The Farm Earnings/Income Statement is the financial instrument providing detail of how your business arrived at a level of profit or lack of therein. It is the difference between revenue and costs on an accrual basis (adjusted for Prepaid Expense, Accounts Payable and Feed, Livestock and other inventories) minus depreciation. Also subtracting unpaid management and labor charges or an amount for family living produces the margin available to service debt, grow assets or pay expenses during times of low revenue.
A general recommendation to control business financial risk is similar to the Boy Scout Creed; "be informed and be prepared." Manage the business to maximize profit versus minimizing income tax liability. Generate and retain wealth to be in a position to better withstand those times when profit is nonexistent. Profit can be affected by controlling costs and/or increasing production and financial efficiency. Thus, Net (Operating) Profit Margin, an indication of how successful a business manager is at controlling costs and, Asset Turnover Ratio, an indication of how efficient the business is in producing wealth are important financial parameters.
Through this three-part series we've identified the "Big Three" financial statements, the Cash Flow Statement, the Farm Earnings Statement, and the Balance Sheet, needed to access and plan for your present and future financial success. We've also identified the short comings of standard benchmark levels and the implications given differing market and business performance levels. David Crass of the accounting firm Michael, Best & Friedrich recently commented that "Working Capital will continue to be king and risk management will take on a heightened role as price volatility persists in agricultural markets." But what can you do about it?
It is commonly accepted that global or industry wide traditional financial recommendations did not lend themselves to addressing the severe financial stress experienced by farm business managers during 2009. It may also be coming clear that traditional on-farm business management likely could not plan for nor effectively address (react to) the kind of divergence between input costs and prices received for farm commodities given this dramatic of a scenario. This said managers have two choices; to throw up their hands and do nothing leaving business outcomes to fate or, to take a proactive approach utilizing available information and management talents to minimize the negative effects of the next milk price downturn.
For those who choose the later, a new decision making model is available to assist you. What you need to utilize the financial planner is a beginning/ending Balance Sheets plus a projected Balance Sheet for the coming year if significant changes in assets and liabilities are predicted.
Two years of Income Statements are preferred. Likewise, last year's Cash Flow Statement along with a projection for next year is needed. Parts of the "Planner" are spreadsheet versions of each of the "Big Three" financial instruments to allow you to easily develop each report if needed. The forecast versions of the Income and Cash flow Statements allow you to identify both predicted income and expense values.
In addition, the tool performs a Sensitivity Analysis adding additional power to your analysis. For instance you predict an average milk price of $18 per cwt and have varied each monthly price received from $16 to $20 but believe your estimate may be 10 percent high or low. The Sensitivity Analysis varies your Working Capital projection over five percentage levels based on the range you choose to evaluate for both expected Revenues and Operating Expenses.
Output information includes;
-- Current and projected Liquidity, Solvency and Equity levels/changes
-- Current and projected Net Farm Income From Operations, Net Farm Income, Rate of Return on Assets, Working Capital: Revenue and Working Capital: Operating Expense Ratios, Operating Profit Margin and Asset Turnover Ratio.
-- Current and projected monthly and annual cash flows
-- Current and projected Current Ratio and Working Capital levels
-- Average milk price and cwt needed to break even on Cash Flow
From this user defined output the dairy farm manager can compare actual expenses and income to projections then make indicated adjustments at anytime in both decisions made as well as fine tune the projection. The decision support tool will automatically update the projection for the balance of the year once changes to the budget are made at any time throughout the year.
To simplify and streamline this valuable management process, UW-Extension specialists have developed the "Planning for the Next Swing in Milk Price" program and "Working Capital Decision Support System" suite of decision tools for your use. Your UW-Extension county agricultural agent, Technical College Instructor or farm records business consultant can help you access this resource.
Bolton is a dairy and livestock Extension agent for the UW Center for Dairy Profitability.