Management Metrics for Business Health Brenda Duckworth, CPA EXECUTIVE Women in Ag You are committed to increasing your knowledge You are open minded You can see the benefit of networking with other top producers 1
ARE YOU USING DATA or INFORMATION? Overwhelmed 2
Would you go on a hike without a compass or map? Data, if not molded into information, remains as DATA. The decision to be made determines whether you have data or information 3
1. What is the decision to be made? 2. Which data will be useful in this decision? 3. How will you mold that data into information? My commitment to you I wanted to help, but my job description had not yet been defined My aspirations were never to grow up to be a CPA Did it with the sole intention of helping AG producers Been called an accidental accountant 4
Measurement of Operations Accounting = measurement of what you have done Financial performance Financial position Numerous ways to measure each Did you know You can show a profit and be bankrupt You can show a net loss and still be very healthy Your net income is not your bank balance (usually) Asset purchases & sales Loan payments & advances Cash Flow Statement is the reconciliation between Income Statement & Balance Sheet 5
Diagnosing Health Problems SYMPTOMS Medical Pain Coughing Bleeding Financial Mounting debt Bad credit score Inability to secure loan Diagnosing Health Problems OTHER TOOLS Medical Bloodwork X rays MRIs, CAT scans, etc. Financial Financial statements Cost of production Ratios 6
Treat the PROBLEM not just the SYMPTOMS Proper diagnosis is key! Better yet, use preventative measures to avoid financial sickness or emergencies! 7
You are HERE Financial PERFORMANCE How your business performed within a given time range Most common measurement Income statement (Profit & Loss Statement) P&L by Profit Center Cash Flow Statement Repayment Capacity and Financial Efficiency Income taxes are calculated based on your performance Very important measurement, but by far not the whole story 8
Financial POSITION Cumulative measurement of past performances At a given point in time (as of a certain date) Balance sheet (equity) Ratios Solvency Liquidity Repayment capacity Projections Cannot accurately project, if you do not have a solid (accurate) foundation Crop budgets Projected income Projected expenses Cash flow budget Projected net income is not (necessarily) projected CASH 9
Performance: Income Statement Measure of management decisions over a range of time Result of operations Matching principal Performance: Cost of Production Solid historical costs Cost per acre (for comparability) Cost per unit of production All overhead costs should be absorbed (eventually) by the profit centers Some costs carried as Investment in growing crops Some costs carried as Grain/cattle inventory 10
Decision to be made: Which enterprises (crops) are making a profit, and which are not. Useful Information: Income statement by enterprise 11
Would you rather have this? OR THIS?? Cost of production analysis is the foundation for all management reports True results of operations (net income) Accurate current assets Cost based inventory Cost based investment in growing crops Accurate, comparable ratios 12
Cost of production analysis leads to better informed management decisions Crop budgets cash flow projections Where to place hedge Performance: Cash Flow Statement Cash flow statement reconciles the income statement to the balance sheet Not all cash outflows are expenses Loan payments 13
Diagnosis Symptom: inadequate cash flow, causing high interest expense Evidence of cash flow problem: Cash Flow Statement showed deficits Used operating note to pay long term loan payments Interest expense ratio was higher than standard Why is there a cash flow problem? Poor performance (net income)? Sales problem Low prices Low yield Timing (waiting on better prices) Expense problem Inefficient use of direct inputs Inefficient use of overhead inputs Purchased assets with cash? Too many loan payments? 14
Bleeding Benjamins Cash flow problems are to financials as bleeding is to physical problems they both create the most immediate emergencies! Underlying Causes Short term, like low yields due to weather; should correct quickly Diagnosed with Performance Measures Cumulative; demands management changes to correct Diagnosed with Position Measures 15
Tend to focus on Performance in most of our management efforts. Lenders will evaluate Position, but less on performance. Advice for users of financial measures Best when used to identify trends within an operation They help in asking the right questions, but they don t provide answers Be selective in choosing financial measures to evaluate If derived from incomplete or poorly prepared financial statements, can be misleading 16
5 Financial Criteria As recommended by: Farm Financial Standards Council (FFSC) 1. Liquidity 2. Solvency 3. Profitability 4. Repayment capacity 5. Financial efficiency Disclaimer of Industry Standard May not have been derived from comparable data Accounting not standardized Should not be relied upon Should be used only as a gauge 17
Analysis Know how the ratios are calculated Only then, can you make informed management decisions that will drive those ratios Consult the Farm Financial Standards Council (FFSC) Financial Guidelines 5 Financial Criteria As recommended by: Farm Financial Standards Council (FFSC) 1. Liquidity 2. Solvency 3. Profitability 4. Repayment capacity 5. Financial efficiency 18
Liquidity Liquidity measures the ability of a farm business to meet financial obligations as they come due in the ordinary course of business, without disrupting the normal operations of the business. Closer Look: Working Capital Will be a very important financial measure as income drops Calculation: current assets current liabilities Translation: will there be enough cash from receivables and cash on hand (less payables) to pay operating expenses? 19
Closer Look: Working Capital Expressed in dollars, so it is a relative number If there is a deficit, operating note might be advanced If there is excess (after paying operating expenses), you could pay down long term debt, buy assets with cash, build a cash buffer, or take a draw. Example 20
Diagnosis Symptom: Negative Working Capital What caused this? Did current assets dramatically decrease? Inventory decreased Cash decreased Accounts receivable decreased Did current liabilities dramatically increase? Couldn t pay supply vendors Operating debt jumped up Position: Balance Sheet As of a point in time Cumulative measurement of past decisions 21
5 Financial Criteria As recommended by: Farm Financial Standards Council (FFSC) 1. Liquidity 2. Solvency 3. Profitability 4. Repayment capacity 5. Financial efficiency Solvency Solvency measures provide (a) an indication of the firm s ability to repay all financial obligations if all assets were sold (for the prices indicated), and (b) an indication of the ability to continue operations as a viable business after a financial adversity (such as drought), which typically results in increased debt or reduced equity. 22
Solvency Closer Look: Debt to Asset Ratio These 3 ratios are all evaluations of equity Assets liabilities = equity Owned owed = net ownership Lenders are very interested in solvency Calculation: Total assets / Total liabilities Translation: Percentage ownership of the business Are you upside down? How risky (healthy) is your business? 23
Example Diagnosis Symptom: Debt to Asset Ratio is in the Weak zone, and trending in a bad direction What is causing this? Debt is growing faster than assets Performance (net income) issue? Are the fixed assets depreciating and not being replaced? Is cash being drawn from the business, rather than paying down debt? 24
5 Financial Criteria As recommended by: Farm Financial Standards Council (FFSC) 1. Liquidity 2. Solvency 3. Profitability 4. Repayment capacity 5. Financial efficiency Profitability Profitability measures the extent to which a business generates a profit from the use of land, labor, management, and capital. 25
Closer Look: Return on Assets Calculation: Net income + interest owner withdrawals, net / average total assets Translation: Effective interest rate on your (and your lenders ) investment Example 26
Diagnosis Symptom: Return on Assets Ratio is negative in 1 st & 3 rd year. What is causing this? Poor performance Inefficient assets 5 Financial Criteria As recommended by: Farm Financial Standards Council (FFSC) 1. Liquidity 2. Solvency 3. Profitability 4. Repayment capacity 5. Financial efficiency 27
Repayment Capacity Repayment capacity measures the ability of a borrower to repay term farm debt from farm and non farm income. Closer Look: Term Debt & Capital Lease Coverage Ratio Calculation: Capital debt repayment* / total principal & interest on term debt Translation: tells whether your business produced enough income to cover all intermediate and longterm debt payments. A ratio of 0.25 means there is only 25% more than what is needed to cover the intermediate and long term debt payments Capital Debt Repayment Capacity = net income + depreciation owner draws + interest on term debt 28
Example 5 Financial Criteria As recommended by: Farm Financial Standards Council (FFSC) 1. Liquidity 2. Solvency 3. Profitability 4. Repayment capacity 5. Financial efficiency 29
Financial Efficiency Financial efficiency measures the intensity with which a business uses its assets to generate gross revenues and the effectiveness of production, purchasing, pricing, financing, and marketing decisions. Financial Efficiency 30
Closer Look: Financial Efficiency Operating Exp Ratio + Depreciation Exp Ratio + Interest Exp Ratio + Net Income % = 1 For every dollar earned, % pay for operating (inputs), % pays for interest, % pays depreciation, & % is net income. Equipment turnover = gross rev / avg total equip; higher = more efficient Example 31
Words of Caution Comparability among operations Benchmarking is difficult Reason Farm Financial Standards Council (FFSC) was created Type of accounting records Asset valuation differences Accrual vs. cash basis of accounting Investment in growing crops Inventory at cost vs. fair market value Size of operation Enterprises (crops) Geographic location Non quantifiable Changes Strategic changes may take several accounting cycles Advice for users of financial measures Best when used to identify trends within an operation They help in asking the right questions, but they don t provide answers Be selective in choosing financial measures to evaluate If derived from incomplete or poorly prepared financial statements, can be misleading 32
AgKnowledge = Kennedy & Coe, LLC AgKnowledge is a division of Kennedy & Coe Was developed from the same intentions as mine: the desire to help Started in Mississippi Contact Information Brenda Duckworth, CPA Kennedy & Coe, LLC / AgKnowledge Brenda.Duckworth@kcoe.com 970 685 3500 33