Download Calculate Your Own Working Capital/Ratio

Session 4 – Keeping Your
Financial Score
Course Flow
• [MH to insert course flow chart here]
Program-at-a-glance
Advanced Farm Management Program Schedule 2014/15 - An Overview
DAY 1
DAY 2
DAY 3
DAY 4
9:00am to 9:30am
9:30am to 10:00am
Course Introduction
Review & MAP Update
10:30am to 11:00am
11:00am to 11:30am
Review & MAP update
Risk Management
Business Planning and Review & MAP Update
MAP Introduction
10:00am to 10:30am
Case Study SWOT
Personal Leadership
(Kolbe A)
DAY 5
Financial Analysis III
(Scorecard)
Financial Analysis I
(Business Structure,
Financial Statements,
Taxation)
Financial Analysis II
(Ratios & Operating
Efficiency)
Branding & Marketing
Your Farm
11:30am to 12:00pm
12:00pm to 12:30pm
Lunch Break
12:30pm to 1:00pm
1:00pm to 1:30pm
Risk Management
Mobile Technology
MAP Continued
1:30pm to 2:00pm
2:00pm to 2:30pm
2:30pm to 3:00pm
Commodity Marketing
Farm Business Vision &
Strategic Direction
Case Study & Wrap-up
3:00pm to 3:30pm
3:30pm to 4:00pm
Core Values & Beliefs
Human Resources
Kolbe A Preparation
Building Your
Management Team
Management Action Plan
Completion
Remember the Rules of
Engagement
•
•
•
•
Class participation
Work assignments
Build your Management Action Plan (MAP)
Instructor feedback/coaching
Session 4 Agenda
• 9:00am
• 9:30am
Review and MAP Update
Financial Analysis II (Ratios and
Operating Efficiency)
• 12:00pm Lunch
• 1:00pm Commodity Marketing with
John DePutter
• 3:45pm Evaluations and Adjourn
Session 3 Review
Business Structure and Taxation
• Proprietorship
• Partnership
• Corporation
Session 3 Review
•
•
•
•
•
Manage assets not taxes - 15½%
Cash vs. accrual
Matching principle
Proprietorship, Partnership, Corporation
We talk about tax because we do not
know what to ask
Session 3 Review
Where Are We Now?
Completion of your MAP
• Vision
• SWOT
Strategy
• Risk
• Communications – Kolbe
Review of Session 3
Financial statements:
• Cash versus accrual method
• Matching principle
• Variable, fixed and mixed expenses
• Balance Sheet
• Statement of Income
• Statement of Cash Flow
Review of Session 3
ASSET
TURNOVER
(ROI)
EBITDA
(Efficiency)
CASH
CASH IS KING
“I’ve always wanted to be somebody, but I see
now I should have been more specific.” - Lily
Tomlin
Review of Session 3
If the Human Resources session was successful, you should…
 Understand the components of a solid Human
Resources program
 Know your primary responsibilities as an employer
 Assess your most pressing HR issues
 Evaluate your own practices against some HR best
practices
Review of Session 3
Core elements of a solid HR
platform
Stage I - Foundational
•
•
•
•
•
•
Legislative compliance
Employment contract
Health and Safety
Defined job duties
Competitive compensation
Basic HR policies
Review of Session 3
Core elements of a solid HR
platform
Stage II - Supporting Growth
•
•
•
•
•
•
•
Organizational structure
Clear roles and responsibilities
Compensation strategy
Training and development
Group Benefits
HR Policies – handbook
Performance Management
Conflict Resolution Modes*
A
S
S
E
R
T
I
V
E
N
E
S
S
Collaborating
Competing
Compromising
Avoiding
Accommodating
COOPERATIVENESS
*Sources: Thomas-Killman Conflict Mode Instrument and the Canadian Management Centre
Specific Learning Objectives
When you leave today, you will be able
to:
• Understand importance of ratio analysis using
liquidity, profitability and solvency ratios
• Understand EBITDA
Industry Overview – Producer
Perspective
• The following issues impact success:
– Knowledge vs. Task Orientation (head or labour
tasks)
– Response to required skills
– Response to the new Business Rules
– Understanding ag trends
– Adoption of business tools
– Knowledgeable financial and economic
performance
Knowledge, the Premier Input
“The emerging reality of the 21st Century will be
that those businesses which are organized
around knowledge, rather than tasks, will have
the opportunity to create wealth.”
Peter Drucker
• Knowledge has become “the premier
input in every production system.”
What’s Happening In Ag Today
• Consolidation in many sectors
• Rapid integration of technology
• Increased volatility
– Market prices
– Input prices
• Competition on a global scale
• Lending environment due to the economy
Lending Changes in Agriculture
Who thinks lending criteria has changed?
Commitment to Education
CANEI
“It’s not about getting 1000% better in one
thing, it’s about getting 1% better in 1000
things.”
Potential Education Benefits
Are all problems, people problems?
• People Problems
– Missing skills
– Missing knowledge
– Missing understanding
Six Steps to Success
Jack Welch, former CEO, General Electric
• Face reality as it is: not as it was, not as you
wish it were.
• Be candid with everyone
• Do things right; do right things
• Change before you have to
• If you don’t have a competitive advantage -don’t compete
• Control your own destiny or someone else
will
“You can have a better future if you
stop trying to have a better past”.
Dan Sullivan
The Strategic Coach Inc.
Excellent Analytical Skills and
Capabilities are Essential How do
you get these?
Options:
• Employ a professional
• Learn (become) a professional yourself
• Combination of both
Chart of Accounts
Manual of Accounts
Competitive Advantages
1.
2.
3.
4.
Managerial Competence
Revenue Management
Asset Management
Cost Control
Components of any business
Operations: How well do you generate operating
profit?
Capital: How well do you utilize this profit?
Taking Control
• How do we evaluate the financial performance of
your business?
• Solution:
– Answer the question - How well you generated
operating profit (Operations Management)
– Answer the question - How you used the operating
profit (Capital Management)
Big Picture Improvement
• When developing big picture, first decide how
you want each area to perform in that year of
focus. The performance areas are:
–
–
–
–
–
Operations
Interest
Personal living
Loan repayment
Asset growth/risk
How Do You Fund Business Growth?
Debt
Equity
Profit
Which do you prefer?
Debt
Limitations
1.
2.
3.
4.
Requires interest/principal payments
Others control your access to debt
Lenders and their policies change
Interest rates fluctuate
Benefits of its use
• Can acquire profitable assets without sharing
ownership and cost is usually lower
Equity
Limitations
1. Three components of Equity
–
Contributed capital, profit, market value change
2. Investors
–
Funding, selling and management
3. Market value changes
–
Are out of our control, up, down
Benefits of its use
• Subordinated to debt
• Less or no present or future cash cost required
• Can add contributed capital
Profit
Limitations
1. Growth limited to amount of profit
2. Profits fluctuate
3. Profit by itself rarely is adequate to fund all
expansion needs
Benefits of its use
• No required present or future cash for interest or
principle
• Less risk
Only Two Problems
•
•
•
Assets do not generate adequate revenue to provide
Operations with enough capacity to convert to Profit.
Operations are not efficient enough in converting
Revenue to Profit to service capital requirements.
DEBT IS NEVER A CORE PROBLEM.
Assessing viability
•
•
Viability is a measurement of a business’ ability to
realize long-term success
Three important areas to monitor:
Focus on
In workshop
Liquidity
Balance sheet
Statements and ratios
Solvency
Balance sheet
Statements and ratios
Profitability
Income statement
Efficiency
Assessing viability
•
Ratio analysis involves the calculation of specific amounts
that are proven indicators of optimum financial
performance
•
Ratios are calculated from key figures within the financial
statements
Ratio analysis
Why bother?
•
The trends that these ratios highlight are valuable tools for longerterm analysis
•
Trends, comparison and benchmarking
•
Lenders use ratios to monitor your financial health
•
Assist with decision making on business major business transactions
•
Financial toolkit
Financial Performance Analysis of
Capital
• Capital financial performance analysis measures how
operating profit was used.
Interest
Rent/Leases
Growth / Risk
Owner
withdrawals
Debt-Principal
Repayment
Operating Efficiency Formula
Measures how well operations produce capacity (cash).
How much does it cost to produce $1.00 of revenue?
Operating Costs Divided by Total Adjusted Revenues * 100
Equals Operating Efficiency Percentage
*The lower the percent, the better the efficiency.
Application of the Operating Profit Use Rule
Category
Production Expense Percentage
30%
40%
50%
Adjusted revenue
300,000
300,000
300,000
Production expenses
90,000
120,000
150,000
EBITDA / Operating Profit
210,000
180,000
150,000
Interest Cost / Lease / Rent
52,500
45,000
37,500
Living
52,500
45,000
37,500
Principal
52,500
45,000
37,500
Growth/Risk
52,500
45,000
37,500
Operating Efficiency
Exercise 4.1 – use appendix E
•
Adjusted revenue:
Revenue
Add: Closing inventory
Less: Opening inventory
Adjusted revenue
Operating expenses:
Cost of production
Less: Opening inventory
Short-term interest
Rent
Leases
Other – to normalize
Plus: Administrative expenses
Less: Amortization
Long-term interest
Management wages
Other – to normalize
Other – to normalize
Adjusted expenses
$
(A)
(
$
$
(
(
(
(
(
(B)
Operating expense ration (B)(A) x 100
(
(
(
(
(
$
)
)
)
)
)
)
)
)
)
)
)
%
Operating Efficiency
* Using your own operation’s financial statements, calculate your own
operating efficiency – Exercise 4.1(a)
Your Farm Operating Efficiency
Exercise 4.1(a)
Revenue
Adjustments:
Other
Other
Other
Other
Adjusted revenue
$
$
(A)
Expenses (*):
$
Total expenses
Operating efficiency
•
$
(B)
((B/A)x100)
Expenses exclude interest, leases, amortization, family wages, rent, income
taxes, property taxes.
Liquidity
The ability of a business to meet its financial obligations as they come
due in the ordinary course of business
Key Figures:
1.
Working Capital
2.
Current Ratio
3.
Debt Structure Ratio
Calculating working capital
•
Net current assets available to finance operations
into the next operating cycle
current assets – current liabilities = working capital
•
Health check!
– Aim for minimum 3 months expenses
Calculating current ratio
•
The measure of working capital expressed as a ratio
of current assets to current liabilities
current assets / current liabilities = current ratio
•
Health check!
– A ratio greater than 1 is preferable but aim for greater than 2
– A high ratio (>4) can indicate inefficient use of resources
Exercise 4.2
Calculate Working Capital/Ratio
Current assets:
$
(A)
Current liabilities:
$
(B)
Working capital:
$
(A-B)
Working capital ratio:
:
1:00
Using appendix C
(A/B)
Exercise 4.2(a)
Calculate Your Own Working Capital/Ratio
Current assets:
$
(A)
Current liabilities:
$
(B)
Working capital:
$
(A-B)
Working capital ratio:
:
1:00
(A/B)
Use your own balance sheets based on an accrual basis
Calculating Debt Structure
• Current debt as a percentage of total debt
Health Check:
Good - < 20%
Poor - > 35%
Exercise 4.3
Calculate Months of Working Capital
Cash outflows:
$
1,400,000 (A)
Working capital:
$
(B)
# of Months
Months
Using exercise 4.2
How long does working capital last?
Exercise 4.4
Calculated Debt Structure
Current debt:
$
(A)
Divided by total debt:
$
(B)
Percentage
% (A/B*100)
Using Appendix C
Exclude due to shareholder
Exercise 4.4(a)
Calculate Your Own Debt Structure
Current debt:
$
(A)
Divided by total debt:
$
(B)
Percentage
% (A/B*100)
What percentage of total debt is due within 12 months?
Linking to the balance sheet
Balance sheet
Liquidity
Assets
Current assets
Long-term assets
Total assets
Liabilities
Current liabilities
Long-term liabilities
Total liabilities
Owner’s equity
Total liabilities & owner’s equity
Working
capital
+
Current
ratio
Solvency
Measure of debt compared to the amount of
capital invested in the business
Key Figures:
1. Debt to Equity Ratio (Leverage)*
2. Equity Ratio*
3. Debt Servicing Ratio
*Use a FMV balance sheet
Calculating debt to equity ratio
•
Compares the usage of debt and equity to finance the
farm
total liabilities / owner’s equity
– A leverage ratio used by lenders who base the calculation on the
fair market value of the equity as opposed to book value
•
Health check!
– Lower ratios are preferable; aim for less than 0.4
– A higher ratio (>.5) indicates greater long-term risk and less
flexibility
Exercise 4.5
Calculate Debt to Equity (Leverage)* Ratio
Total liabilities
$
(A)
Total equity at FMV
$
(B)
Leverage ratio
$
(A/B)
For every $1.00 in equity, how many dollars of debt?
Use appendix C and exercise 1.3
*Done using FMV
*Exclude shareholder loan
Exercise 4.5(a)
Calculate Your Own Debt to Equity (Leverage)*
Ratio
Total liabilities
$
(A)
Total equity at FMV
$
(B)
Leverage ratio
$
(A/B)
For every $1.00 in equity, how many dollars of debt?
Use appendix C and exercise 1.3
*Done using FMV
Calculating equity ratio
•
Measures the proportion of assets financed by the
owners
total equity / total assets
– The higher the ratio, the more resources are supplied by the owners
as opposed to the creditors.
•
Based on assets at FMV
•
Health check!
– Higher ratios are preferable; aim for .5
– A higher ratio indicates more likelihood of solvency
Exercise 4.6
Calculating Equity Ratio*
Owner’s equity at FMV
$
(A)
Total assets at FMV
$
(B)
Equity ratio
% (A/B*100)
What percentage of farm assets is financed by the owner?
Use appendix C and exercise 1.2 (total assets at FMV)
*Done using FMV
Exercise 4.6(a)
Calculate Your Own Equity Ratio*
Owner’s equity at FMV
$
(A)
Total assets at FMV
$
(B)
Equity ratio
% (A/B*100)
What percentage of farm assets is financed by the owner?
Linking to the balance sheet
Balance sheet
Solvency
Assets
Current assets
Long-term assets
Total assets
Liabilities
Current liabilities
Debt to
asset
ratio
Long-term liabilities
Total liabilities
Owner’s equity
Total liabilities & owner’s
equity
Debt to
equity
ratio
Equity
ratio
EBITDA
What is it?
• Earning Before Interest, Taxes, Depreciation and
Amortization
• Leases/Rent
• Family Wages/Draws
Calculating debt servicing ratio
•
Measure of debt service capacity
•
Indicates the ability to continually generate cash to repay term debt
debt servicing capacity / annual term principal and interest
– A linking ratio (links the income statement and balance sheet)
– A measure of long-term solvency used by lenders
•
Health check!
– Higher ratios are preferable; aim for higher than 2.0
– A higher ratio indicates ability to repay term debt
Exercise 4.7
Calculating Pellegrino EBITDA
Income before taxes
$
x,xxx,xxx
Add:
Amortization
xxx,xxx
Interest – long-term
xxx,xxx
– short-term
xx,xxx
Amortization
xxx,xxx
Rents
xx,xxx
Leases
xx,xxx
Family wages
xxx,xxx
EBITDA
x,xxx
Less family living
Available for debt servicing
Use appendix C
(110,500)
$
xx,xxxx (A)
Exercise 4.7 (cont’d)
Available for debt servicing
$
x,xxx(A)
Less:
Principal (current portion)
$
xxx,xxx
Interest – Short-term
xx,xxx
– Long-term
xxx,xxx
Rent
Lease
Surplus
xxx,xxx
xx,xxx
x.xxx.xxx
$
x,xxx,xxx(B)
Debt servicing ratio
x.xx
(A/B * 100)
How many dollars are available to service commitments?
Use appendix C
Exercise 4.7(a)
•
Calculate Your Own EBITDA
Financial Performance Analysis
Risk
Growth
237,232
26.3%
Interest
Lease
Rent
288,181
32.0%
Living
110,500
12.3%
Principal
264,396
29.4%
Surplus - $900,309
Linking to the financial statements
Solvency
Income statement
Revenue
less
Cost of goods sold
equals Contribution margin
less Overhead (fixed) costs
(Adjusted net income)
equals Net income
Statement of cash flow
Cash inflow
Cash outflow
Opening cash balance
Closing cash balance
Debt servicing ratio
Review the viability process
• Calculate liquidity
– Working capital
– Current ratio
– Debt structure ratio
• Calculate solvency
– Debt to equity ratio
– Debt to asset ratio
– Equity ratio
– Debt servicing ratio
• Calculate operating efficiency
• EBITDA
Your MAP
•
Do you have a clear vision for the future direction of
your farm?
•
Are you using your financial information to manage your
farm?
•
Do you use the cash or accrual method of accounting?
Why did you choose this method?
Your financial statements
• What types of financial statements do you have?
• Balance sheet showing all your farm assets, liabilities and equity
• Income statement prepared using the accrual basis
• Statement of cash flows
Your Map
• Chose your liquidity ratios
• Chose your solvency ratios
• Calculate your operating efficiency
Calculate your ratios
Scorecard
Description/Ratio
Adjusted Revenue
Production Expense
EBITDA
Operating Efficiency %
Net Worth
Working Capital Ratio
2008
2009
2010
2011
2012
2013F
2014F
Actions
Responsibility (Who)
OPERATING EFFICIENCY:
Goal:
Action:
INNOVATION:
Goal:
Action:
FINANCIAL:
Goal:
Action:
SUCCESSION PLAN:
Goal:
Action:
HUMAN CAPITAL:
Goal:
Action:
COMMODITY MARKETING:
Goal:
Action:
SALES & MARKETING:
Goal:
Action:
OTHER:
Goal:
Action:
Timeline (When)
The Gazelle
“Every morning when the sun comes up a gazelle wakes.
The gazelle knows that he must outrun the fastest lion or
he will be eaten.
When the sun comes up the lion also wakes. The lion
knows that he must outrun the slowest gazelle or he will
starve.
The lesson is simple; it doesn’t matter whether you are a
gazelle or a lion, when the sun comes up you had better be
running.”