Financial Management In Sheep Production

Financial Management In Sheep Production Shepherd's Weekend Jan 3-4, 2009 Roger Betz Southwest Michigan Farm Management Michigan State University Exte...
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Financial Management In Sheep Production Shepherd's Weekend Jan 3-4, 2009 Roger Betz Southwest Michigan Farm Management Michigan State University Extension Michigan Sheep Breeders Jan 2009

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Roger Betz District Extension Farm Management Agent Southwest Michigan Michigan Sheep Breeders Jan 2009

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Topics for Today 

Levels of Accounting and Business Records



Balance Sheet or Net Worth Statement



Ewe Flock Budgets Comparisons

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Source: Arnold Oltmans. Farm Financial Statements. Century Communications. Michigan Sheep Breeders Jan 2009

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Levels of Accounting and Record Keeping  Level

1 - INCOME TAX for IRS  Level 2 - FINANCIAL - Whole Farm Analysis  Level 3 - MANAGEMENT - Enterprise or Cost Accounting  Level 4 - PRODUCTION RECORDS

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Level 1 - INCOME TAX for IRS Cash Income - Cash Expenses - Depreciation Sched F (farm) and Sched D (capital gains) Advantages: 1. Relatively Simple 2. Meets IRS Requirements 3. Important component of Analysis Tools Disadvantages: 1. Can be very poor indicator of profit or loss 2. Provides little information for decision making 3. Does not provide information for monitoring financial progress Michigan Sheep Breeders Jan 2009

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Level 2 FINANCIAL Whole Farm Analysis Accrual Income Statement Trend Analysis of Balance Sheets Reconciliation of Net Worth A.

Requires Level I (Income Tax)

B.

Beginning & Ending Balance Sheets (Dec. 31 each year or your Fiscal Year) Michigan Sheep Breeders Jan 2009

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Farm Example – Sheep Farm 

         

Cash Income........................ $80,000 Cash Expense ...................... $65,000 Tax Depreciation.................... $5,000 Schedule F Farm Income $10,000 Make or Lose Money? Beginning Lamb & Crop Inventory………. $25,000 Ending Lamb & Crop Inventory............$ 10,000 Make or Lose Money? Beginning Prepaid Expenses...........$5,000 Ending Prepaid Expenses..............$15,000 Make or Lose Money? $10,000 minus $15,000 plus $10,000 = $5,000 Change in Unpaid Bills? Michigan Sheep Breeders Jan 2009

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Assets on the Balance Sheets (Net Worth Statement) 1. 2. 3. 4. 5. 6.

Accurate Market Value Inventory of crops, feed, minerals, supplements Livestock (lambs) on hand Inventory Dollar Value of vet & livestock supplies, tags, drugs, Prepaid Expenses, fuel, fertilizer, seed, chemicals Money owed to you (including cash & savings) Cost Basis (depreciation schedule) & Market Value of machinery, breeding Michigan Sheep Breeders Jan 2009 livestock, buildings, land

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Liabilities on the Balance Sheets 1. 2.

3. 4.

Unpaid bills and accounts payable Accrued unpaid Income and Social Security taxes Accrued Interest to December 31 Verified Loan Balances - current versus non-current

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Details on Balance Sheets Need quantities and prices used for each item  2,123 bu corn @ $4.07 = $8,641  247 Mkt Lambs, 98lbs 93.00/cwt = $22,512  Unpaid Bills – Feed $543, Utilities $312  Repairs - Tractor = $1,563  2008 Property Taxes = $2,367  Need detail to accrue individual expenses and determine other production measures 

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Level 2 FINANCIAL Whole Farm Analysis (contd.) Advantages: 1. Allows managers to understand their business as a whole 2. Can accurately monitor Financial Progress 3. Meet the needs of lenders and IRS 4. Provides financial information for Estate Planning 5. Useful in evaluating the feasibility of Expansion 6. Not as complicated as Enterprise analysis 7. Can be done without computer assistance 8. Better than 90% of farm businesses Michigan Sheep Breeders Jan 2009

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Level 2 FINANCIAL Whole Farm Analysis (contd.)

Disadvantages: 1. Does not indicate which enterprises Ewes vs Lambs vs Corn vs Hay is more profitable Crops vs livestock and Synergies? 2. Requires extra effort once per year to develop net worth statement & reconciliation statements 3. Requires some effort in learning and applying the concepts Michigan Sheep Breeders Jan 2009

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Production Information From The BALANCE SHEET  Feed 

Efficiency? What did the animals eat? lbs & $

 Beginning Inventory + Production + Purchases - Sales - End Inv = Feed Use 

Lbs of Lamb Produced?  Sales - Beginning Inventory – Purchases + Ending Inventory = Lbs Lamb Produced



Feed Use (divided by) Lamb Produced = Feed Efficiency Michigan Sheep Breeders Jan 2009

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Level 3 MANAGEMENT Enterprise or Cost Analysis for Individual Crops and Livestock Species or Phase A. B.

Requires LEVEL 2 to be effective Eventual allocation of all cash income and expenses to individual profit centers Can Be - individual crops, farms, fields and livestock production phases

C.

Must allocate non cash cost (depreciation, unpaid labor) Michigan Sheep Breeders Jan 2009

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Level 3 MANAGEMENT Enterprise or Cost Analysis (cont'd.)

Advantages: 1. Determine Profitability of Individual Crops and Livestock 2. Determine which enterprises to expand and contract 3. Multi dimensional analysis possible 4. Which Farms to rent/sell/buy 5. Production Phase - Ewes versus finishing lambs Michigan Sheep Breeders Jan 2009

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Level 3 MANAGEMENT Enterprise or Cost Analysis (Contd.) Disadvantages: 1. Must allocate income and expenses with SUFFICIENT detail 2. Difficult without computerized system 3. Difficult to allocate and keep track of during the year 4. Must spend sufficient time in setting up system and learning concepts 5. Will the investment in time and expense payoff Michigan Sheep Breeders Jan 2009

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Level 4 - Production Records Tied to Financial Records (contd.) Advantages: 1. Incorporates the production with the economics to help determine relationships Disadvantages: 1. Production information alone often does not give sufficient indication of profitability 2. Can be time consuming

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Balance Sheet or Net Worth Statement Balance Sheet defined: A

List of Assets Owned and Debts Owed  -- At a Given Time,  -- With Quantities & Dollar Values Attached

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If the Question Is: “Are my assets worth more than my liabilities?” The Problem is SOLVENCY! If Net Worth is Positive, the Business is Solvent Definition:

$ Assets - $ Liabilities (Debts) = $ Net Worth or Equity

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Balance Sheet Analysis To remember. . . Basic equations   

Assets Assets Assets

= Debt + Equity minus Debts = Equity minus Equity = Debt

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What is the Balance Sheet or Net Worth Statement?  Picture

in time -- a specific point, as in “Midnight, 12/31/XX.”  Shows financial position -- ability to handle risk  Net result of past  Very important component to track and monitor financial progress  Basic building block for financial analysis Michigan Sheep Breeders Jan 2009

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The Balance Sheet Name -- What does this represent? Partnership, individual, combined Needs to be consistent over time

Date -- This is as of what date? Listing of all assets and all liabilities Balances at the bottom of form Assets = Liabilities plus Equity

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Balance Sheet Preparation 





Some Issues IDENTIFY clearly the person(s) or the business entity being described SEPARATE the business assets and liabilities from the personal Be CONSISTENT as to WHEN the Balance Sheet is prepared at a minimum, prepare a net worth statement when your accounting year ends



Valuation of Assets -- costs and/or market recommend two column balance sheet

The Balance Sheet is the Cornerstone to Financial Management Michigan Sheep Breeders Jan 2009

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Parts of the Balance Sheet

Assets = What you own; have control of

 Current assets  Normally converted to cash in 12 months, like crops, market livestock, prepaid expenses, cash, savings  Intermediate Assets  Useful life of one to 10 years -- machinery, breeding livestock, equipment, stocks, some buildings  Long Term Assets  Normal useful life of more than 10 years -- land, buildings, stocks  Selling would typically decrease volume or size of business Michigan Sheep Breeders Jan 2009

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Parts of the Balance Sheet (Current) Liabilities -- What you owe someone else (against what you own)

 Current Liabilities  Existing items scheduled to be paid in the next 12 months  Unpaid bills, accrued interest, property taxes  Operating loans  Principal payments on term debts to be made in the next 12 months Michigan Sheep Breeders Jan 2009

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Parts of the Balance Sheet (Intermediate) Liabilities -- What you owe to someone else (against what you own)

 Intermediate Liabilities  What is scheduled to be paid in one to 10 years (subtract out the current position)  Typically, machinery loans, breeding livestock, special use buildings  Match up to the intermediate assets

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Parts of the Balance Sheet (Long Term) Liabilities -- What you owe to someone else (against what you own)

 Long Term Liabilities  What was scheduled originally as 11 or more years  Land debt, house payments  Match up to the long term assets

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Parts of a Balance Sheet (Term Debts) Definition:  Term Debts - paid over more than 1 year:  Intermediate liabilities (Intermediate term)

 Long Term liabilities (Long term)

Term debts are not current loans Michigan Sheep Breeders Jan 2009

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Balance Sheet Specials 1. Rented assets Assets: 1) Belong on landlord’s balance sheet 2) Footnote on tenant’s 3) Unpaid rent is short-term debt 4) Growing crops and Inventory

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Balance Sheet Specials Growing Crops 1) 2) 3) 4) 5) 6) 7)

Date sets the list Winter Wheat Pastures Alfalfa Stockpiling Turnips, Brasicas Value = Cost of variable inputs

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Balance Sheet Specials 3. Leased Items buildings)

(tractors, pickups,

Assets: A) On user’s balance sheet = lease payments due Market value if any above lease payments due

Liabilities B) = lease payments due Michigan Sheep Breeders Jan 2009

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Balance Sheet Specials 4. Government Commodity Loans

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How To Build A Balance Sheet 1. Do a count: 1. 2. 3. 4. 5.

Crops: bushels, tons, etc. Animals: head and pounds Supplies Buildings Land: acres

2. $ Prices for each of the above. 1. Recommend both cost and market value for term assets Michigan Sheep Breeders Jan 2009

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How To Build A Balance Sheet 3. Machinery list

(depreciation schedule?)

Cost less depreciation = book value

4. 5. 6. 7.

Assemble the above into the format Add up the assets Add up the debts Assets minus debts = net worth or equity

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“Z” Farms Balance Sheet Trends example)

Dec. 31, 20X1 Dec. 31, 20X2

Net Worth $400,000 WHY?

$450,000

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Change in Net Worth due to: 1.

Retained Earnings From profits earned and retained in business

2.

Market Valuation Equity From change in market value of assets

3.

From Contributed Capital

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Retained Earnings (contributed capital) Dollars earned by the business that are kept or retained for reinvestment in the business Calculated by:  $ Total Assets @ Cost Value Basis  $ Total Liabilities before Contingent Liabilities

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Valuation Equity Dollars of asset value that are created because the market value of term assets is greater than the book value

Calculated by: + $ Total assets @ Market Value basis - $ Total Liabilities including Contingent Liabilities - $ Retained Earnings (contributed Capital)

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What a Balance Sheet is NOT  Does

NOT necessarily tell you if the business is making money  Unless done with certain detail, it does NOT tell you where net worth came from

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A Good Balance Sheet 1.

One page summary

2.

Name and date

3.

Shows type of farm

4.

Cost and market columns

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A Good Balance Sheet 5.

6.

7.

Indicates physical quantities of major items Sequence of items Sale time: quick to long Assets less debts equals net worth (Own - Owe = Equity)

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The Balance Sheet: Building Block for Financial Analysis  Financial

Position  Trend Analysis  Feeds Into the Income Statement  Communication to Self  Communicating with those outside the business  Needs Good Detail Michigan Sheep Breeders Jan 2009

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Source: Arnold Oltmans. Farm Financial Statements. Century Communications. Michigan Sheep Breeders Jan 2009

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Questions ?

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