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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.”