Farm Financials in Fifteen Minutes

Business Planning & Financial
Tools
Paul Dietmann, Emerging Markets Specialist
Badgerland Financial
New Farmer Summit
April 4, 2014
New Glarus, WI
[email protected]
(608) 370-6956
Badgerland Financial
Rural lending (& other financial services) cooperative
 Farm Credit System association
 300+ employees
 Serves 33 counties in Southern Wisconsin
 15,000 members
 Largest ag lender in Wisconsin
 Paying $9.55 million in cash dividends to
farmers/members for 2013 business
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Badgerland Financial territory
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Why should I care about all of this
financial stuff?
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To build your business plan
To project the farm’s financial performance early
in the year
To help with tax planning & preparation
To measure progress over time
To make wise investment decisions
To get financing
To alert you quickly when changes are needed
“The next best thing to finding out you’re right is to
find out you’re wrong as quickly as possible.”
-John Manley, Chief Equity Strategist for Wells Fargo Advantage Fund, quoted in the Business
section of the Wisconsin State Journal, Feb. 18, 2012.
Financials aren’t everything
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Farming is a lot more than just a business
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Quality of life goals are more important than
financial goals
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BUT, if you don’t know the financial picture,
quality of life can decline in a hurry
Key Concepts
Cash Flow…in the short run
 Profitability…also important
 Need both to be a sustainable business
 Three tools are particularly useful for
forward planning
 Three financial statements needed to
measure progress
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Profitability and Cash Flow
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Related but very different
Can be profitable with negative cash flow
 Can have strong cash flow and be
unprofitable
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Cash flow is critical in short run
 Profitability and cash flow are important
in the long run
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“The most basic possible definition of a good
business is this: It generates more cash than it
consumes. Good managers keep finding ways
of putting that cash to productive use. In the
long run, companies that meet this definition are
almost certain to grow in value…”
Source: Benjamin Graham, The Intelligent Investor, Revised
Edition, 2003, commentary by Jason Zweig on p.308.
The business plan you take to a
lender or investor should:
Tell your story
 Be concise (quality > quantity)
 Show that you’ve objectively
considered all risks
 Show that you understand how to
manage finances
 Paint a realistic picture of the future
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Source: www.agplan.umn.edu
Financial pieces of a business plan
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Month-by-month cash flow projection backed by
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Enterprise budgets
Detailed assumptions
Annual balance sheet on Jan. 1
 Income statement
 Annual statement of cash flows
Simple enterprise budget
Expected Gross Revenue (market weight x market price)
(can be per acre, per bed, per crop, etc.)
-Variable costs
-Overhead costs
= Net return
Breaking down costs
Variable
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Costs
Costs that increase as
farm production
increases
Can includes seed,
fertilizer, fuel, other
crop expenses,
utilities, hired labor
Overhead
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Costs
Costs that exist on
the farm whether or
not anything is being
produced
Includes depreciation,
interest, repairs,
property taxes,
insurance, value of
farmers’ labor
Organic corn enterprise budget
140 bushels x $10/bushel
Seed
Soil amendments
Tillage
Planting
Harvesting
Hauling/drying
Crop insurance
Interest on operating loan
Land charge
$1,400
$90
$300
$100
$20
$35
$20
$30
$14
$609
$210
-$609
-$210
$581
Budget assumes all field operations are custom-hired.
Land charge includes organic certification.
Breakeven price to
cover variable costs
$609/140 bu = $4.35
Breakeven price to
cover all costs
$819/140 bu = $5.85
Enterprise budgeting
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Variable costs are relatively easy
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Overhead costs are a bit tougher. We need to
annualize costs of capital investments
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Machinery & farm vehicles
Farm buildings
Irrigation system
Fencing, trellising or other infrastructure
Other capital investments?
Overhead costs
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How long until you have to renovate or replace?
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Machinery (7-10 years)
Farm vehicles (5-7 years)
Farm buildings (15-20 years)
Irrigation system (10-15 years)
Fencing, trellising or other infrastructure (15-20 years)
Other capital investments?
Example for a small vegetable farm
Overhead costs per acre, per year
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Machinery $30,000 ÷ 10 yrs ÷ 3 acres = $1,000
Irrigation system $12,000 ÷ 15 yrs ÷ 3 acres = $267
High tunnel, packing shed $10,000 ÷ 12 yrs ÷ 3 acres = $278
Greenhouse film $600 ÷ 4 yrs ÷ 3 acres = $50
Trellising $1,000 ÷ 10 yrs ÷ 3 acres = $33
Delivery vehicle $10,000 ÷ 7 yrs ÷ 3 acres = $476
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Total overhead: $2,104/acre/year
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Vegetable enterprise budget
Gross income per acre
$15,000
Seed/plants
Fertilizer/compost
Other supplies (plastic mulch, etc)
Hired labor
Utilities
Marketing expenses
Fuel & oil
$1,500
$500
$1,000
$2,000
$100
$100
$50
$5,250
Land charge
Repairs, insurance
Other overhead costs
$200
$300
$2,104
$2,604
TOTAL COSTS
NET RETURN/ACRE
$7,854
$7,146
How much can you make?
It’s tempting to just do this….
Gross income per acre
$15,000
Seed/plants
Fertilizer/compost
Other supplies (plastic mulch, etc)
Hired labor
Utilities
Marketing expenses
Fuel & oil
$1,500
$500
$1,000
$2,000
$100
$100
$50
$5,250
Land charge
Repairs, insurance
Other overhead costs
$200
$300
$2,104
$2,604
TOTAL COSTS
NET RETURN/ACRE
$7,854
$7,146
$7,146/acre x 3 acres = $21,438
But this is
how it looks
at tax time…
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And neither is a true picture
Some limitations with our example
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Don’t know what the farmer has invested in the
farm
Don’t know if all income and all expenses are
included
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Any farm production bartered, consumed, stored for future
sale?
Any bills not paid?
Don’t know the “opportunity cost” of the farmer’s
labor
Don’t have a clear picture of the farm’s cash
flow
Cash flow projection
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Month-by-month projection for each income
and expense category
 Should include off-farm income
 Includes scheduled debt payments and family
living costs
 Helps predict when cash shortages will hit so a
plan can be developed
Info needed for monthly cash flow
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Enterprise budgets
Beginning cash on-hand
Non-farm income
Family living costs
Any planned capital investments or sales
Any planned new borrowing
Payments on existing debt
Family living costs
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Basic needs – food, clothes, household expenses
Health & life insurance, plus health care costs not
covered by insurance
Child care costs
Non-farm vehicle
Savings
Investment for retirement
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What if we start with $20,000 instead of $5,000?
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What if we boost gross farm income by $5,000?
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What if we added $18,000 of nonfarm income?
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What if we start with $20,000, boost farm income by $5,000 & nonfarm $18,000?
Record-keeping
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Keep it simple
Set up categories that
make sense to you
Align your categories
with Schedule F
Adopt a system that
you can easily maintain
Understanding & using the three
financial statements
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Balance sheet—What the farm is worth, how
it’s financed
 Income statement—How effectively the farm
generates profits
 Annual statement of cash flows—A summary
of sources and uses of cash during the year
The Balance Sheet
A snapshot of the investment in the farm business
(assets) and the financing methods used (a
combination of liabilities and owner’s equity).
Balance sheet measures your financial position.
The other two statements measure your financial
performance.
The Balance Sheet
Assets – Everything that is owned by or
payable to the business on the date the
balance sheet is prepared
 Liabilities – All obligations owed by the
business on the balance sheet date
 Owner’s Equity or Net Worth – Total assets
minus total liabilities
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Why do we need a balance sheet?
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To measure how much the farm is worth
 To see how much of the farm’s value belongs
to the farmer
 To monitor whether the value is going up or
down over time
 To use it in combo with other financial
statements to calculate a variety of ratios that
gauge financial health
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Information from balance sheet
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Liquidity – Ability of the business to meet its
current (short term) liabilities with current assets
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Solvency - Ability of the business to pay off all
of its debts if it were to be sold tomorrow
8 more
buckets of
liquid assets!
Liquidity
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Current assets: Cash and anything that will
either be converted to cash or used up within a
year
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Crop and feed inventories, market livestock
inventories
Growing crops
Accounts receivable
Prepaid expenses and supplies
Liquidity
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Current liabilities: Anything that is due now or
will come due within a year
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Accounts payable
Principal due within a year on term loans
Accrued interest on term loans
All principal and accrued interest on operating
loans
Liquidity ratios
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Current ratio – Current assets divided by
current liabilities
GOAL: The current ratio needs to be at least 1.0,
preferably 2.0 or more
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Working capital – All current assets minus
all current liabilities
GOAL: Working capital at least 15% of annual gross
farm income
Working capital: key measure of risk
Current Assets – Current Liabilities = Working Capital
Net working capital should be at least 15% of the
annual gross revenue of the farm
Strong working capital position allows the farm to:
a) withstand an unexpected setback
b) take advantage of an unexpected opportunity
WORKING CAPITAL EXAMPLE
Our net working capital in this example is -$1,534
If annual gross revenue of the farm is $45,000, our net working capital
should be $6,750 (15% of annual gross revenue). We are $8,284 short
We would want to see the deficit made up over four years from cash flow
$8,284 ÷ 4 years = $2,071/year that needs to come from cash flow
Common liquidity problems
Working capital consists mainly of feed
inventories and receivables, not much cash
Spending too much cash on capital purchases
instead of building working capital reserves
Operating losses carried forward year-to-year
Poorly structured debt
Large, unplanned expenses
Solvency ratios
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Equity-to-Asset ratio – Owner’s equity divided
by total assets.
GOAL: Should be greater than 50%
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Debt-to-Equity ratio – All farm liabilities divided
by owner’s equity.
GOAL: Should be 43% or less over the long run. It can
be higher in the short-run.
Common solvency problems
Taking on longer term debt to cover for negative
cash flow
Erosion in market values of assets
Assets depreciating faster than the loan balances
are being paid off
The Income Statement
One year’s income and expenses, and how much
revenue was retained by the business.
It’s not a cash flow statement…it includes noncash items.
Also known as a “Profit and Loss” statement
Why do we need an income statement?
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Gives us a way to account for everything of
value generated by the farm during the year,
not just the cash it brought in.
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Gives us a way to account for all expenses
incurred, not just those that were paid in cash.
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Tells us if the farm is generating an adequate
return for the farmer’s devotion of time and
money…Is the farm profitable?
What is “farm profitability?”
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The ability of the farm to generate an
adequate financial return on the farmer’s
investment of time and money in the
farm
How do we measure profitability?
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Rate of return on farm assets – The “interest rate”
being earned on all of the investments in the farm.
GOAL: Higher than interest on borrowed money
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Rate of return on farm equity – The “interest rate”
being earned on YOUR investment in the farm. GOAL:
Higher than ROROA
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Operating profit margin – Net farm income divided by
gross farm income. GOAL: 20% +
The Income Statement
Income – Includes cash sales of farm products,
government payments, custom work income. Also
includes changes in the inventory of feed, crops,
and livestock, and changes in prepaid expenses
and accounts receivable.
Expenses – Includes all cash operating expenses
including interest (but not principal) payments. It
also includes depreciation.
Income Statement
Income
Vegetable sales $45,000
GROSS FARM INCOME $45,000
Expenses
Schedule F cash operating expenses $19,650
Interest on farm loans $10,000
TOTAL CASH FARM EXPENSE $29,650
Net CASH Farm Income $15,350
Change in prepaid expenses +/Change in accounts receivable +/Change in crop inventory +/Total accrual adjustments
$ ----
-Economic depreciation $5,500
Economic depreciation
Machinery $30,000 x 15% = $4,500
Buildings $20,000 x 5% = $1,000
NET FARM INCOME $9,850
Rate of Return on Assets
Net Farm Income
+ Farm interest
- Value of farmer’s labor
Return on farm assets
$9,850
$10,000
$18,000
$1,850
$1,850/$185,000 (total farm assets) = 1%
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ROROA should be higher than the interest rate on farm loans
Rate of Return on Equity
Net Farm Income
- Value of farmer’s labor
Return on farm equity
$9,850
$18,000
-$8,150
-$8,150/$15,000 (farm net worth) = -54%
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Rate of Return on Equity should be higher than ROROA
Operating profit margin
Return on farm assets
Value of farm production
$1,850/$45,000 = 4.1%
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Operating Profit Margin should be better than 20%
Income
Vegetable sales $45,000
GROSS FARM INCOME $45,000
Expenses
Schedule F cash operating expenses $19,650
Interest on farm loans $10,000
TOTAL CASH FARM EXPENSE $29,650
Net CASH Farm Income $15,350
Change in prepaid expenses +/Change in accounts receivable +$5,000
Change in crop inventory +/+Total accrual adjustments $5,000
-Economic depreciation $5,500
NET FARM INCOME $14,850
Economic depreciation
Machinery $30,000 x 15% = $4,500
Buildings $20,000 x 5% = $1,000
Rate of Return on Assets now
Net Farm Income
+ Farm interest
- Value of farmer’s labor
Return on farm assets
$14,850
$10,000
$18,000
$6,850
$6,850/$185,000 (total farm assets) = 3.7%
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ROROA should be higher than the interest rate on farm loans
Common Profitability Problems
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Capital investment too high relative to income
 Depreciation too high
 Putting too little—or no—value on farmer’s
labor
 Operating expenses too high, particularly feed,
labor, & interest
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High market values for assets (Makes it difficult
to achieve adequate rates of return on assets &
equity)
Annual statement of cash flows
All cash flowing into the operation (including loan
proceeds) and all cash flowing out (including family
living expenses, taxes, principal and interest
payments) on an annual basis.
Where is the farm’s cash coming from?
Is there enough cash to cover operating
expenses, family living costs, income
taxes, and loan payments, and still have
money left to replace stuff that’s rusting,
rotting, or wearing out?
Overly Simple Statement of Cash Flows
Beginning cash balance
$5,000
Net cash farm income
$15,350
Nonfarm income
$--0--
Net cash available
$20,350
Family living draw
($18,000)
Income taxes & SS
$--0--
Cash avail for principal pymts
+ Farm interest paid
Cash available for P & I
Scheduled P & I payments
Cash surplus or deficit
$2,350
$10,000
$12,350
($16,534)
($4,184)
From the
Income
Statement
We need a bit more detail
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Beginning cash balance
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Cash flow from operations
 Cash flow from investing activities
 Cash flow from financing activities
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Net change in cash
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Ending cash balance
Annual statement of cash flows
Beginning cash balance
$5,000
Cash flow from operations
Vegetable sales
Farm operating expenses
Net cash from operations
$45,000
($19,650)
$25,350
Cash flow from investing
Capital purchases
Capital sales
Net cash from investing
($ 0)
$ 0
$ 0
Cash flow from financing
Proceeds from new loans
Loan payments
Off-farm wages
Family living draw
Net cash from financing
$ 0
($16,534)
$ 0
($18,000)
($34,534)
Net change in cash
Surplus or deficit
($9,184)
($4,184)
Key cash flow ratio
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Capital Debt Repayment Capacity (CDRC) –
Cash available for debt repayment divided by
total demands on available cash*. GOAL: Higher
than 115%
*net cash farm income minus family living expenses and income taxes, plus interest on capital debt
scheduled P & I payments plus cash needed for both Capital Asset Replacement and working capital
Capital Debt Repayment Capacity
CDRC should be
higher than 115%
Machinery $30,000 x 15% =
Bldgs $20,000 x 5% =
4,500
1,000
$5,500
Breakdown for Line 13: Principal and Interest $16,534
$150,000 mortgage, 6% interest, 20-yr amortization
$20,000 machinery note, 5% interest, 7-yr am.
$13,078
$3,456
Harriet’s CDRC with extra $5,000 farm income &
$18,000 non-farm income
Machinery $30,000 x 15% =
Bldgs $20,000 x 5% =
4,500
1,000
$5,500
CDRC should be higher than 115%
Common cash flow problems
Volatile prices for farm production and inputs
Combined with
Relatively high debt load
Too little working capital reserves
Sometimes a debt structure problem; more likely it’s the
debt level rather than structure.
Rarely a problem of family living expenses being too
high.
Profitability and Cash Flow
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Related but very different
Can be profitable with negative cash flow
 Can have strong cash flow and be
unprofitable
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Cash flow is critical in short run
 Profitability and cash flow critical in long
run
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What about other sources of funds?
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USDA Farm Service Agency
County revolving loan funds
WEDC
Social investors (such as Slow Money WI)
Crowdfunding via Kickstarter & others
Crowdfunding under WI Act 52
Effective capital structure
Debt
is a contractual obligation
to pay back funds lent to the
company under a specific set of
terms with specified recourse
should the obligation not be met.
Typical Capital Structure Over Time - %
120
100
80
60
Equity
is a claim to residual
profits after all of the rest of the
company’s obligations are met.
Equity
Debt
40
20
0
1
2
3
4
5
An effective capital structure for a food business:
- Uses equity (or its equivalents) to provide sufficient cash for the business to
grow during its early years, and to provide sufficient balance sheet strength to
qualify the business for borrowing.
- Uses debt, often with guarantees, to fund collateralizable asset purchases
and to fund inventory and receivables.
SOURCE: Tera Johnson, Founder of Tera’s Whey
A few final suggestions
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Quality of life should be #1 business goal
Need to have positive cash flow to keep doing
what you love to do
Doesn’t make sense to borrow money at 6% to
achieve a 3% ROROA or ROROE
Always do a January 1 balance sheet whether
you intend to borrow money or not
Don’t draw any big conclusions from one
year’s financials
Thank You!
Paul Dietmann
Badgerland Financial
(608) 370-6956
[email protected]