Financial Benchmarks for Cooperatives

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1 Financial Benchmarks for Cooperatives 2018 Michigan Cooperative Directors & Managers Conference Dr. Chris Peterson Nowlin Chair of Consumer-Responsive Agriculture Michigan State University Dr. H. Christopher Peterson 2018

2 Co-op Benchmarking: The Issues Does a cooperative have good financial condition? Are a cooperative s financial benchmarks consistent with its business strategy? Is a cooperative financially flexible enough to seize a strategic opportunity? Are a cooperative s control and risk management functions equal to the task?

3 Benchmarks Help the Board Know Board needs to know enough to carry out its duties: Safeguard financial condition (fiduciary) Evaluate strategic options, returns and risks (current & future) Execute policy level review Exercise strategic control Carry out their representation function

4 Financial Condition Basics Good financial condition arises from: Operating profitability Income statement Efficient asset management Left hand side of balance sheet Efficient capital structure management Right hand side of balance sheet Appropriate returns to owners Where do you find this for a cooperative?

5 Financial Condition Basics A cooperative is in danger if: It can not pay its bills. Short-run liquidity Long-run solvency It can not make the right investments. Access and timing are everything! It can not pay members appropriate returns. Fair, sustainable, and competitive

6 Financial Benchmark: Compared to What? What are the standards of comparison? Trends across time Comparison to long-range objectives and strategies: PLANS!!!!!! Comparison to industry averages Comparison to best in class Competitors Firms/cooperatives in other industries doing the same function

7 Financial Benchmark: Compared to What? Minimum Wall Street Rules of Thumb: Sales Growth 2-4 Times the Rate of Inflation Net Income Growth of 10-15% and Income Stability Annual Return on Equity At Least 12-15% Debt To Total Assets of 40-50%

8 TABLE 10 Combined financial ratios, U.S. ag co-ops, by operating type, Measure Marketing Supply Service Total Total Ratio Current ratio Debt-to-assets Long-term-debt-to-equity Times interest earned Fixed asset turnover Equity-to-assets Expenses-to-gross revenue Source: Agricultural Cooperative Statistics 2015, USDA Percent Gross margin Return on total assets Return on member equity

9 TABLE 11 Combined financial ratios, U.S. ag co-ops, by operating type, Measure Dairy Fruit/Veg Grains Sugar Ratio Current ratio Debt-to-assets Long-term-debt-to-equity Times interest earned Fixed asset turnover Equity-to-assets Expenses-to-gross revenue Source: Agricultural Cooperative Statistics 2015, USDA Percent Gross margin Return on total assets Return on member equity

10 Other Ratios in USDA Ag Co-op Stats Common size income statements and balance sheets by type of cooperative (line items as % of total) How do you compare in operating income generation How do you compare on composition of assets How do you compare on composition of liabilities and equity Top 10 and Top 100 cooperative ratios Ratios by sales size Farm supply has info on 11 classes by sales size running from < 1 million to > $500 million

11 Cooperative Benchmarking Top 5 Cooperatives February 2018

12 Local Income Local Income 3.50% 3.00% 2.50% 2.00% 1.50% 1.00% 0.50% 0.00% A B C D E 2015 Q Q Q3

13 Current Ratio Current Ratio A B C D E 2015 Q Q Q3

14 LTD to Local Equity LTD to Local Equity A B C D E 2015 Q Q Q3

15 Percent of Equity Attached to a Member 80.00% Percent of Equity Attached to a Member 70.00% 60.00% 50.00% 40.00% 30.00% 20.00% 10.00% 0.00% A B C D E

16 Agronomy Gross Margin and Service Revenue 30.00% Gross Margin and Service Revenue 25.00% 20.00% 15.00% 10.00% 5.00% 0.00% A B C D E 2015 Q Q Q3

17 Fertilizer Gross Margin 25.00% Fertilizer Gross Margin 20.00% 15.00% 10.00% 5.00% 0.00% A B C D E 2015 Q Q Q3

18 Grain Margin and Service Revenue 9.00% Gross Margin and Service Revenue 8.00% 7.00% 6.00% 5.00% 4.00% 3.00% 2.00% 1.00% 0.00% A B C D E 2015 Q Q Q3

19 Personnel Expense/Gross Margin 50.00% Personnel Expense/Gross Margin 45.00% 40.00% 35.00% 30.00% 25.00% 20.00% 15.00% 10.00% 5.00% 0.00% A B C D E 2015 Q Q Q3

20 3 Year Summary of Midwest Co-op Financial Results

21 Local Income 1.00% 0.90% 0.80% 0.70% Local Income High % % % 0.60% 0.50% 0.40% 0.30% 0.20% 0.10% Low 2017 (2.15%) 2016 (1.26%) 2015 (.86%) 0.00%

22 Current Ratio Current Ratio High Low

23 Personnel Expense/Operating Expense 47.40% 47.20% 47.00% 46.80% Personnel Expense/Operating Expense High % % % 46.60% 46.40% 46.20% 46.00% 45.80% 45.60% 45.40% Low % % %

24 Grain Margin & Service Revenue 6.40% 6.20% 6.00% 5.80% 5.60% 5.40% 5.20% 5.00% Gross Margin and Service Revenue High % % % Low % % % 4.80%

25 Agronomy Gross Margin & Service Revenue 26.00% 25.00% 24.00% 23.00% 22.00% 21.00% Gross Margin and Service Revenue High % % % Low % % % 20.00%

26 Energy Gross Margin & Service Revenue 18.00% 16.00% 14.00% 12.00% Gross Margin and Service Revenue High % % % 10.00% 8.00% 6.00% 4.00% 2.00% Low % % % 0.00%

Food Co-ops Upper Quartile Median Sales 16,728,554 6,597,928 Sales Growth 6.38% 1.73% Gross Margin 38.88% 37.48% Personnel 26.25% 24.40% Gross Wages 19.90% 18.56% Net Income 1.42% 0.

27 Food Co-ops Upper Quartile Median Sales 16,728,554 6,597,928 Sales Growth 6.38% 1.73% Gross Margin 38.88% 37.48% Personnel 26.25% 24.40% Gross Wages 19.90% 18.56% Net Income 1.42% 0.20% Days Cash On Hand Cash over Accounts Payable Inventory Turnover Inventory Days Turns X Earns Total Debt to Equity Current Ratio Quick Ratio Return on Assets 5.08% 0.71% Debt Service Coverage Ratio Sales per Labor Hour

28 For more information on how to participate in Cooperative Benchmarking, contact: Rosemary Mahoney or - Stacey Webster swebster@iowainstitute.coop

29 Additional Benchmarks (Grain/Farm Supply) Banks Local savings / total sales = 1.5-2% Net profit / total assets = 8% Labor expense / gross income = 40% Fixed expenses / gross Income = 30 Net worth (Equity) > 50% of total assets Loan covenants often require specific ratio levels Other common benchmarks Turns x earns > 1 (10 asset turns x 1.5 profit margin = 1.5) Working capital: 1.5% of grain sales; 2.5% of farm supply sales Days receivable: days Source: Phil Kenkel, Bill Fitzwater Cooperative Chair, Oklahoma State Financial ratio calculator: You enter your income statement and balance sheet data and it calculates rations in a red light, green light or no light format

30 Benchmarks reflecting strategy! Customer Value = Relationship Perceived Benefits Price And your offer of customer value > the competition s

31 Only two ways to increase customer value and competitive advantage! Low Cost Advantage Lowering price to increase customer value Market a commodity product For example, Cargill Unique Benefits Advantage Increasing bundle of unique benefits to increase customer value. Market a differentiated product For example, John Deere

32 What Are the Returns and Risks? Low Cost Advantage Customer values price more than benefits Returns: low margin, high volume Risk: Not being lowest cost Unique Benefits Advantage Customer values benefits more than price Returns: high margin, captured customer Risk: Not being unique

33 Benchmarks should reflect strategy The DuPont Formula PM x TAT x EM = ROE Profit Margin (PM) = Net Margin Total Revenue (Sales) [x100] Total Asset Turnover (TAT) = Total Revenue Total Assets Equity Multiplier (EM) = Total Assets Equity Return on Equity (ROE) = Net Margin Equity [x100]

34 Benchmarks should reflect strategy DuPont Formula: PM x TAT x EM = ROE How do you interpret these ratios? Absolute value For PM, TAT, and ROE, it depends on industry For EM, the range is 2 to 3 across many industries. Trend across time: up, stable, down? Consistency? All four keys to good financial condition! operating profitability (PM) income statement asset management (TAT) balance sheet left side capital structure management (EM) right side ownership profitability (ROE) composite result

35 Benchmarks should reflect strategy Three Ways to Generate 20% ROE? PM x TAT x EM = ROE 5% x 2 x 2 = 20% (ROI = 10%) 2% x 5 x 2 = 20% (ROI = 10%) 2% x 2 x 5 = 20% (ROI = 4%) Let s compare: Co-op A: 1% PM x 5.0 TAT x 2.96 EM = 14.8% ROE Co-op B: 1% PM x 2.5 TAT x 10.9 EM = 25.0% ROE

36 Benchmarks should reflect strategy Operating profitability Profit margin Key expense ratios Key Benchmark Area Cost Adv. Benefits Adv. Efficient Asset Management Total Asset Turnover Key asset ratios (inventory turn, Days Rec) Return on Investment Efficient Capital Structure Management Equity Multiplier (TA/E) Key ratios (e.g., Days Pay, D/E, TIER) Lower Lower Higher Cash quicker Same* Same* Same* Higher Adds to benefits Lower Adds to benefits Same* Same* Same* Return on Equity Same* Same* *UNLESS THERE IS A STRATEGIC REASON WHY IT NEEDS TO BE DIFFERENT

37 Benchmarks in Strategic Control Good control keeps the organization headed in the right direction. This is what the board should care about Not managing daily operations Process of correcting for variations from benchmarks. Business decisions are risky. Human behavior needs monitoring. Corrective response becomes essential.

38 Control Signals to Watch: Tracking Risk Changes internal to the co-op Excessive changes in credit or inventory Excessive changes to benefits Exceptions to policy/procedure Progress with capital investment projects Member exit or level of complaints Anything tracking a critical internal function

39 Control Signals to Watch: Tracking Risk Changes external to the co-op Interest rate and macroeconomic changes Customer profit/income changes Market growth rate changes Intensity of rivalry--direct or substitute Supply chain changes--forward or backward Anything tracking critical external changes

40 Board s Role in Managing Risk Monitor key risks. Establish benchmarks Establish triggers for action Establish policies that empower management to manage risk. Proper provision of insurance Proper control of credit, inventory, & short-term liabilities Proper use of risk management techniques Use of derivatives Use of hedges and other market risk instruments Monitor effectiveness of risk management policies.

41 Control Signals: Tracking Opportunities Internal potential for profit Product/service R&D Process improvement R&D External potential for profit Emerging products/markets Changing customer preferences Supply chain process improvements

42 Key Takeaway on Co-op Financial Benchmarks Benchmarks need to be consistent with: Good financial condition Desired business strategy Needed flexibility to pursue opportunities Control and risk management functions Effective benchmarks arise from: Internal history and strategic plan/goals Industry averages/standards Best in class comparisons

AEC 851 BUDGETING ACTIVITY ANALYSIS INTRODUCTION TO BUDGETING AND

AEC 851 BUDGETING ACTIVITY ANALYSIS INTRODUCTION TO BUDGETING AND ACTIVITY ANALYSIS P Concepts presented are not complex but important to operations management < A logical way of organizing information