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  1. 1. Farm Management Chapter 18 Farm Business Analysis
  2. 2. Chapter Outline <ul><li>Types of Analysis </li></ul><ul><li>Standards of Comparison </li></ul><ul><li>Diagnosing a Farm Business Problem </li></ul><ul><li>Measures of Profitability </li></ul><ul><li>Measures of Size </li></ul><ul><li>Efficiency Measures </li></ul><ul><li>Financial Measures </li></ul><ul><li>Enterprise Analysis </li></ul><ul><li>Farm Business Analysis and Accounting </li></ul>
  3. 3. Chapter Objectives <ul><li>To show how farm business analysis contributes to the control function of management </li></ul><ul><li>To suggest standards of comparison to use </li></ul><ul><li>To outline a procedure for locating economic or financial problem areas </li></ul><ul><li>To review measures that can be used to analyze solvency, liquidity, and profitability </li></ul><ul><li>To identify measures of business size </li></ul><ul><li>To illustrate the concept of economic efficiency </li></ul><ul><li>To demonstrate the use of enterprise analysis </li></ul>
  4. 4. Table 18-1 Returns to Management per Farm by Level of Gross Sales Source: Iowa Farm Business Association
  5. 5. Types of Analysis <ul><li>Profitability </li></ul><ul><li>Farm Size </li></ul><ul><li>Efficiency </li></ul><ul><li>Financial </li></ul><ul><li>Enterprise </li></ul>
  6. 6. Standards of Comparison Once a measure has been calculated, the problem becomes one of evaluating the result. Is the value good, bad, or average? Compared with what? Can it be improved?
  7. 7. Three Basic Standards <ul><li>Budgets: measures are compared against budgeted goals or objectives identified during planning </li></ul><ul><li>Comparative farms: measures are compared against actual results from similar farms </li></ul><ul><li>Historical trends: the manager looks for improvement over time </li></ul>
  8. 8. Diagnosing a Farm Business Problem A complete whole-farm business analysis can be carried out using a systematic procedure to identify the source of the problem.
  9. 9. Figure 18-1 Procedures for diagnosing a farm business problem
  10. 10. Measures of Profitability <ul><li>Net farm income </li></ul><ul><li>Return to labor and management </li></ul><ul><li>Return to management </li></ul><ul><li>Rate of return on farm assets </li></ul><ul><li>Rate of return on farm equity </li></ul><ul><li>Operating profit margin ratio </li></ul>
  11. 11. Table 18-2 Measures of Farm Profitability Comparison group based on Illinois Farm Business Farm Management Association data for dairy farms
  12. 12. Figure 18-2 How is the total revenue pie divided?
  13. 13. General Comments <ul><li>Two cautions regarding returns to labor, </li></ul><ul><li>management, assets and equity: </li></ul><ul><li>The estimation of opportunity costs </li></ul><ul><li>used in calculating returns is somewhat </li></ul><ul><li>arbitrary. </li></ul><ul><li>2) The returns are average returns to </li></ul><ul><li>factors, not the marginal returns. </li></ul>
  14. 14. Measures of Size <ul><li>Quantity of sales </li></ul><ul><li>Total or gross revenue </li></ul><ul><li>Value of farm production </li></ul><ul><li>Total farm assets </li></ul><ul><li>Total acres farmed </li></ul><ul><li>Livestock numbers </li></ul><ul><li>Total labor used </li></ul>
  15. 15. Table 18-3 Measures of Farm Size Comparison group based on Illinois Farm Business Farm Management Association data for dairy farms
  16. 16. Value of Farm Production <ul><li>Total (gross) revenue </li></ul><ul><li>minus livestock purchases </li></ul><ul><li>minus feed purchases </li></ul><ul><li>equals value of farm production </li></ul>Value of farm production is a convenient way to compare the size of different types of farms.
  17. 17. Efficiency Measures production Efficiency = resources used
  18. 18. Economic Efficiency <ul><li>Asset turnover ratio: gross revenue ÷market value of total farm assets </li></ul><ul><li>Operating expense ratio: total operating expenses÷gross revenue </li></ul><ul><li>Depreciation expense ratio: total depreciation expense÷gross revenue </li></ul><ul><li>Interest expense ratio: total farm interest expense÷gross revenue </li></ul>
  19. 19. Economic Efficiency (continued) <ul><li>Net farm income from operations ratio: net farm income÷gross revenue </li></ul><ul><li>Livestock production per $100 feed fed </li></ul><ul><li>Feed cost per 100 pounds of gain </li></ul><ul><li>Crop value per acre </li></ul><ul><li>Gross revenue per person </li></ul><ul><li>Machinery cost per crop acre </li></ul>
  20. 20. Table 18-4 Measures of Economic Efficiency Comparison group based on Illinois Farm Business Farm Management Association data for dairy farms
  21. 21. Physical Efficiency Poor economic efficiency can result from poor physical efficiency. Physical efficiency measures bushels harvested per acre, pigs weaned per sow, and pounds of milk sold per cow.
  22. 22. Table 18-5 Measures of physical efficiency Comparison group based on Illinois Farm Business Farm Management Association data for dairy farms
  23. 23. Financial Measures <ul><li>Solvency: debt/asset ratio, change in equity </li></ul><ul><li>Liquidity: current ratio, working capital </li></ul><ul><li>Measures of repayment capacity: term debt and capital lease coverage ratio , capital replacement and term debt repayment margin </li></ul>
  24. 24. Term Debt and Capital Lease Coverage Ratio This ratio is computed by dividing the cash available for term debt payments for the last year by the total term debt payments due next year. The ratio should be greater than 1. “ Term debt” refers to liabilities with scheduled, amortized payments.
  25. 25. Capital Replacement and Term Debt Repayment Margin This measure is calculated by taking the difference between cash available and total term debt payments due.
  26. 26. Cash Available <ul><li>net farm income from operations </li></ul><ul><li>plus total nonfarm income </li></ul><ul><li>plus depreciation expense </li></ul><ul><li>plus interest paid on term debt and capital leases </li></ul><ul><li>minus withdrawals for family living and personal income taxes </li></ul>
  27. 27. Table 18-6 Measuring the Financial Condition of the Business Comparison group based on Illinois Farm Business Farm Management Association data for dairy farms
  28. 28. Farm Business Analysis Case Study <ul><li>Example farm in tables 18-2 to 18-6 had net farm income considerably lower than comparison group </li></ul><ul><li>The resource levels of the sample farm are about the same, with a little more labor than average </li></ul><ul><li>Our sample farm has more debt, pays higher average interest rates, and has considerably more depreciation expense </li></ul><ul><li>To improve profitability, the farm may need to reduce debt load, reduce the size of the machinery complement, and increase production efficiency </li></ul>
  29. 29. Enterprise Analysis <ul><li>Crop enterprise analysis </li></ul><ul><li>Livestock enterprise analysis </li></ul><ul><li>Internal transactions </li></ul><ul><li>Verifying inventories </li></ul>
  30. 30. Table 18-7 Example of an Enterprise Analysis for Peanuts
  31. 31. Table 18-8 Income Statement Example with Enterprise Accounting
  32. 32. Table 18-9 Verifying Crop Inventories * Equal to total value of crop increase ($43,648 - $8,835)
  33. 33. Table 18-10 Verifying Livestock Inventories (cattle) * Equal to total hundredweight of gain produced (6,641 – 1,890 – 1,908) **Equal to total value of livestock increase ($488,698 - $151,200 - $143,100)
  34. 34. Farm Business Analysis and Accounting Most farm accounting programs calculate many of the measures and ratios used for farm business analysis. Most also have the ability to perform basic enterprise analysis.
  35. 35. Summary A whole-farm business analysis is like a complete medical examination. It should be conducted periodically to check for symptoms that indicate the business is not functioning as it should.