STANDARDIZING CANADIAN FARM FINANCIAL STATEMENTS. Larry Martin, Ph.D, Principal AME

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1 STANDARDIZING CANADIAN FARM FINANCIAL STATEMENTS Larry Martin, Ph.D, Principal AME

2 Background We teach a mini-mba for Canadian top farmers called CTEAM We see and CTEAM participants tell us: Few operating statements the same No opportunity to benchmark Much more tax advice than management performance from accountants. I don t know how I m doing We have standardized it in CTEAM with benchmarks. Often see transformative results.

3 We Discussed the Results with BDO Extremely useful in assessing management performance and identifying strategic issues. Presented it to BDO s National Agriculture Committee Did a pilot with 80 farms for 2016 tax year BDO will expand the project this year and roll out the format to all of its agricultural clients

4 Objectives Explain the standardized statement Show preliminary results from 2016 BDO process Illustrate how the statement s ratios can assist in assessing and improving management

5 The Standardized Operating Statement Is organized into categories logical to all farming operations Based on two principles: Principle 1: Managing operations is different than managing capital/finances. Operating statement organized to reflect each. Cost components separated into operations and capital activities Principle 2: All farms, no matter what commodities they produce, have five standard sets of costs. Operating statement organized accordingly into the five categories.

6 Standardized Operating Statement - Revenue from Operations Should be done with accrual statement Includes: sales of products, crop insurance claims, custom work, change in product inventory Does not include: government payments, gain or loss on disposal, investment income, non-farm income These are included at the end under other income and expenses

7 Standardized Operating Statement Operating Cost Categories Cost of goods sold Material purchased for transformation into final product: Feed, seed, fertilizer, chemicals, changes in input inventory, CI payments Direct Operating Expenses Costs of operation for machinery &equipment, (R&M, fuel) Costs of shipping and receiving Expense for operating labour Operating Overheads Admin salaries, sales salaries, professional fees, office rent and utilities, promotional fees and advertising, etc

8 Standardized Operating Statement Capital Cost Categories Cost of Capital Depreciation/Amortization, rents land and machinery, leasing fees, land clearing, property taxes (In line with new IFRS rules) Interest Costs Long and short term interest Lease interest if available

9 Standardized Operating Statement - Cost Categories (+) Revenue from Farming (Sales) (-) Cost of Goods Sold (COGS) (=) Gross Margin (GM) (-) Direct Operating Expenses (DOE) (=) Contribution Margin (CM) (-) Operating Overheads (OH) (=) EBITDA(R?) (-) Depreciation/Amortization/Lease/Rent (CoC) (=) EBIT (-) Interest Expenses (=) EBT from Operations (+/-) Other Income/Expenses (=) Net Income before Taxes

10 In CTEAM, We See All Sorts of Organization Farm statement set up to mimic AgriStability requirements Farm Statements with depreciation in Cost of Goods Sold Fixed and variable

11 Standardizing This Way Plus a standard balance sheet can provide ratios to benchmark performance

12 Balance Sheet Assets Liabilities (Debt) & Equity Current Assets Cash & Marketable Securities AR Inventory Prepaids Fixed Assets Machinery & Equipment Buildings Land Other Assets Investments Goodwill, Patents, Quota Taxes = TOTAL ASSETS = Current Liabilities Bank indebtedness AP & Accrued expenses Current portion, LTD Taxes Long Term Liabilities Long Term Debt Long term notes Mortgages Taxes Equity Preferred Common Retained Earnings = TOTAL DEBT + EQUITY 12

13 BDO Study Based on 78 farms Done by Joerg Zimmermann and me Sorted into quartiles based on profitability Profitability measured two ways: EBT per dollar of assets EBT per dollar of sales Both gave the same results

14 Study of 78 BDO farms L. 1/4 AVG U. 1/4 + Revenue (REV) 100% 100% 100% (-) Cost of Goods Sold (COGS) - 47% - 40% - 33% = Gross Margin (GM) = 53% = 60% = 67% (-) Direct Operating Expenses (DOE) - 33% - 29% - 27% = Contribution Margin (CM) = 20% = 31% = 40% (-) Over heads (OH) - 8% - 6% - 5% = EBITDA = 12% = 25% = 35% (-) Dep./Amort./Lease/land rent (COC) - 27% - 19% - 15% = EBIT = - 15% = 6% = 20% (-) Interest expense (FIN) TBD TBD TBD = EBT TBD TBD TBD (+/-) Other Income = Net Income

15 These Results are Generally Quite Consistent with Work Done by MNP 25 yrs ago and Work By US Financial People In general % Gross Margin for profitable farms should be > 65% There should be $.65 left per dollar of sales after paying fertilizer, chem, seed, feed, CI) If not, yields too low, prices too low, or costs too high Higher for hort, much lower for feedlots and wean finish. Knowing these ratios will tell you if you operations need improvement and give you a good idea of your ability to generate cash Best to have a number of years.

16 Study of 78 BDO farms L. 1/4 AVG U. 1/4 + Revenue (REV) 100% 100% 100% (-) Cost of Goods Sold (COGS) - 47% - 40% - 33% = Gross Margin (GM) = 53% = 60% = 67% (-) Direct Operating Expenses (DOE) - 33% - 29% - 27% = Contribution Margin (CM) = 20% = 31% = 40% (-) Over heads (OH) - 8% - 6% - 5% = EBITDA = 12% = 25% = 35% (-) Dep./Amort./Lease/land rent (COC) - 27% - 19% - 15% = EBIT = - 15% = 6% = 20% (-) Interest expense (FIN) TBD TBD TBD = EBT TBD TBD TBD (+/-) Other Income = Net Income

17 These Results are Generally Quite Consistent with Work Done by MNP 25 yrs ago and Work By US Financial People In General, DOE is 22-25%, which is higher than old standard, likely because it s dominated by labor and fuel, Increased in price more than agricultural products Likely higher for horticultural operations because of high labor costs On average $.40 left of each dollar of sales after paying CoGs and DOE

18 Study of 78 BDO farms L. 1/4 AVG U. 1/4 + Revenue (REV) 100% 100% 100% (-) Cost of Goods Sold (COGS) - 47% - 40% - 33% = Gross Margin (GM) = 53% = 60% = 67% (-) Direct Operating Expenses (DOE) - 33% - 29% - 27% = Contribution Margin (CM) = 20% = 31% = 40% (-) Over heads (OH) - 8% - 6% - 5% = EBITDA = 12% = 25% = 35% (-) Dep./Amort./Lease/land rent (COC) - 27% - 19% - 15% = EBIT = - 15% = 6% = 20% (-) Interest expense (FIN) TBD TBD TBD = EBT TBD TBD TBD (+/-) Other Income = Net Income

19 These Results are Generally Quite Consistent with Work Done by MNP 25 yrs ago and Work By US Financial People In general, Operating Efficiency for most profitable farms should be > 35% Ie $.35 left of each dollar of sales after paying all operating costs If less, revenue is too low or costs are too high (feedlots and wean-finish livestock operations, much less)

20 Study of 78 BDO farms L. 1/4 AVG U. 1/4 + Revenue (REV) 100% 100% 100% (-) Cost of Goods Sold (COGS) - 47% - 40% - 33% = Gross Margin (GM) = 53% = 60% = 67% (-) Direct Operating Expenses (DOE) - 33% - 29% - 27% = Contribution Margin (CM) = 20% = 31% = 40% (-) Over heads (OH) - 8% - 6% - 5% = EBITDA = 12% = 25% = 35% (-) Dep./Amort./Lease/land rent (COC) - 27% - 19% - 15% = EBIT = - 15% = 6% = 20% (-) Interest expense (FIN) TBD TBD TBD = EBT TBD TBD TBD (+/-) Other Income = Net Income

21 Use in Performance Assessment and Diagnosis CoC>15% - over capitalized, most frequently metal petters (!) or land rents.

22 Three Example Farms Farm A Farm B Farm C Revenue ($MIL) $1.58 $1.64 $1.55 CoGS (35%) %Gross M Ratio (65%) DOE (15-20%) % Cont M Ratio (45-50%) OH (10-15%) Operating Effic (35%) CoC & Int (15%) % EBT Ratio (20) 19 8 (16) EBT ($000) $300 $131 $(248)

23 Summary Farm A is most profitable, generally good, but not outstanding performance in all areas. Can tighten up all around, especially DOE. Depending on Balance Sheet, can grow with cash generated. Farm B has really good on CoGs and OH, but 48% on DOE, and 18% on capital are high. B has very high labour cost, suggesting insufficient sales for the amount of labour and capital. Probably needs to fix this before more growth Farm C is ok on CoGs, not bad on DOE, very good on OH, but has a huge capital burden. It is in several areas indicating overcapitalization for the amount of sales. Needs to generate more revenue or reduce capital.

24 In Addition: Capital costs of equipment are: 8% of Rev for 25% most profitable 15-16% of Rev for lowest 25% Huge implications for determining capital investment eg

25 Capital Cost Equipment Lower 25% ~ 15% of REV Ave REV all = $3.3 M => $495,000 x 7 years = $3.47 M Upper 25% ~ 9% of REV => $297,000 x 7 years = $2.08 M

26 Value in Planning When we put the series of three webinars together, one of our FMC colleagues thought the planning one should be first I argued this one should go first, because knowing your financial performance is important in determining your strategy If you have 40% CoGS, 43% DOE, 15% Operating Efficiency, and 8:1 Debt/EBITDA, growth is not likely your main strategic goal. But if you have 30% CoGS, 22% DOE, 43% Operating Efficiency and 2:1 Debt/EBITDA, it can be.

27 Next Steps With 2017/18 Project Increase the number of observations and add years to continue to confirm the ratios Strong evidence benchmarks different by type of farm will test Add detailed benchmarks for additional categories eg machinery operating cost/ha, long and short term interest Exploring ways to present results to farmers visually for most effect.

28 STANDARDIZING CANADIAN FARM FINANCIAL STATEMENTS Larry Martin, Ph.D Principal AME

29 Larry Martin B.Sc. (1966) and M.Sc. (1968), Ohio State University; Ph.D., University of Illinois (1972) , University of Guelph, Dep t. of Ag. Ec. & Business; Department Chair, , George Morris Centre 2002 Fellow, Canadian Agricultural Economics Society 2012 QE ll Diamond Jubilee Medal for contributions to Canada 2011 Wilson Loree Award for Excellence in Farm Business Management , Chair, Agri-Food Competitiveness Council Director: Taps Brewing Co; Lake Erie Farms, (Formerly) Cold Springs Farms; Big Sky Farms; Ridley Canada Ltd.; Father and grandfather of two each Perennial Gardner Catch the odd fish