$

Managing CapitalManaging Capital/Financial Risk/Financial Risk

Craig Binkowski

Southern Michigan Bank & Trust Coldwater

$

Production

Farm Business Risk Profile

FARMBusiness

Marketing

HumanResourcesLegal

Financial

We will focus only on Production, Marketing and Financial today

(Health & Labor)

$

Topics in Financial SectionTopics in Financial Section• Financial Balance Sheet (What’s at risk?)

• Cost of Production / Revenue Requirements:

– Total Economic costs

– Cover Direct Cost

– To Maintain Equity

– Meet Cash Flow Demands

• “Cost of Production” Worksheet

• Incorporating Financial Information into Risk Management / Control Decisions

$

Financial Risk ManagementFinancial Risk Management• Increase Equity through Farm Profit

– Net Worth increase without inflation in asset values

• Meet Cash Flow Demands

• Monitor cost & availability of Debt Capital– Interest Rate Risk– Sources of Capital

• Financial Information for measurement and monitoring is available and used

$

3 Basic Financial Statements3 Basic Financial Statements1. BALANCE SHEET: Assets, liabilities, and net worth

Annual Change in Net Worth2. INCOME STATEMENT:

Inventory Adjusted (Accrual)3. Projected CASH FLOW: After Scheduled Term Debt Principal &

Interest Payments, Family Living, Income Taxes

$

Example Farms for the Game:Example Farms for the Game:Designed to Simulate Today’sDesigned to Simulate Today’s

Market EnvironmentMarket Environment

• Green = Low Debt Farm (Sorry)Green = Low Debt Farm (Sorry)

• Yellow = Moderate Debt FarmYellow = Moderate Debt Farm

• Red = High Debt FarmRed = High Debt Farm

$

Balance SheetBalance Sheet

• Current balance sheet tells you:– Financial position of your business/Self

– Your capacity to withstand risk “Take a Hit” and remain solvent

• Three-five years of balance sheets tell you:– Trends in equity of your business

– Need Both Cost Basis (Book Value)

– And Market Value

– Dual Column Balance Sheet

$

Balance Sheet Debt LevelsBalance Sheet Debt Levels

Page 4 FINLRB output

Low Medium HighCurrent Farm Assets 431,000 431,000 431,000Intermed. Farm Assets + 616,000 616,000 616,000Long Term Farm Assets + 974,000 974,000 974,000Total Farm Assets =2,021,000 2,021,000 2,021,000

Current Farm Liabilities 50,782 317,516 376,586Intermed. Farm Liabilities + 82,014 253,300 412,502Long Term Farm Liabilites + 271,458 338,634 524,562Total Liablilities = 404,254 909,450 1,313,650

Equity 1,616,746 1,111,550 707,350Debt to Asset Ratio 20 45 65Equity to Asset Ratio 80 55 35

$

Income Statement:• History:

– Did your business make or lose money last year? • How much? • Was your neighbor’s experience similar?

– What has been the past performance of your business? Relative to your neighbors?

• Projections (pro-forma):– What will be different from the past? Why?– Do you “expect” the business to make a profit?– How much can revenue fall due to price and/or

yield shortfalls before there is a loss?

$

Income StatementIncome Statement

Page 2 of FINLRB output

Low Medium HighGross Farm Income + 563,284 563,284 563,284Non Interest Cash Exp. - 393,945 393,945 393,945Interest Expense - 30,576 68,714 109,271Net Cash Farm Income = 138,763 100,625 60,068Inventory/Accrual Adj. + 0 0 0Net Operating Profit = 138,763 100,625 60,068Depreciation - 60,000 60,000 60,000Net Farm Income = 78,763 40,625 68

$

Liquidity - Cash Flow Statement

• Ability of your business to meet its cash flow obligations

• Accounts for all sources and uses of cash including debt and capital activity

• Helps you assess how much room there is for “stuff going wrong” -- RISK!

• Helps you assess if adjustments need to be made in the financial structure of your business.

• Does NOT tell you if your business made a profit!

$

Liquidity- Cash Flow StatementLiquidity- Cash Flow Statement

Page 3 of FINLRB output

Low Medium HighNet Cash Farm Income + 138,763 100,625 60,068Nonfarm Income + 0 0 0Net Cash Available = 138,763 100,625 60,068Family Living - 30,000 30,000 30,000Income Taxes & Social Security - 25,626 11,369 10Cash Avail. for Princ. Payments = 83,137 59,256 30,058Farm Interest Paid + 30,576 68,714 109,271Cash Avail. for P& I Payments = 113,713 127,970 139,329Total Sched. Principal & Interest - 58,655 184,428 176,312Cash Avail. after Loan Payments = 55,058 (56,458) (36,983)Cash Required for Replacement - 40,978 0 13,521Cash Surplus or Deficit = 14,080 (56,458) (50,504)

$

Change In Net Worth:Change In Net Worth:• Did Your Net Worth Increase last year? Or

Decrease? Trend? Why?– From Retained Earnings out of Farm Profit?– From Asset InflationAsset Inflation? Machinery? Land?– From Contributed CapitalContributed Capital? (Outside sources)

• Do you expect your net worth to increase next year? Or, decrease?

• How much room do you have for “stuff to go wrong” RISK!

$

Change in Net WorthChange in Net Worth

Page 4 of FINLRB output

Hand calculate the % Change in Equity

Low Medium HighNet Farm Income 78,763 40,625 68Net non Farm Income + 0 0 0Family Living - 30,000 30,000 30,000Income Taxes - 25,626 11,369 10Change in Net Worth = 23,137 (744) (29,942)

Percent Change in Equity 1.4% -0.1% -4.2%

$

Understand the Numbers for Your Understand the Numbers for Your Farm Business!

• Critical in today’s environment• Understand what the numbers mean

and signal• Monitor Business EVERY year …

routinely• Use professional assistance if needed

$

Cost of ProductionCost of Production

Roger Betz

District Extension Farm Management Agent SW Michigan

$

Cost of Production WorksheetCost of Production Worksheet• Allocates Overhead cost to each acre and

combines with Direct Cost to determine “Cost of Productions” for various crops

• “Cost of Productions”?– Economic

– Direct Cost

– Maintain Net Worth

– Meet Cash Flow Demands

• Useful in Marketing and Crop Insurance Decisions

$

Cost of Production Worksheet - page 2

CORN SOYS1. Paid on Yield per Acre in Bushels 128.5 432. TIMES Selling Price per Bu x $2.10 $5.303. EQUALS Gross Income per Acre =$269.85 $227.90

DIRECT COST/AC 4. Seed $25.00 $26.40 5. Fertilizer $54.80 $13.00 6. Herbicides $20.35 $18.75 7. Insecticides $__________$__________ 8. Drying Fuel $14.00 $__________ 9. Crop Fuel & Oil $9.35 $7.5010. Crop Repairs $23.60 $20.2012. Crop Utilities $2.40 $1.5013. Crop Haul & Truck $15.42 $5.1614. Crop Marketing $__________ $1.7215. Crop Insurance $__________$__________16. Other $__________$__________17. TOTAL DIRECT COST/Ac $164.92 $94.23

$

Cost of Production - OverheadCost of Production - Overhead

Cost of Production Page 2- Medium Debt

19. Acres Cropped 2,00020. Interest 68,71421. Hired Labor 25,00022. Land Rents 82,50023. Machinery Leases 024. Real Estate Taxes 14,10025. Farm Insurance 12,00026. Farm Utilities 1,20027. Other Expenses 028. Depreciation 60,00029. Total Accounting Overhead Cost 263,514

$

Economic Cost of ProductionEconomic Cost of Production

Cost of Production Worksheet

Page 2 - Medium Debt Farm

29. Total Accounting Overhead Cost 263,514

30. Value of Unpaid Labor 45,66431. Value of Unpaid Equity Capital 66,69332. Total Economic Overhead Cost 375,871

33. Total Economic Overhead Cost/Ac $187.94CORN SOYS

34. Total Economic Costs/Ac $352.86 $282.17 (line 17 for each crop) PLUS (line33)35. Total Economic Cost / Bu $2.75 $6.56

$

Total Direct CostTotal Direct Cost

Cost of Production Worksheet Page 2 Medium Debt Farm

CORN SOYS36. Acres planted each crop 1,000 1,000

37. Total Direct Cost/Ac (line 17) $164.92 $94.23

38. Direct Cost per Bushel $1.28 $2.19 For each crop (line 37)DIVIDED BY (line 1)39. Total Direct Cost for Crop 164,920 94,230 For each crop (line 36) TIMES (line 37)

40. Total Direct Cost for all crops combined 259,150

$

Revenues to Maintain Net WorthRevenues to Maintain Net Worth

Cost of Production Worksheet Page 2 Medium Debt Farm

41. Total Economic Overhead Cost (line 32) 375,87142. Minus Gov. Program & Other Net Incomes - 65,53443. Minus Value of Unpaid Equity (line 31) - 66,69344. Plus Income Taxes + 11,36945. Minus Value Unpaid Family Labor (line 30) - 45,66446. Plus Actual Family Living & Other Draws + 30,00047. “Maintain Net Worth Overhead Cost” = 239,34948. “Maintain Net Worth Overhead Cost” per Acre $119.6749. Total Crop Revenues Needed to Maintain Net Worth 498,499

CORN SOYS50. Total Revenues Needed / Acre $284.59 $213.90 (line 37 for each crop) PLUS (line 48)51. Maintain Net Worth per Bu $2.21 $4.97

$

Revenues to Meet Cash FlowRevenues to Meet Cash Flow

Cost of Production Worksheet Page 2 Medium Debt Farm

52. “Maintain Net Worth Overhead Cost” (line 47) 239,34953. Minus Depreciation (line 28) - 60,00054. Minus Interest Expense (line 20) - 68,71455. Plus Scheduled Principal and Interest + 184,42856. Plus Cash required for Capital Replacement + 057. “Meet Cash Flow Demands Overhead Cost” = 295,063

58. “Meet Cash Flow Overhead Cost” per Acre $147.53

59. Total Crop Revenues Needed to Meet Cash Flow Demands 554,213

CORN SOYS60.Total Crop Revenue Needed per Acre $312.45 $241.76 (line 37 for each crop) PLUS (line 58) 61. Meet Cash Flow Demands per Bu $2.43 $5.62

$

Break Even Income & Prices Break Even Income & Prices “Cost of Production”“Cost of Production”

Medium Debt Farm CORN SOYS

34. Total Economic Cost per Acre $352.86 $282.1735. Per Bu $2.75 $6.56

37. Direct Cost per Acre $164.92 $94.2338. Per Bu $1.28 $2.19

50. Maintain Net Worth per Acre $284.59 $213.9051. Per Bu $2.21 $4.97

60. Meet Cash Flow Demands per Acre $312.45 $241.7661. Per Bu $2.43 $5.62

$

Break Even Incomes & PricesBreak Even Incomes & Prices“Cost of Production”“Cost of Production”

High Debt Farm CORN SOYS

34. Total Economic Cost per Acre $361.01 $290.3235. Per Bu $2.81 $6.75

37. Direct Cost per Acre $164.92 $94.2338. Per Bu $1.28 $2.19

50. Maintain Net Worth per Acre $299.19 $228.5051. Per Bu $2.33 $5.31

60. Meet Cash Flow Demands per Acre $309.47 $238.7861. Per Bu $2.41 $5.55

$

What Percent of Equity are What Percent of Equity are YouYou Willing to Risk?Willing to Risk?

Low Medium HighNet Worth 1,616,746 1,111,550 707,350

5% 80,837 55,578 35,36810% 161,675 111,155 70,73515% 242,512 166,733 106,10320% 323,349 222,310 141,47025% 404,187 277,888 176,838

$

Can I use Risk Management Tools Can I use Risk Management Tools to Minimize Equity Loss?to Minimize Equity Loss?

Lines 49 and 50 Cost of Prod. Worksheet

Crop Revenue Needed to Low Medium HighMaintain 100% of Equity 469,540 498,499 527,697Corn per Acre $270.12 $284.59 $299.19Soybeans per Acre $199.43 $213.90 $228.50

10% of Equity Loss 161,675 111,155 70,735% of Crop Rev. Can Lose 34.4% 22.3% 13.4%Corn/Ac (Protect 90%) $177.11 $221.14 $259.09Soys/Ac (Protect 90%) $130.76 $166.21 $197.87Corn / Bu (Protect 90%) $1.38 $1.72 $2.02Soys/Bu (Protect 90%) $3.04 $3.87 $4.60

$

Key Questions for Your Farm Business :Key Questions for Your Farm Business :1. Appropriate Financial Information Available? Historical, Current,

and Future

2. Adequate Understanding of Financial Conditions and Risk Positions?

3. Realistic Plans & Underlying Assumptions?

4. What level of Equity Protection can Risk tools provide?

5. Should you utilize Financial Risk Management Strategies?

$

STOP!STOP!• What is the key financial information for your

farm?• What are the revenues required to: • Meet Economic Cost• Cover Direct Cost • Maintain Net Worth • Meet Cash Flow Demands • Start to think through your crop insurance

and marketing plans