Introduction January 10, 2019 Michael Langemeier Department of Agricultural Economics Purdue University Purdue.edu/commercialag
White County Farms Enterprises Corn; 1,500 acres Soybeans; 1,500 acres Owned and Rented Acres Owned = 750 Rented = 2,250 Cash Rent = $245 per acre Land Values Beginning of 2018 = $7,774 per acre End of 2018 = $7,815 per acre
Financial Ratios Operating Profit Margin Ratio Measures the extent to which a business generates a profit from the use of land, labor, management, and capital. Computed by dividing net farm income plus interest expense minus unpaid family and operator labor by value of farm production. Asset Turnover Ratio Measures the intensity with which a business uses its assets to generate value of farm production. Computed by dividing value of farm production by average total assets.
Financial Ratios (continued) Capital Debt Repayment Margin Measures a farm s ability to repay operating loans and to cover the current portion of principal and interest due on noncurrent loans such machinery, building, and land loans. Computed by subtracting principal and interest on term debt, income and self-employment taxes, and family living expenses from the sum of accrual net farm income, off-farm income, and depreciation.
Financial Ratios (continued) Replacement Margin Measures a farm s ability to repay operating loans, to cover the current portion of principal and interest on noncurrent loans, and to replace machinery. Computed by subtracting cash used for capital replacement (e.g., depreciation times 1.15) from the capital debt repayment margin. For a farm to grow, the average long-run replacement margin has to be positive.
Operating Profit Margin Ratio West Central Indiana Case Farm 0.400 Annual Average 0.350 0.300 0.250 0.200 0.150 0.100 0.050 0.000-0.050-0.100 07 08 09 10 11 12 13 14 15 16 17 18P 19P
Asset Turnover Ratio West Central Indiana Case Farm 0.450 Annual Average 0.400 0.350 0.300 0.250 0.200 0.150 0.100 0.050 0.000 07 08 09 10 11 12 13 14 15 16 17 18P 19P
Capital Debt Repayment Margin West Central Indiana Case Farm $800,000 Annual Average $700,000 $600,000 $500,000 $400,000 $300,000 $200,000 $100,000 $0 -$100,000 -$200,000 07 08 09 10 11 12 13 14 15 16 17 18P 19P
Replacement Margin West Central Indiana Case Farm $700,000 Annual Average $600,000 $500,000 $400,000 $300,000 $200,000 $100,000 $0 -$100,000 -$200,000 -$300,000 07 08 09 10 11 12 13 14 15 16 17 18P 19P
Checklist for Loan Renewal Most recent tax return and balance sheet List of all loans, include terms and payments Yield history for each crop produced Marketing plan for each crop produced Crop insurance documentation Projections and budgets for the upcoming year Net farm income Repayment capacity Working capital Enterprise costs and returns
Checklist for Loan Renewal (continued) Narrative that includes: Issues that you have recently encountered (e.g., personnel, machinery, storage, weather, etc.) Future goals Management structure and future changes Management succession plan
Focus of this Workshop Financial Analysis Use tax return and balance sheets to create accrual net farm income and compute financial ratios Examine repayment capacity Financial Projections Enterprise budgets Pro-forma financial statements Income statement Sources and uses of funds statement Repayment capacity Working capital
Financial Analysis January 10, 2019 Michael Langemeier Department of Agricultural Economics Purdue University
Case Farm File: White County Farms Market Value Balance Sheets, 2018 Notes for Market Value Balance Sheet, 2018 Schedule F, 2018 Repayment Capacity Measures, 2018
Balance Sheet 15
Beginning of Year BALANCE SHEET Assets Current $2,943,939 Noncurrent $7,403,296 Liabilities Current $567,538 Noncurrent $848,926 Equity $8,930,772 End of Year BALANCE SHEET Assets Current $3,073,558 Noncurrent $7,481,611 Liabilities Current $576,546 Noncurrent $915,832 Equity $9,062,790 Precise classification of assets & liabilities is important! Identifying reason(s) for equity change is also important!
Problems with Some Balance Sheets 1) Not completed the same time each year ü Seasonal changes in inventories make it important to complete balance sheet at the same time each year 2) Do not include notes or comments ü Difficult to figure out what prices were used to value inventories ü Difficult to analyze change in land values 3) Use tax rather than economic depreciation ü Using tax depreciation understates net farm income ü Benchmarks use economic depreciation rather than tax depreciation
Loan Structure: White County Farms 1) Operating Loan Balance outstanding at the end of the year 2) Machinery Loan Revolving loan on machinery Loan-to-value ratio for machinery is currently 28% 3) Land Loan Loan on 300 acres of cropland Current land loan balance is 21% of market value Has zero debt on another 450 acres
Current Assets Item 1/1/18 12/31/18 Cash 1,993,837 2,095,165 Fertilizer and Supplies 52,955 53,733 Investment in Growing Crops 0 0 Crops Held for Sale and Feed 897,147 924,660 Market Livestock 0 0 Total 2,943,939 3,073,558
Non-Current Assets Item 1/1/18 12/31/18 Breeding Livestock 0 0 Machinery and Equipment 1,480,910 1,533,069 Buildings 91,886 87,292 Land 5,830,500 5,861,250 Total 7,403,296 7,481,611
Current Liabilities Item 1/1/18 12/31/18 Accounts Payable 0 0 Notes Due within One Year 500,000 500,000 Current Portion of Term Debt 40,860 47,895 Accrued Interest 26,678 28,651 Total 567,538 576,546
Non-Current Liabilities Item 1/1/18 12/31/18 Notes Payable 355,103 435,928 Real Estate Debt 493,823 479,904 Total 848,926 915,832
Liquidity and Solvency White County Farms Current Ratio CR = (current assets / current liabilities) CR = 3,073,558 / 576,546 CR = 5.33 Solvency DTAR = (total liabilities / total assets) DTAR = 1,492,378 / 10,555,168 DTAR = 0.141 Evaluation?
Schedule F 24
Schedule F Gross Income = $2,009,135 Total Expenses = $1,844,182 Net Farm Profit = $164,953 How is Net Farm Profit from a Schedule F related to Net Farm Income?
Problems with Schedule F 1) Ignores accrual adjustments Fertilizer and Supplies Investment in Growing Crops Crops Held for Sale and Feed Market Livestock Accrued Expenses 2) Tax depreciation is substantially different than economic depreciation 3) Operator and family labor is not included
Computing Accrual Net Farm Income 27
Using Schedule F and Balance Sheets to Compute Net Farm Income The next four slides use information from the Schedule F and balance sheets for White County Farms to compute: Gross Revenue Operating Expense Interest Expense EBITA Net Farm Income Purdue Farm Financial Performance Spreadsheet
Computation of Gross Revenue Item Source Operation Amount Cost of Livestock Sold Schedule F 0 Gross Income Schedule F + 2,009,135 Breeding Livestock Sales Form 4797 + 0 Change in Current Assets (exclude cash, supplies, and prepaid expenses) Balance Sheet (E-B) + 27,513 Gross Revenue = 2,036,648
Computation of Operating Expense Item Source Operation Amount Cost of Livestock Sold F 0 Total Expenses F + 1,844,182 Depreciation F - 167,966 Mortgage Interest F - 53,355 Other Interest Paid F - 33,807 Change in Accounts Payable Change in Prepaid Expenses BS (E-B) + 0 BS (E-B) - 778 Operating Expense = 1,588,276
Computation of Interest Expense Item Source Operation Amount Mortgage Interest F 53,355 Other Interest Paid F + 33,807 Change in Accrued Interest BS (E-B) + 1,973 Interest Expense = 89,135
Computation of EBITA and Net Farm Income Item Operation Amount Gross Revenue 2,036,648 Operating Expense - 1,588,276 EBITA = 448,372 EBITA 448,372 Interest Expense - 89,135 Depreciation (exclude section 179 expense) - 167,966 Net Farm Income = 191,271
Net Farm Income Uses Along with off-farm income, net farm income is used to pay income and self-employment taxes Net farm income is used to make principal payments on term debt Net farm income is used to replace machinery and buildings, and for expansion As a rule of thumb, a farm needs approximately 110 to 120% of depreciation to replace machinery and buildings
Miscellaneous Information Item Amount Principal on Term Debt 40,860 Cash Used for Capital Replacement 193,161 Off-Farm Income 0 Income and Self-Employment Taxes 0 Family Living Expenses 90,000
Repayment Capacity 35
Capital Debt Repayment Margin Net Farm Income plus Net Off-Farm Income plus Depreciation minus Owner Withdrawals minus Principal on Term Debt minus Unpaid Operating Debt from Prior Period equals Capital Debt Repayment Margin
Capital Debt Repayment Margin Why is this margin so important? It clearly illustrates that net farm income, net off-farm income, and depreciation have to be large enough to cover owner withdrawals and principal on term debt Positive margin is needed to replace machinery and grow the business
Item Capital Debt Repayment Capacity White County Farms Net Farm Income (1) 191,271 Off-Farm Income (2) 0 Income and Self-Employment Taxes (3) 0 Interest Expense on Term Debt (4) 55,329 Depreciation (5) 167,966 Family Living Expenses (6) 90,000 Capital Debt Repayment Capacity {(1+2-3+4+5)-6} 324,566
Capital Debt Repayment Margin and Replacement Margin Item White County Farms Capital Debt Repayment Capacity (7) 324,566 Principal on Term Debts and Capital Leases (8) 40,860 Unpaid Operating Debt from Prior Period (9) 0 Capital Debt Repayment Margin (7-(4+8+9)}; 10 228,377 Cash Used for Capital Replacement (11) 193,161 Replacement Margin {10-11} 35,216
Repayment Capacity for White County Farms What does the capital debt repayment margin and replacement margin tell us about the repayment capacity of White County Farms? Does White County Farms have the capacity to repay debt? Does White County Farms have the capacity to replace machinery and buildings? Does White County Farms have the capacity to expand?
EC-712-W Measuring and Analyzing Farm Financial Performance 41
EC-712-W Spreadsheet Enter Schedule F and balance sheet information Outputs: Financial Ratios Repayment Capacity Sensitivity Analysis Breakeven Gross Revenue
Financial Projections January 10, 2019 Michael Langemeier Department of Agricultural Economics Purdue University
Enterprise Analysis 44
Introduction An enterprise budget is an organization of revenue, expenses, and net return for a single enterprise. Uses: Identify bottlenecks to profitability Identify the more profitable enterprises to be included in a whole-farm plan
Opportunity Cost The income that could be received by employing a resource in its most profitable alternative. Examples: Unpaid operator labor Interest charge on owned assets
Opportunity Cost of Management Often omitted from enterprise budgets. Opportunity charges on operator labor and owned assets are typically included. If no opportunity cost for management is shown in the budget, the estimated profit or earnings should be interpreted as estimated net return to management.
Organization Gross Revenue (GR) Variable Costs (VC) Contribution Margin (CM) Overhead Costs (OC) Earnings
Gross Revenue (GR) Crop Revenue Government Payments Crop Insurance Indemnity Payments Miscellaneous Revenue
Variable Costs (VC) Fertilizer Seed Pesticides Dryer fuel Machinery fuel Machinery repairs Hauling Interest Insurance and miscellaneous
Contribution Margin (CM) Definition CM = GR - VC Interpretation For a farm to produce in the short-run, it needs to be able to cover all variable costs. A positive contribution margin, however, does not ensure that the farm is earning an economic profit.
Fixed or Overhead Costs (OC) Machinery Ownership Labor Land
Earnings Definition Earnings = GR VC OC Earnings = CM - OC Interpretation For a farm to produce in the long-run, it needs to cover all costs (i.e., earnings are greater than or equal to zero).
Long-Run Cash Rent Spreadsheet 2019 Crop Budgets Corn/Soybean Rotation High Productivity Soil Percent of Acres Included in Analysis = 25% Outputs: Projected Earnings Breakeven Rents Working Capital Analysis
Pro-Forma Financial Statements 55
Pro-Forma Financial Statements Historical financial statements are often the starting point for developing a financial plan. Pro-forma financial statements can be used in conjunction with capital budgeting to examine the feasibility of expansion or the purchase of a major asset.
Pro-Forma Financial Statements To achieve goals, changes to the operation and/or farm growth are often necessary. Review strengths, weaknesses, opportunities, and threats Consider alternatives: Change enterprises Add value Restructure debt Increase farm size
Pro-Forma Financial Statements Sensitivity Analysis Analyzing how changes in key assumptions affect income, cost, and profitability objectives. Construct several financial plans using different values for production levels, key prices, and interest rates.
Pro-Forma Financial Statements Most Likely Scenario Planning Model Examine impact of most likely scenario on financial statements. Use sensitivity analysis to vary the assumptions made in the financial plan. Revenue assumptions Cost assumptions
Pro-Forma Financial Statements Spreadsheet Inputs Inventories and Financing Crop Acres Crop Income Other Income Expenses Tax Estimate Non-Farm
Pro-Forma Financial Statements Spreadsheet (continued) Outputs Income Statement Sources and Uses of Funds Statement Repayment Capacity Working Capital
Pro-Forma Spreadsheet Base Case Crop Prices and Yields Rotation Corn: Fall Crop Sales = $3.77 Ending Inventory = $3.78 Crop Yield = 185.0 Rotation Soybeans: Fall Crop Sales = $9.25 Ending Inventory = $9.30 Crop Yield = 56.0
Pro-Forma Spreadsheet Crop Yield Scenarios 10% Lower 5% Lower Base Case 5% Higher 10% Higher
Crop Yield Scenarios Financial Metric 10% Lower 5% Lower Base Case 5% Higher 10% Higher Net Farm Income Profit Margin Ratio Working Cap. per Crop Acre (2018=$832) -$202,507 -$111,173 -$19,840 $71,493 $162,826-12.1% -6.2% -0.9% 3.9% 8.2% $776 $791 $806 $822 $837 Capital Debt Repayment Margin -$167,662 -$76,328 $15,005 $106,338 $197,671
Key Points Pro-forma financial statements are useful in forecasting profitability, net cash flow, repayment capacity, and changes in working capital. Pro-forma financial statements should be used to gauge whether net cash flow is strong enough to purchase additional assets.