Getting Your Financial House in Order. Top Producer Conference 2010 Dick Wittman

Transcription

1 Getting Your Financial House in Order Top Producer Conference 2010 Dick Wittman

2 What we already know Volatility is way of future Commodity prices Input costs energy, fertilizer, rents, capital Interest rates??? Many farming at the margin We re back to basics to survive Understanding cost of production Studying trends in key financial metrics All looking for strategic silver bullets to survive and excel

3 Diesel Price Trends $4.00 $3.50 $3.00 Price/Gal $2.50 $2.00 $1.50 $1.00 $0.50 $ Year not all bad news! Drovers Journal Dec 2006 Original Cost = $150,000 Tanker Load price/#of N in NH3 $0.63 $0.60 $0.57 $0.54 $0.51 $0.48 $0.45 $0.42 $0.39 $0.36 $0.33 $0.30 $0.27 $0.24 $0.21 $0.18 $0.15 $0.12 $0.09 $0.06 $ $0.29 $0.26$0.25 $0.14 $0.11 $0.12 $0.14 $0.18 $0.21 $ $ $0.21 Replmt Cost = $450,000

4 Inspiration for Message Truly amazed Technology for monitoring key health indicators Innovative techniques for restoring health Teamwork of experts building solutions

5 Themes in this presentation What vital signs are you watching? Using Dupont Model to examine trends increasing cost of capital equipment hidden dangers of iron 0% Rising rents and land prices Special Focus on Capital Debt Repayment Capacity Prescriptions for Building Financial Health Strategies for survival in Putting doctors on your management team Advisory Boards CFO s

6 What gauges do we monitor? Seeding Rate Temperature Oil Pressure Acres/Hour Gallons/Acre Working Capital Debt/Asset Ratios ROE & ROA Accrual Net Income Cap Debt Rep Capacity Unit Cost of Production

7 Using Dupont Model to ID Impact of escalating costs Equipment (with & without interest) Land price and rents escalation How cost trends impact core gauges Profit Margin Ratio Turnover Ratio Leverage ROE, ROA Capital Debt Repayment Capacity

8 DuPont Model ROA Drivers (Asset Turnover Ratio)* x (OPM Ratio)** = Return on Assets X *Gross Farm Revenue x **Net Farm Inc = ROA Ave Farm Assets Gross Farm Revenue X

9 DuPont Model ROE Drivers ROE = Profitability x Asset Efficiency x Leverage Ratio = Op Profit Margin x Asset Turnover x Assets/Equity Ratio NFI = NFI x GF Revenue Equity GFRevenue Farm Assets Equity X X X X x Farm Assets

10 SIMPLIFIED DU PONT FINANCIAL ANALYSIS MODEL Developed by Ag Education & Consulting ROE Return on average farm equity -7.8% Return on average farm assets 0.5% plus Spread betw een ROA and Interest cost -7.2% multiplied by Average debt/equity ratio 1.15 Operating Margin Operating profit margin 1.6% Return on average farm assets 0.5% multiplied by minus Average asset turnover 29.0% Average cost of liabilities 7.6% Asset Turnover Debt/ Equity Average debt/equity ratio 1.15 Net farm income from operations (NFIFO) + divided by Interest - Withdraw als $9,386 Gross revenues $576,068 divided by Average farm assets $1,983,454 Average farm equity $920,878 divided into Average farm liabilities $1,062,576 Remember my Job Every Strategic Decision impacts financial performance

11 Dupont Model Simulation Results Data Set Base Case Case #2 eqmt cost Case #3 Eqmt + Int Case #4 Case #2 rent & r.e. Case #5 add Int on re Revenue 2,371,600 - Healthy 8,000ac farm; 50% owned; Var Oper Costs 1,783,000 $65/ac rents good +100,000 financial indicators Fixed Op Cost 90, ,000 Interest Costs 134,700 - trade +36,000 off power unit & 3 combines +84,000 Net Farm Inc 363, ,300 for 2@ 267,300 0 int. 1st 167,300 yr; then to 6% 83,300 Chg in NFI +/- -60,000-36, ,000-84,000 Labor/Mgmt W/D 0 -increase equip assets +$600,000 Average Assets 6,058, ,000-5 year life; 50% +1,200,000 salvage value => Ave Liabilities 2,469, ,000 $60,000 economic depreciation/yr. +1,200,000 Average Equity 3,589,000 - No change in operating costs OPM 21.0% 18.5% (increase 18.5% in maintenance 14.3% offset by 14.3 ATR.39 to 1.36 to 1 equipment.36 to 1 operating.30 to efficiencies) 1.30 to 1 ROA 8.2% 6.6% 6.6% 4.3% 4.3% ROE 10.1% 8.5% - OPM 7.4% 12%... ATR 3.5% 8% 2.3% Ave Cost of Debt 5.5% 4.4% 5.6% 5.6% 6.0% - ROA 20%... ROE 16% - but ave. cost debt dropped!!

12 Dupont Model Simulation Results Data Set Base Case Case #2 eqmt cost Case #3 Eqmt + Int Case #4 rent & r.e. Case #5 add Int on re Case #3 Revenue 2,371,600 -Same scenario as Var Oper Costs 1,783,000 Case +100,000 #2, BUT Fixed Op Cost 90, ,000 Interest Costs 134, ,000 - Interest kicks in Net Farm Inc 363, , , ,300 83,300 Chg in NFI +/- -60,000-36,000 - $36, ,000interest -84,000 Labor/Mgmt W/D 0 expense drops NFI $36,000 Average Assets 6,058, ,000 +1,200,000 Ave Liabilities 2,469, ,000 - ROE takes +1,200,000 further hit: Average Equity 3,589,000 13% decline OPM 21.0% 18.5% 18.5% - Ave 14.3% cost debt 27% 14.3 ATR.39 to 1.36 to 1.36 to 1.30 to 1.30 to 1 ROA 8.2% 6.6% 6.6% 4.3% 4.3% ROE 10.1% 8.5% 7.4% 3.5% 2.3% Ave Cost of Debt 5.5% 4.4% 5.6% 5.6% 6.0%

13 Dupont Model Simulation Results Data Set Base Case Case #2 eqmt cost Case #3 Eqmt + Int Case #4 rent & r.e. Case #5 add Int on re Revenue 2,371,600 Var Oper Costs 1,783, ,000 Fixed Op Cost 90, ,000 Interest Costs 134, , ,000 Net Farm Inc 363, ,300 Chg in NFI +/- -60,000 Labor/Mgmt W/D 0 267,300-36, , ,000 83,300-84,000 Average Assets 6,058, ,000 +1,200,000 Ave Liabilities 2,469, ,000 +1,200,000 Average Equity 3,589,000 OPM 21.0% 18.5% 18.5% 14.3% 14.3 ATR.39 to 1.36 to 1.36 to 1.30 to 1.30 to 1 ROA 8.2% 6.6% 6.6% 4.3% 4.3% ROE 10.1% 8.5% 7.4% 3.5% 2.3% Ave Cost of Debt 5.5% 4.4% 5.6% 5.6% 6.0% Case #4 - Rent $25/ac (+100,000); land value inflates $300/ac (+$1,200,000) - NFI $100,000 OPM -23%... ATR -17% ROA -35% ROE -53%

14 Dupont Model Simulation Results Data Set Base Case Case #2 eqmt cost Case #3 Eqmt + Int Case #4 rent & r.e. Case #5 add Int on re Revenue 2,371,600 Var Oper Costs 1,783, ,000 Fixed Op Cost 90, ,000 Interest Costs 134, , ,000 Net Farm Inc 363, ,300 Chg in NFI +/- -60,000 Labor/Mgmt W/D 0 267,300-36, , ,000 83,300-84,000 Average Assets 6,058, ,000 +1,200,000 Ave Liabilities 2,469, ,000 +1,200,000 Average Equity 3,589,000 OPM 21.0% 18.5% 18.5% 14.3% 14.3 ATR.39 to 1.36 to 1.36 to 1.30 to 1.30 to 1 ROA 8.2% 6.6% 6.6% 4.3% 4.3% ROE 10.1% 8.5% 7.4% 3.5% 2.3% Ave Cost of Debt 5.5% 4.4% 5.6% 5.6% 6.0% Case #5 Land increase with debt financing: = $84,000 interest - NFI $84,000 OPM, ATR & ROA same BUT ROE 34%

15 Are there other risks we should fear?

16 CDRC Analysis Capital Debt Repayment Capacity Farmers tend to ignore CDRC Complicated; no news is good news Critical metric for bankers More focus on coverage vs. operating margin Common oversight farmers rarely consider capital replacement

17 Repayment Capacity - Ability to service debt, lease obligations and replace capital Three Indicators: 1) Term Debt & Capital Lease (Coverage) Ratio = ( Net Farm Income + Non-farm Inc + Depreciation + Inter Expense Term & Capital Leases Inc Tax Expense Family Living WD ) divided by Principal & Interest on Term Debt and Capital Leases 2) Capital Replacement and Term Debt Repayment Margin = Capacity Commitments = Margin Capacity = NFIFO + Non-Farm Inc + Depr Inc Tax Family WD Commitments = Prin. Pmts on Term Debt and Capital Leases + Cash Capital Replacement Outlays 3) Debt/Income Ratio = Ave Total Liabilities / NFIFO

18 Capital Replacement & Term Debt Repayment - CRTDR Base Case Case #2 eqmt cost Case #3 Eqmt + Int Case #4 Case #2 rent & r.e. Case #5 add Int on re Net Farm Inc 363, , , ,300 83,300 + Non-farm Inc 60,000 60,000 $60,000 60,000 lower NFI 60,000 60,000 - Income Taxes 84, ,800 44,800 28,000 - Family Draws 0 0 $12,000 less 0 taxes 0 0 Net Earnings 339, , , , ,300 + Deprec Expen 90, ,000 $60, ,000 increased 150,000 depreciation 150,000 exp + Term Int Expen 125, , , , ,000 Total Capacity 554, ,300 $60, ,500 increased 493,500 equip payments 510,300 - Term Princ Pmts 180, , , , ,000 - Term Int Expen 125, ,000 Margin 161,000 drops 161,000 $48, ,000 - Cap Asset Repl 120, , , , ,000 from comfortable 30% to 17% Tot Commitmts 425, , , , ,000 CRTDR Margin 129,300 81,300 52,500 (27,500) (169,700) Margin % 30% 17% Coverage 10% Ratio drops -5% 17% -25% Coverage Ratio & Debt 1.43 to Income Ratio 1.23 is rising.91 Debt to Inc Ratio

19 Capital Replacement & Term Debt Repayment - CRTDR Base Case Case #2 eqmt cost Case #3 Eqmt + Int Case #4 rent & r.e. Case #5 add Int on re Case #3 Net Farm Inc 363, , , ,300 83,300 + Non-farm Inc 60,000 60,000 60,000 60,000 60,000 - Income Taxes 84, ,800 $36,000 44,800 added interest 28,000 - Family Draws expense 0 0 Net Earnings 339, , , , ,300 + Deprec Expen 90, , ,000 taxes 150,000 lowered 7, ,000 + Term Int Expen 125, , , , ,000 Total Capacity 554, , ,500 Margin 493,500 drops to 510,300 10% - Term Princ Pmts 180, , ,000 now 240,000 very tight! 315,000 - Term Int Expen 125, , , , ,000 - Cap Asset Repl 120, , , , ,000 Tot Commitmts 425, , , , ,000 CRTDR Margin 129,300 81,300 52,500 (27,500) (169,700) Margin % 30% 17% 10% -5% -25% Coverage Ratio Debt to Inc Ratio

20 Capital Replacement & Term Debt Repayment - CRTDR Base Case Case #2 eqmt cost Case #3 Eqmt + Int Case #4 rent & r.e. Case #5 add Int on re Net Farm Inc 363, , , ,300 83,300 + Non-farm Inc 60,000 60,000 60,000 60,000 60,000 - Income Taxes 84, ,800 44,800 28,000 - Family Draws Net Earnings 339, , , , ,300 + Deprec Expen 90, , , , ,000 + Term Int Expen 125, , , , ,000 Total Capacity 554, , , , ,300 - Term Princ Pmts 180, , , , ,000 - Term Int Expen 125, , , , ,000 - Cap Asset Repl 120, , , , ,000 Tot Commitmts 425, , , , ,000 CRTDR Margin 129,300 81,300 52,500 (27,500) (169,700) Margin % 30% 17% 10% -5% -25% Coverage Ratio Debt to Inc Ratio Case #4 - $100,000 drop NFI reduces taxes $20,000. Still show a PROFIT but, Margin drops $88,000 CRTDR now in NEGATIVE territory!

21 Capital Replacement & Term Debt Repayment - CRTDR Base Case Case #2 eqmt cost Case #3 Eqmt + Int Case #4 rent & r.e. Case #5 add Int on re Net Farm Inc 363, , , ,300 83,300 + Non-farm Inc 60,000 60,000 60,000 60,000 60,000 - Income Taxes 84, ,800 44,800 28,000 - Family Draws Net Earnings 339, , , , ,300 + Deprec Expen 90, , , , ,000 + Term Int Expen 125, , , , ,000 Total Capacity 554, , , , ,300 - Term Princ Pmts 180, , , , ,000 - Term Int Expen 125, , , , ,000 - Cap Asset Repl 120, , , , ,000 Tot Commitmts 425, , , , ,000 CRTDR Margin 129,300 81,300 52,500 (27,500) (169,700) Margin % 30% 17% 10% -5% -25% Coverage Ratio Debt to Inc Ratio Case #4 $84,000 inter expense drops NFI; taxes $20,000; r.e. princ $75,000 Margin drops $142,200 now in serious margin deficit!

22 Summary of Impacts Dynamics are forcing farmers to seek more acres to justify higher capital overhead Imbalance - cost of production vs. revenue Working capital depleted Leverage unserviceable; CDRC negative ROA & ROE below acceptable investor targets No longer bankable customer!!

23 Strategic Questions to Ask Will equipment costs continue rising? New?? Used?? Will interest free rolls continue? Where will interest rates go especially if headed for inflation? Will commodity price rises keep up with input cost increases? Will investors tolerate declining ROE caused by cost capital?

24 Strategies to Consider Offensive/Defensive Keep (or get) off-farm job!! Lock in pricing farm inputs; interest rates Re-negotiate land lease arrangements Pay down debt Pay cash for capital purchases (land, equip) Hone skills in cost management MA wkshps Optimize equip access alternatives Lock in profitable margins Identify Cost of Production projections Set targets to lock in profits Don t be afraid to pay taxes

25 Buy, Lease, or custom hire my harvest? Cost/hour to operate 30 Combine $177,000 new Hrs Use Cost/Hr 100 $ BEP-> this is ancient history, folks!!!

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27 Marketing Strategies Need to match up financial analysis & marketing disciplines Cost of production Cashflow Projections Accrual Based Risk transfer tools crop insurance Margin targets Use volatility as our friend U.S. Farm Report are experts ever wrong?

28 Cost prodn = $ % profit margin = $5.25

29 25% profit margin = $ % profit margin = $4.08 Cost prodn = $3.40

30 25% profit margin = $95/cwt 20% profit margin = $91/cwt Cost prodn = $76/cwt

31 Who s Prescribing Your Meds? Mentors, Peer networks CFO s Advisory Boards

32 Where do you find good CFO? 3 TEPAP alumni multi-site grain operations and farm supply businesses Hired controller/cfo away from big firm making hrs/wk $75,000/yr, 30 hrs/week + $35,000 secretary/data entry person Formed service bureau with office, computers, accounting systems, 401k Total cost = $150,000 split 3 ways

33 Advisory Boards Purpose & Value Created Provide independent sounding board and source of counsel Value Created Objectivity in decision making Access to Strategic innovation Generally accepted business practices Injection of experience outside own sphere

34 Advisors Can Play Useful Roles Defining proper roles of board, CEO and Sr. managers Setting compensation board, CEO, staff (especially where family involved) Strategic planning and implementation of strategic shifts Ownership transfers and capital injections/withdrawals Coaching process to get incompatible players off the bus Being a champion for disenfranchised owners Guiding financial analysis processes and communications of results to boards, senior managers (example: SR FCS ppt) Demonstrating how to run effective meetings: i.e. annual meeting of board of directors, or family council Transition planning Sounding board for family conflict issues and guiding conflict resolution based on professional business precedents Balancing interests between insiders and off-farm stakeholders Helping clients build capacity in specialized roles (CEO, Bd chairman, CFO, etc.)

35 Summary Don t have crystal ball not all headed to emergency room Check your vitals limit # gauges Study industry trends & impacts on your business download Dupont Model & Trend Sheet Develop hit list of defensive & offensive strategies to survive Flesh out team of doctors advisory boards, CFO Beware of Self-Medication!