non-cash expenses Depreciation most common Also through accrual adjustments

You can have non-cash income Accrual adjustments

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Just Like Balancing a Check Book

Beginning Cash Balance + Inflows - Outflows = Ending Cash Balance

Your business performance is measured the same way using a complete set of financial statements

These are Linked

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Statement of Owner Equity

Beginning Owner Equity + Net Income - Withdrawals + Contributions - Distributions +/- Change in Valuation = Ending Owner Equity

Balancing a CheckbookBeginning Equity+/- Activity= Ending Equity

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Some Topics for Examination

Withdrawals Non-business income Government Payments Cost of Production Debt Load (asset and liability structure) Asset revaluation Capital asset purchase Risk Protection Tools (Insurance) Non-cash income Non-cash expense (not depreciation) Contributed capital Distributed capital

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Withdrawals

Note the: Net worth (equity) on the balance sheet and the

change in equity from beginning to end of year Note net income (Accrual Adjusted Income

Statement) The relationship between cash flow and the

balance sheet, follow the red arrows. Change family withdrawals to zero What is relationship of Net Income and

change in equity What does this tell us about how equity

growth in the business MUST occur Change family withdrawals back to $30,000

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Continuation of Owner Withdrawals

With a positive Cash Flow No operating loan carryover May be a negative net worth change If so, the system tells how much owner

draw is impacting net worth Also indicates the amount of money from

non-business sources that must be brought into the operation

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Continuation of Owner Withdrawals

With a negative Cash Flow Will have an operating loan carryover

Carryover amount indicates the dollar adjustment necessary from:

Off farm earnings Income and/or expense adjustements Combination of all the above

If from Off-Farm, enter as a nonbusiness cash inflow. May still be a negative equity change Correct with more non-business inflow

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Family Living & Form of Ownership

Sole Proprietor versus Corporation Change family living withdrawal to a business

expense Zero out Owner Withdrawals and enter total

dollars of “family living” on the “Other Cash Business Expense” line of the Cash Flow

Illustrates the effects of a corporate form of ownership

Review effects on Income Statement, Cash Flow, Balance Sheets, Relationship between Net Income and Net Worth

Change

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Non Business Income

Income not generated by business assets

Types of non business income Off farm wages Non farm earnings (interest, dividends, etc)

Interest earned on a farm business checking account would be considered business income.

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Government Payments

Note current profit levels and cash flow position

Reduce/eliminate government payments on crops

Effects on cash flow, net income, equity Implications for profit

Profit Net Cash Flow Taxable Income Implications for the size of the business

Where is the risk?

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Cost of Production

Implications for this operation Do you know your cost of

production?????? Enterprise record keeping system

Quicken or QuickBooks Spreadsheets that allow you to allocate

income and expenses to enterprises If you can not measure it, you

can not manage it

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Debt Load and Structure

Example starts with approximately 16.5% debt load

What is the debt load that can be carried by an operation this size?

What about debt structure? Short vs long term debt

How does family living withdrawal effect debt carrying capacity?

Crop vs Livestock operations

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Asset Revaluation

Assets are occasionally revalued to reflect inflationary pressures Machinery, land, buildings, improvements,

breeding livestock Necessary to accurately reflect the

market value of these assets Do not misinterpret this increase in

equity Is not due to business performance Can be very misleading and can mask

serious business performance issues

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Capital Asset Purchase

Question: Will purchasing a new capital asset increase your net worth? Pickup, new bull, combine, center pivot, etc.

What is affected Ending asset balance, ending liabilities, cash

inflows and cash outflows, net income Bottom line, You CAN NOT buy equity Equity or growth in equity must be earned The only way to do this is make the new

asset earn additional revenue and/or reduce costs Increase net income

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Risk Protection Tools (Insurance)

Example used here is limited to the Basic Unit coverage provided by MPCI

Only three Basic Units are allowed in this example

Enter “example” levels of MPCI coverage for up to three Basic Units.

Set initial yields and prices at low levels to simulate bad year.

Turn MPCI section on/off to show affects of using MPCI insurance.

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Non-Cash Income

Non-cash income adjustments are made on the Accrual Adjusted Income Statement to reflect changes in Current Asset values on the beginning and ending balance sheet.

Include changes in: Crops Held for Sale Market Livestock Other Current Assets Cash Invested in Growing Crops

See the AccrualAdj tab for complete details

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Non-Cash Expense (Not Depreciation)

Non-cash expense adjustments are Made on the Accrual Adjusted Income

Statement Reflect changes in Current Asset and

Current Liabilities section of the beginning and ending Balance Sheet.

See the AccrualAdj tab of the spreadsheet for a detailed review of these adjustments

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Three Types of Contributed/Distributed Assets

Cash or Near Cash Listed on the Current Assets portion of the Balance

Sheet Capital assets, which include:

Long term depreciable assets Breeding livestock Machinery and equipment Buildings and improvements Land

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What is Contributed Capital

Capital not generated by the operation but given to the operation to support our farming habit Off farm income (wages/salary) Nonbusiness income (dividends, etc.) Gifts, inheritances, etc.

Will have affects on: Equity, Profits, Cash Flow

Earned versus Unearned

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What is Distributed Capital

What is distributed capital? Capital taken out of the operation

Will have different affects on: Equity - Short term vs long term

Immediate reduction in asset value Profits - Short term vs long term

Reduction in ability to produce income in the future

Cash flow - Short term vs long term Swapping assets within a family

structure run as one business?

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Income Taxes

The RDFinancial spreadsheet is distributed with the Income and S.S. tax estimator turned off. It can be turned on in cell W8 on the

Statements tab Users can enter additional cash

business expenses in cell I22 of the Statements tab to show the affects on the financials Net Worth, Net Income, Cash Flow

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Summary

You MUST measure your Financial Business Positions and Performance

Must be efficient Maximize output per unit of input Often we try to maximize just output Low cost producer The right size producer (size matters) Family structure matters

Manage marketing, production, family risk Financial analysis measures the impact of

these

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Business Position & Performance

What is key to your ability to survive? Managing all forms of risk

Production, Human, Marketing, Financial, Legal

With respect to the financial end Profits are critical Profits Net Cash Flow Taxable Income Earned positive Cash Flow also helps a

great deal If you can’t measure it, you can’t

manage it!!

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Business Must Produce Net Worth Internally

Every dollar of income goes towards increasing net worth

Every dollar of expense goes towards decreasing net worth

If growth in Net Worth comes only from external sources, your on shaky ground

You must be profitable enough to pay for: Family Living , Debt Principal, Savings,

Reinvestment, Retirement Positive Cash Flow is good but……

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Accrual Adjusted Financials:

Catch problems with: Inventory sell down to manage cash needs Selling capital asset base, your

manufacturing plant (livestock, machinery, land, etc.)

Capital distributions Unearned equity increases

Allows accurate business performance evaluation for each time period

Shows strengths and weaknesses Will not be easy the first time through

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Must Do Your Own Detailed Analysis

http://www.montana.edu/extensionecon/softwaredownloads.html

“RDFinancial” = Readers Digest Version “WFBudgets” = Intermediate version “Financial Statements” = Very detailed “Machines” = Enterprise budgeting for

crops “CCFS” = Cow-Calf, Feeder, Stocker

enterprise budgeting

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How To Get There

What is your business plan? Do you have a management team to help

with: Production decisions Marketing decisions Financial analysis Human resources

Are communications good among team members?

Are team members missing that are critical to the overall success of the business?

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Parting Comment

Do not risk the future of your operation (family and business) with frustration over preparing detailed financial statements. Just do it!


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