New Economic Realities - Taking Charge of Risk Management in ...

New Economic Realities - Taking Charge of Risk Management in ...

Managing Capital /Financial Risk Craig Binkowski Southern Michigan Bank & Trust Coldwater $ Farm Business Risk Profile Production Marketing FARM Business Legal Financial Human Resources (Health & Labor) We will focus only on Production, Marketing and Financial today $ Topics in Financial Section Financial Balance Sheet (Whats at risk?) Cost of Production / Revenue Requirements:

Total Economic costs Cover Direct Cost To Maintain Equity Meet Cash Flow Demands Cost of Production Worksheet Incorporating Financial Information into Risk Management / Control Decisions $ Financial Risk Management Increase Equity through Farm Profit Net Worth increase without inflation in asset values Meet Cash Flow Demands Monitor cost & availability of Debt Capital Interest Rate Risk Sources of Capital Financial Information for measurement and monitoring is available and used $ 3 Basic Financial Statements 1. BALANCE SHEET: Assets, liabilities, and net worth Annual Change in Net Worth 2. INCOME STATEMENT: Inventory Adjusted (Accrual)

3. Projected CASH FLOW: After Scheduled Term Debt Principal & Interest Payments, Family Living, Income Taxes $ Example Farms for the Game: Designed to Simulate Todays Market Environment Green = Low Debt Farm (Sorry) Yellow = Moderate Debt Farm Red = High Debt Farm $ Balance Sheet Current balance sheet tells you: Financial position of your business/Self Your capacity to withstand risk Take a Hit and remain solvent Three-five years of balance sheets tell you:

Trends in equity of your business Need Both Cost Basis (Book Value) And Market Value Dual Column Balance Sheet $ Balance Sheet Debt Levels Current Farm Assets Intermed. Farm Assets Long Term Farm Assets Total Farm Assets Low Medium High 431,000 431,000 431,000 + 616,000 616,000 616,000 + 974,000 974,000 974,000 = 2,021,000 2,021,000 2,021,000

Current Farm Liabilities 50,782 Intermed. Farm Liabilities + 82,014 Long Term Farm Liabilites + 271,458 Total Liablilities = 404,254 Equity Debt to Asset Ratio Equity to Asset Ratio 317,516 376,586 253,300 412,502 338,634 524,562 909,450 1,313,650 1,616,746 1,111,550 20 45 80 55 Page 4 FINLRB output 707,350 65 35

$ Income Statement: History: Did your business make or lose money last year? How much? Was your neighbors experience similar? What has been the past performance of your business? Relative to your neighbors? Projections (pro-forma): What will be different from the past? Why? Do you expect the business to make a profit? How much can revenue fall due to price and/or yield shortfalls before there is a loss? $ Income Statement Gross Farm Income Non Interest Cash Exp. Interest Expense Net Cash Farm Income Inventory/Accrual Adj. Net Operating Profit Depreciation Net Farm Income + =

+ = = Low 563,284 393,945 30,576 138,763 0 138,763 60,000 78,763 Medium 563,284 393,945 68,714 100,625 0 100,625 60,000 40,625 Page 2 of FINLRB output High 563,284 393,945

109,271 60,068 0 60,068 60,000 68 $ Liquidity - Cash Flow Statement Ability of your business to meet its cash flow obligations Accounts for all sources and uses of cash including debt and capital activity Helps you assess how much room there is for stuff going wrong -- RISK! Helps you assess if adjustments need to be made in the financial structure of your business. Does NOT tell you if your business made a profit! $ Liquidity- Cash Flow Statement Net Cash Farm Income Nonfarm Income Net Cash Available Family Living Income Taxes & Social Security Cash Avail. for Princ. Payments Farm Interest Paid

Cash Avail. for P& I Payments Total Sched. Principal & Interest Cash Avail. after Loan Payments Cash Required for Replacement Cash Surplus or Deficit + + = = + = = = Low 138,763 0 138,763 30,000 25,626 83,137 30,576 113,713 58,655 55,058 40,978 14,080

Page 3 of FINLRB output Medium High 100,625 60,068 0 0 100,625 60,068 30,000 30,000 11,369 10 59,256 30,058 68,714 109,271 127,970 139,329 184,428 176,312 (56,458) (36,983) 0 13,521 (56,458) (50,504) $ Change In Net Worth: Did Your Net Worth Increase last year? Or Decrease? Trend? Why?

From Retained Earnings out of Farm Profit? From Asset Inflation? Inflation Machinery? Land? From Contributed Capital? Capital (Outside sources) Do you expect your net worth to increase next year? Or, decrease? How much room do you have for stuff to go wrong RISK! $ Change in Net Worth Net Farm Income Net non Farm Income Family Living Income Taxes Change in Net Worth + = Percent Change in Equity Low 78,763 0 30,000 25,626 23,137

Medium 40,625 0 30,000 11,369 (744) High 68 0 30,000 10 (29,942) -0.1% -4.2% 1.4% Hand calculate the % Change in Equity Page 4 of FINLRB output $ Understand the Numbers for Your Farm Business! Critical in todays environment

Understand what the numbers mean and signal Monitor Business EVERY year routinely Use professional assistance if needed $ Cost of Production Roger Betz District Extension Farm Management Agent SW Michigan $ Cost of Production Worksheet Allocates Overhead cost to each acre and combines with Direct Cost to determine Cost of Productions for various crops Cost of Productions? Economic Direct Cost Maintain Net Worth Meet Cash Flow Demands

Useful in Marketing and Crop Insurance Decisions $ 1. Paid on Yield per Acre in Bushels 2. TIMES Selling Price per Bu 3. EQUALS Gross Income per Acre DIRECT COST/AC 4. Seed 5. Fertilizer 6. Herbicides 7. Insecticides 8. Drying Fuel 9. Crop Fuel & Oil 10. Crop Repairs 12. Crop Utilities 13. Crop Haul & Truck 14. Crop Marketing 15. Crop Insurance 16. Other 17. TOTAL DIRECT COST/Ac CORN SOYS 128.5 x $2.10 =$269.85

43 $5.30 $227.90 $25.00 $26.40 $54.80 $13.00 $20.35 $18.75 $__________$__________ $14.00 $__________ $9.35 $7.50 $23.60 $20.20 $2.40 $1.50 $15.42 $5.16 $__________ $1.72 $__________$__________ $__________$__________ $164.92 $94.23 $ Cost of Production Worksheet - page 2

Cost of Production - Overhead 19. 20. 21. 22. 23. 24. 25. 26. 27. 28. 29. Acres Cropped Interest Hired Labor Land Rents Machinery Leases Real Estate Taxes Farm Insurance Farm Utilities Other Expenses Depreciation Total Accounting Overhead Cost Cost of Production Page 2- Medium Debt

2,000 68,714 25,000 82,500 0 14,100 12,000 1,200 0 60,000 263,514 $ Economic Cost of Production 29. Total Accounting Overhead Cost 263,514 30. Value of Unpaid Labor 31. Value of Unpaid Equity Capital 32. Total Economic Overhead Cost 45,664 66,693 375,871 33. Total Economic Overhead Cost/Ac

$187.94 CORN $352.86 SOYS $282.17 $2.75 $6.56 34. Total Economic Costs/Ac (line 17 for each crop) PLUS (line33) 35. Total Economic Cost / Bu Cost of Production Worksheet Page 2 - Medium Debt Farm $ Total Direct Cost 36. Acres planted each crop 37. Total Direct Cost/Ac (line 17) CORN 1,000 SOYS 1,000

$164.92 $94.23 38. Direct Cost per Bushel $1.28 For each crop (line 37)DIVIDED BY (line 1) 39. Total Direct Cost for Crop 164,920 For each crop (line 36) TIMES (line 37) $2.19 40. Total Direct Cost for all crops combined Cost of Production Worksheet Page 2 Medium Debt Farm 94,230 259,150 $ Revenues to Maintain Net Worth 41. 42. 43.

44. 45. 46. 47. 48. 49. Total Economic Overhead Cost (line 32) Minus Gov. Program & Other Net Incomes Minus Value of Unpaid Equity (line 31) Plus Income Taxes Minus Value Unpaid Family Labor (line 30) Plus Actual Family Living & Other Draws Maintain Net Worth Overhead Cost Maintain Net Worth Overhead Cost per Acre Total Crop Revenues Needed to Maintain Net Worth 50. Total Revenues Needed / Acre (line 37 for each crop) PLUS (line 48) 51. Maintain Net Worth per Bu + + = 375,871 65,534 66,693 11,369

45,664 30,000 239,349 $119.67 498,499 CORN SOYS $284.59 $213.90 $2.21 Cost of Production Worksheet Page 2 Medium Debt Farm $4.97 $ Revenues to Meet Cash Flow 52. 53. 54. 55. 56. 57. Maintain Net Worth Overhead Cost (line 47)

Minus Depreciation (line 28) Minus Interest Expense (line 20) Plus Scheduled Principal and Interest Plus Cash required for Capital Replacement Meet Cash Flow Demands Overhead Cost 239,349 60,000 68,714 184,428 0 295,063 + + = 58. Meet Cash Flow Overhead Cost per Acre $147.53 59. Total Crop Revenues Needed to Meet Cash Flow Demands 554,213 60.Total Crop Revenue Needed per Acre (line 37 for each crop) PLUS (line 58)

61. Meet Cash Flow Demands per Bu CORN SOYS $312.45 $241.76 Cost of Production Worksheet Page 2 Medium Debt Farm $2.43 $5.62 $ Break Even Income & Prices Cost of Production Medium Debt Farm 34. Total Economic Cost per Acre 35. Per Bu 37. Direct Cost per Acre 38. Per Bu 50. Maintain Net Worth per Acre 51. Per Bu 60. Meet Cash Flow Demands per Acre 61. Per Bu CORN

SOYS $352.86 $2.75 $164.92 $1.28 $284.59 $2.21 $312.45 $2.43 $282.17 $6.56 $94.23 $2.19 $213.90 $4.97 $241.76 $5.62 $ Break Even Incomes & Prices Cost of Production High Debt Farm 34. Total Economic Cost per Acre 35. Per Bu 37. Direct Cost per Acre

38. Per Bu 50. Maintain Net Worth per Acre 51. Per Bu 60. Meet Cash Flow Demands per Acre 61. Per Bu CORN SOYS $361.01 $2.81 $164.92 $1.28 $299.19 $2.33 $309.47 $2.41 $290.32 $6.75 $94.23 $2.19 $228.50 $5.31 $238.78 $5.55 $

What Percent of Equity are You Willing to Risk? Net Worth 5% 10% 15% 20% 25% Low Medium 1,616,746 1,111,550 80,837 55,578 161,675 111,155 242,512 166,733 323,349 222,310 404,187 277,888 High 707,350 35,368 70,735 106,103

141,470 176,838 $ Can I use Risk Management Tools to Minimize Equity Loss? Crop Revenue Needed to Maintain 100% of Equity Corn per Acre Soybeans per Acre Low Medium 469,540 498,499 $270.12 $284.59 $199.43 $213.90 High 527,697 $299.19 $228.50 10% of Equity Loss % of Crop Rev. Can Lose Corn/Ac (Protect 90%) Soys/Ac (Protect 90%) Corn / Bu (Protect 90%) Soys/Bu (Protect 90%)

161,675 34.4% $177.11 $130.76 $1.38 $3.04 70,735 13.4% $259.09 $197.87 $2.02 $4.60 111,155 22.3% $221.14 $166.21 $1.72 $3.87 $ Lines 49 and 50 Cost of Prod. Worksheet Key Questions for Your Farm Business : 1. Appropriate Financial Information Available? Historical, Current, and Future 2. Adequate Understanding of Financial Conditions and Risk Positions? 3. Realistic Plans & Underlying Assumptions?

4. What level of Equity Protection can Risk tools provide? 5. Should you utilize Financial Risk Management Strategies? $ STOP! What is the key financial information for your farm? What are the revenues required to: Meet Economic Cost Cover Direct Cost Maintain Net Worth Meet Cash Flow Demands Start to think through your crop insurance and marketing plans $

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