Estimating the Profitability of Your Non-Timber …ufdcimages.uflib.ufl.edu › IR › 00 › 00 › 18 › 13 › 00001 › fr01500.pdfEstimating the Profitability of Your Forestland

1. This document is Circular 836, one of a series of the School of Forest Resources and Conservation, Florida Cooperative Extension Service, Institute ofFood and Agricultural Sciences, University of Florida. First published: November, 1989. Reviewed August, 1998. Please visit the FAIRS Web site athttp://hammock.ifas.ufl.edu.

2. William G. Hubbard, southern regional extension forester; Robert C. Abt, Ph.D., associate professor, N.C. State; Mary L. Duryea, Ph.D., professor;Michael G. Jacobson, Ph.D., professor, School of Forest Resources and Conservation, Cooperative Extension Service, Institute of Food and AgriculturalSciences, University of Florida, Gainesville, 32611.

The Institute of Food and Agricultural Sciences is an equal opportunity/affirmative action employer authorized to provide research,educational information and other services only to individuals and institutions that function without regard to race, color, sex, age, handicap,or national origin. For information on obtaining other extension publications, contact your county Cooperative Extension Service office.Florida Cooperative Extension Service / Institute of Food and Agricultural Sciences / University of Florida / Christine Taylor Waddill, Dean

Circular 836

Estimating the Profitability of Your Non-Timber ForestlandEnterprise 1

William G. Hubbard, Robert C. Abt, Mary L. Duryea, and Michael G. Jacobson2

Background

Forest and farmland owners today have a variety ofinvestment opportunities available to them on their land.Depending on the characteristics of the property, theinterested owner can--in addition to growing trees--harvest pine straw, grow Christmas trees or mushrooms,or lease hunting, fishing, or grazing rights. Some of theseenterprises are added by owners as hobbies--withoutfinancial expectations. Many landowners, however, areinterested in the potential for increased income. This isespecially true for owners of forestland who must oftenwait years before harvesting and selling timber.

When the landowner becomes interested inmanaging an enterprise, a written management planshould be prepared. Management plans include adefinition of objectives and level of involvement, ananalysis of the market situation for the enterprise inquestion, a timetable of important activities, and anidentification of major factors that may limit the successof the enterprise (Duryea et al.1988). The managementof a successful forestry enterprise needs careful planningand decision-making, much like the management of asuccessful business.

If a landowner is interested in making additionalincome from the land, the management plan shouldinclude a financial analysis. If properly done, theanalysis can be among the most valuable tools used inthe planning and decision-making process. Financial

analyses give needed information on the profitability ofan enterprise, or provide assistance in choosing betweentwo or more potential enterprises.

The purpose of this publication is to introduce thelandowner to the financial concepts necessary toproperly evaluate alternative forestry enterprises. Thispublication emphasizes the financial benefits and costs.However, landowners often undertake projects for avariety of reasons other than financial return. Thesenonmarket objectives, such as management forrecreation, nongame wildlife habitat, aesthetics, or soilconservation can also be included in an analysis.Although the concepts are very similar; placing valueson these benefits and costs can be a time-consumingtask. A variety of natural resource economic textsprovide detailed methods for valuing non-market goodsand services.

After an introduction of the general steps involvedin financial analysis a number of detailed examples willbe examined. The costs and returns for the investmentsin the examples represent rough averages. The costs andrevenues for a potential enterprise should be researchedand estimated by the landowner and/or a professional.

Steps in Financial Analysis

Sound financial analysis depends on a completeaccounting of costs and benefits over time. Keepingtrack of the costs and revenues and when they occur is

Archival copy: for current recommendations see http://edis.ifas.ufl.edu or your local extension office.

Estimating the Profitability of Your Forestland Enterprise Page 2

October 1998

Figure 1 . Flowchart of major financial analysis steps.

Figure 2 . Sample time line (Christmas tree farm objective).

important for management of cash flow. The timing and The flowchart in Figure 1 illustrates the steps taken inamounts of these cash flows determine the profitability the financial analysis.of the forest resource enterprise.

1. Identify the Objectives

In the first step the owner's objective and level ofinvolvement are determined. This step may seemsimple. However; simple is seldom easy. It is at thisstage that you must ask yourself, honestly, howinvolved you want to be in the enterprise.

• Will the project be a hobby or do you wish to makeit your major line of work? who can assist you in this step. The events should be

placed in the appropriate spots on a time line. The time• How much time do you want to devote to theproject?

• How much money are you willing to invest?

Because the amount of involvement often depends onthe perceived returns, leave room for flexibility.

Objectives can be changed and the analysis modified.This is a major advantage of sound planning. Theproject can be changed much more easily and cheaplyon paper than on the ground.

2. Determine the Schedule of Activities

In the second step the schedule of activities isdetermined. Contact someone familiar with the product

line is a convenient way to track these activities overtime. A sample time line for a Christmas tree farm isshown in Figure 2.

In this case, planting, pruning, mowing, fertilizing, and require. A full rotation or production cycle should bemarketing are needed. Make sure you include any and studied including costs of preparation and postharvestall activities, including your own, that the project will cleanup. Identify as closely as possible the time of year


PVFV

(1 � i)n


October 1998

(or period) that the activity takes place. Activities thatoccur at the beginning of the year (or period) ratherthan the end may have a significant effect on theoutcome of your analysis.

3. Attach Dollar values to Activities

The third step is to attach dollar values to theschedule of activities. Determining the timing, andamounts of cash flows can be difficult. If you are goingto be personally involved in the management of yourland it is important to include your time as a cost.There are two ways to incorporate your time into thefinancial analysis. The most straightforward way, is toenter an hourly wage for your time into the costcalculations. This wage should reflect the value of yourtime. For example, if you were considering quitting ajob to work on your land, the value of your time is yourcurrent wage. If, on the other hand, you considerworking on your land as recreation or therapy, youmight charge yourself a lower or even zero wage.

The alternative way to evaluate your time is toestimate the hours you will invest, but not to includeyour wages for these hours as a cost. Financial returnscalculated this way include both profits and wages.This figure and the number of hours invested can beused to determine whether your time is worth thereturns.

Predicting other costs and revenues throughout theanalysis period will probably require professionalassistance or at least contact with persons currently inthe business. Dollar figures depend on the present andfuture supplies and demands of the product and anyinput needs. The economic environment constantlychanges. It is therefore important to have the best andmost current information available. For example, if theeconomics of Christmas trees appeared very favorablefive years ago, then many people may have plantedtrees then and today, the increased competition andsupply may keep future prices too low to justify currentinvestment. So even if demand for Christmas trees hasnot changed in the last five years, the changes insupply may affect your investment decision.Note: Some products have grower associations: theFlorida Christmas Tree Association and the ShiitakeMushroom Association. These associations may be ofassistance in determining present and future costs andrevenues. Other products do not yet have well-definedmarkets and prices. In these cases, county extensionagents and foresters, as well as consultants, may be ofsome assistance.

4. Discount Values to the Present

Because the costs and revenues are spread out overthe length of the planning period we must take intoaccount that future dollars are not worth as much astoday's dollar. In financial terms you can see this is truesince you could put less than a dollar in the bank todayto get a dollar back sometime in the future. How longyou have to wait depends on how much less than adollar you started with, the interest rate, and thefrequency of compounding at your bank.

The key factor in analyzing the time value ofmoney is the discount rate or alternative rate of return.This is the cost of borrowing money or the rate ofreturn available in other investments. These otherinvestments may be alternative land uses or simply therate of return available in a savings account or moneymarket fund.

Example. Suppose you were given the choice ofreceiving $100 today or receiving $1,000 in 20 years.We can use financial analysis and the discount rate tocompare these two "costless" investments. Theobjective is to determine the present value of theseinvestments. For the first investment this is easy: thepresent value of receiving $100 today is $100.Determining the present value of receiving $1,000 in20 years, however; is more complicated. If we considerour alternative rate of return to be the rate that we earnon our savings account, then we want to determine howmuch money would we have to put in our savingsaccount today, to be able to withdraw $1,000 in 20years. If this "present value" is greater than $100 then itis the preferable investment. The present value iscalculated as shown in Equation 1:

where n is the number of years, i is the alternative rateof return (expressed in decimal form), and FV is thefuture value. If your savings account pays 7 percentinterest, then n=20, i=.07 (for 7 percent), and FV=$1,000. The calculated PV is $258.42. This provesreceiving $1,000 in 20 years at 7 percent is a betterinvestment since $258.42 is greater than $100. You canverify the accuracy of the formula by noting that oneyear after depositing $258.42 in your account youwould have $258.42 + (.07 x $258.42) or $258.42 x(1.07) which is equal to $276.51. After two years youwould have $276.51 x (1.07) and so on until year 20 inwhich you would have, except for a rounding error;$1,000.



October 1998

Figure 4 . Time lines of two hypothetical investments: A and B.

value of returns less the present value of costs. AssumeCalculating the Net Present Value (NPV)

Unfortunately, most investments involve costs. Toexamine investments with costs you compare their netpresent values (NPV), which is simply the present

that there are now two investments and both requireyou to invest $60 today and $50 at the end of fiveyears. Investment A returns $150 in five years whileinvestment B returns $250 in seven years. Are theseinvestments profitable? If so, which is better? The timeline for these two investments is shown in Figure 3.

Assume a discount rate of 7 percent. Using the investment over and above an investment thatEquation 1 as the PV for investment A, the PV of yields the alternative rate of return (7 percent in thisreturns is $106.95 (FV= $150, n=5, i=.07). The PV of case). Any investment with a positive NPV will returnthe costs is equal to the $60 paid today plus the PV of more than the alternative rate of return used in itsthe $50 in five years. Discounting the $50 for five calculations. In other words, the decision to invest in Ayears (using Equation 1) gives $35.65. The total will return $11.30 more than simply putting $60 in thepresent value of costs, therefore, is $60 + $35.35 or bank today and $50 in the bank in five years. Similarly,$95.65. The net present value of investment A is in investment B the return (NPV) of $60.04 is thattherefore $106.95 - $95.65 or $11.30. much better than putting the money in a savings

Because these investments have the same costs, account.only the revenues need to be calculated for investment For simplicity’s sake, the above examples have notB. In this case, the FV=$250, n=7, and i=.07. The PV included inflation or changes in the purchasing powerof investment B therefore is equal to $155.69 (using of the dollar. There are two ways to incorporateEquation 1). The NPV of investment B is therefore inflation into your analysis. You can do the analysis in$155.69 - $95.65 or $60.04. So investment B is real (constant) dollars or current (inflated or nominal)preferred. This $60.04 represents the current value of dollars. Real dollar analyses net out the effect of


AENPV [i(1 � i)n]

[(1 � i)n1]


October 1998

inflation from all costs, revenues, and interest rates.Current dollar analyses include the effects of inflation.For these reasons, it is important to determine if yourcost and revenue forecasts include inflation. Yourdiscount rate may also need to be adjusted dependingon what type of analysis you undertaken.

Calculating the Internal Rate of Return (IRR)

Sometimes it is desirable to calculate aninvestment's internal "rate of return" (IRR). This issimply the discount rate that makes the NPV equal tozero. For investment A the IRR is 10.8 percent and forinvestment B, the IRR is 17.1 percent. Unfortunately,there is no shortcut formula for calculating this rate ofreturn. To calculate the IRR by hand requires changingthe discount rate in the NPV calculations by trial anderror until you find the discount rate that makes theNPV zero. Most financial calculators can calculate iteasily.

Calculation of a unique IRR for an investment isnot always possible, and rankings of investmentsby IRR are not always the same as rankings by NPV Itis generally preferable to rank investments by NPV Foran in-depth discussion of differences in IRR and NPVcriteria see any finance or capital budgeting textbook.

Before move on to detailed examples, one otherconcept of the time value of money should beintroduced. Often an investor would like to compareforestry investments to annual crops or leasing land ona yearly contract. Once the NPV is calculated it is easyto convert to an annual basis. This is especiallyimportant to those who are comparing two projectswhose production lengths are different. Christmas treesand shiitake mushrooms are examples.

Calculating the Annual Equivalent (AE)

While it takes four or five years to grow aChristmas tree in Florida, mushroom production mayonly take one year. Comparing the annual returnsexpected between the two makes it easy to decidewhich is more profitable. The calculated amount isdefined as the yearly payment that would pay off theNPV of the project. To calculate the yearly, or annual equivalent (AE), thepresent value should first be calculated for the analysisperiod. Then, using the traditional formula favored bymany financial analysts to calculate payments, anannual equivalent can be found using Equation 2:

where AE= Annual Equivalent and the other symbolsare the same as before. The AE is very useful incomparing investments of different project lengths aslong as reinvestment assumptions are made.

Financial Analyses of ForestlandAlternatives

In this section, steps in a financial analysis will bepresented for a number of alternative forestland uses.An example of an enterprise with yearly returns will befollowed by an example of less frequent returns.Finally, a mixture of the two types of investments willbe presented in a Christmas tree farm case.

The following examples are designed to give thelandowner an idea of the steps involved in financiallyanalyzing a forestry enterprise. It should be emphasizedthat financial analysis of these forestry investments isbasically no different than most business analyses. Theprocedures outlined in each example, along withestimates of cash flows, provide valuable information.In the examples, the land is assumed to be owned bythe individual doing the analysis. If this is not the case,the land rent or purchase price must be included in theanalysis.

Example 1: Hunting Leases

The situation: Wayne Baker owns 300 acres ofnatural pine and hardwood. A local hunting club isinterested in leasing the land for hunting for 10years. Wayne knows two neighbors who have leaseswith the club. The first neighbor leases a similarpartial of land for $4/acre. The second neighbor hasmade some improvements that cost him $3,000 upfront. He also has maintenance costs of $500/ year.This neighbor is able to lease the tract for $7.50/acre. Wayne would like to decide which huntingarrangement, if any, to pursue.

To evaluate the profitability of the investment,Wayne must determine his discount rate. As explainedearlier; it is often determined by the next bestalternative he may have. In this case Wayne could puthis money in a Certificate of Deposit (CD) at his bank


PVa[(1 � i)n

1]

i(1 � i)n


October 1998

Figure 6 . Low-intensity hunting: schedule of activities.

Figure 7 . Low-intensity hunting: dollar value.

for 8%. At this rate, if the NPV/earning of hisinvestment is positive, he will be earning more than hewould with the CD. If the NPV is negative, the CD willreturn more.

Each of the hunting lease arrangements should beanalyzed independently and the one with the highestpositive NPV chosen. The projects can be identified asa low-intensity (do nothing) lease and high-intensitylease (improvements and maintenance). The low-intensity lease follows:

1. Low-intensity hunting lease

To begin the analysis, follow the steps outlined before:

Step 1. Identification of the objective. Thelandowner wishes to increase his annual income. Inthis case, a ten-year hunting lease is to be arranged inwhich the landowner has very little or no activeparticipation.

Step 2. Identification of activities. With the low-intensity arrangement, the only activities are theexecution of the lease and the yearly collection ofhunting fees (Figure 4).

Step 3. Attach dollar values to the activities.Assuming no cost of lease execution or fee collectionto Wayne, the yearly expected income is equal to the

per-acre revenue times the total acres in the tract, or$4.00/acre x 300 acres for $1,200 (Figure 5).

Step 4. Discount the cash flows to the present.To calculate the NPV of a yearly return, the presentvalue of each payment needs to be determined.Although this is simply calculating 10 present values(one for each lease payment received) and adding themtogether; it can become quite time-consuming. Imaginea 50-year lease! So, here’s a formula to makecalculations easier. This formula is used when costs orrevenues are incurred at a regular rate throughout the

project length. This formula saves the repetitiouscomputations involved in yearly discounting.

The formula in Equation 3 is simply a derivation ofthe present value formula (Equation 1):


PV$1,200[(1� .08)10

1

.08(1 � .08)10$8,052.10


October 1998

Figure 10 . High-intensity hunting: schedule of activities.

Figure 11 . High-intensity hunting: dollar values.

where a is the yearly cost or revenue and the others areas before.

With low-intensity hunting as shown in Equation 4(where numbers from Wayne’s first neighbor in thecase situation replace the letters in Equation 3)--thereare no costs involved:

Because there are no costs involved, the NPV willbe positive and equal to the PV In this case it is$8,052.10. This is the present value of $1,200 per yearfor 10 years at an 8 percent discount rate. This NPVcan now be compared to the more intensive huntingoperation of Wayne's other neighbor.

2. High-intensity hunting lease

Step 1. Identification of the project andobjectives. The project now involves putting inwildlife food plots, fencing, and shelters. It involvessome start-up cost (and time) as well as intermediatemanagement activities. The lease is 10 years.Objectives are to obtain additional income with someinvolvement in the operation.

Step 2. Identification of activities. With the high-intensity arrangement, Wayne, with the help of hisneighbor; has identified the following activities andtheir timings (Figure 6).

Step 3. Attach dollar values to the activities.Wayne's second neighbor paid a start-up cost of $3,000and $500/year for the hunting operation. Waynebelieves these figures are close to average for the type

of hunting lease arrangement and will probably remainthe same for the next few years. The revenues are equalto $7.50/acre x 300 acres or $2,250/ year. These alongwith the costs are summarized in Figure 7.


PV$2250[(1� .08)10

1

.08(1 � .08)10$15,097.68

PV$500[(1 � .08)10

1

.08(1 � .08)10$3,355.04


October 1998

Figure 14 . Pine-straw production: schedule of activities.

Step 4. Discount the cash flows to the present.The present net value is calculated in Equation 5 in amanner similar to that of the low-intensity lease:

Yearly management costs are calculated similarlyas shown in Equation 6:

Add $3,355.04 to the original $3,000 start-up costto obtain a total cost of $6,355.04. Using Equation 3,the NPV of the high-intensity project, therefore, is thenet present revenues minus the net present costs =$15,097.68 minus $6,355.04 or $8,742.64.

The two projects can now be compared todetermine which project has a higher financial return.The low-intensity lease agreement has a net presentvalue of $8,052.10 while the high-intensity leaseagreement has a NPV of $8,742.64. If all costs(including Wayne's time and effort) and revenues havebeen taken into account, the high-intensity projectreturns $690.54 more than the low-intensity project.Now Wayne can bring in any other nondollar variablesto assist him in deciding which (if any) level ofintensity he will choose.

Example 2: Pine Straw Production

An enterprise may produce periodic revenuesinstead of annual revenues. Pulpwood production, forexample, can provide a return every 20 to 25 years iftrees are replanted after each harvest. An alternativeenterprise compatible with timber production that hasreceived attention lately is the production of pine straw.The following example shows the steps involved incalculating the NPV of periodic returns for a 5-yearraking cycle associated with-pine straw production.

The situation: Mary Smith is contemplating thepossibility of harvesting pine straw on her 10-acresite of 5-year-old slash pine. She has heard thatplantations 10 years and older with no vegetation inthe understory can provide a profit of $60 per acreif raked and baled every five years. She has beenadvised however that her stand has too manyshrubs and hardwoods and it will cost her $1,000 toclear away unwanted vegetation. She would like toknow if the $1,000 investment needed to clean thestand will be profitable or not. She has a discountrate of 7 percent.

Step 1. Identification of the project and objective.The project is pine-straw production with an initialcost, and delayed periodic revenues. The landownerwould like to obtain additional income to pay propertyand other taxes. Participation in the enterprise is low.

Step 2. Identification of activities. Converting thepresent stand to a rakeable one may include herbicideapplication, burning, and mowing. When the plantationreaches 10 years of age, Mary will need to collect thepine-straw fee (Figure 8).


PVa[(1 � i)n

1]

[(1 � i)t1](1�i)n

PV$600[(1 � .07)15

1]

[(1 � .07)51](1�.07)15$950.27


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Figure 15 . Pine-straw production: dollar values.

Step 3. Attach dollar values to the activities.Assuming no cost of collection to Mary, the periodicexpected income in years 10, 15, and 20 is equal to the

per acre revenue times the total acres in the tract, or$60.00/acre x 10 acres for $600 (Figure 9).

Step 4. Discount the cash flows to the present . Aperiodic formula shown in Equation 7, similar to theannual formula (Equation 3), can be used to discountthe periodic cash flows to the present so Mary candetermine whether the $1,000 investment will return atleast 7 percent:

where n is the number of years (or interest bearingperiods) in the analysis and t is the interval in yearsbetween the periodic payments. In Equation 8, n is 15(age 5 to 20) and t equals 5 (payments are receivedevery five years).

Subtracting the cost of $1,000 from the presentvalue leaves -$49.73 or a negative net present value. Inthis case, the revenues to be received in the future donot justify the $1,000 investment (at a 7 percentdiscount rate). In this case Mary should look intodelaying the investment until year 9 (a year before thefirst harvest). An analysis of this could be done rathereasily using expected costs and revenues.

Example 3: Christmas Trees

An example of an enterprise where the economicanalysis involves a period of time before annualincome is received is the case of Christmas treegrowing. In this example, an investment of betweenfour and 10 years is necessary before trees can beharvested. Then, if managed properly, the trees can begrown and cut in such a manner that yearly productioncan become stable.

The situation: Roger Jones owns a small farm innortheast Florida. He has become interested innative-grown Christmas trees. He would like toknow if it can be profitable to grow trees on an acreof cropland adjacent to his pines. The acre hastraditionally given him a return of 8.35% on hisinvestment. He has the option of maintaining hiscurrent crop or investing in Christmas trees. Thetraditional rate therefore is his discount rate.

Table 1. Schedule of activities and dollar values for a hypothetical Christmas tree farm.

Planting (no site preparation needed) $ 200 (Cost)

Pruning (yearly, starting at end of year 3) $ 200 (Cost)

Other yearly operating costs (beginning $ 300 (Cost)at the end of year 1)

Est. harvest value per year for 4 years:

(150 trees/acre x $10 per tree) $ 1500(Revenue)



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Figure 18 . Christmas tree production: schedule of activities.

Figure 19 . Christmas tree production: dollar values.

Step 1. Identification of the project andobjectives. Roger is interested in planting an acre inChristmas trees. He is only interested in one fullrotation (selling in years 4 through 7). If a financialanalysis looks promising, he may decide to bring thetrees into continual production on more acres.

Step 2. Identification of activities. With the help ofan extension specialist and the local growers'association, Roger has identified a list of activities(Table 1 and Figure 10).

Step 3. Attach dollar values to the activities. The with average costs and returns for Christmas treegrowers' association was also able to provide Roger growing in northeast Florida (Table 1, Figure 11).

Step 4. Discount the cash flows to the present.The present value is calculated using first the formulafor annual payments (Equation 2), and then the formulafor present value (Equation 1). This is necessarybecause the annual revenues begin in year four andmust be discounted to the present.

First, calculate the present value of expectedrevenues. Revenues of $1,500 per acre per year areexpected in years 4 through 7. As discussed above, therevenues are not every year from the beginning sousing Equation 9, we must first calculate the PV of thefour years of revenues as of year 4 and then discountthis sum back to the present (from Equation 7):


PV4$1,500[(1� 0.0835)41]

0.0835(1� 0.0835)4$4,929.73

PV0$ 4,929.73

(1 � 0.0835)4$3,576.91

PV3$200[(1 � 0.0835)51]

0.0835(1� 0.0835)5$ 791.23

PV0$791.23

(1 � 0.0835)3$622.03

PV0$300[(1 � 0.0835)71]

0.0835(1� 0.0835)3$1,543.39

AE$1,211.50[0.0835(1.0835)8]

[(1.0835)1] $213.63per acre per year


October 1998

The "PV4" is the present value at year 4 of theinvestment. The continue with the analysis, usingEquation 10, we must bring the PV at year 4 to thepresent value at year 0, where the analysis is beingconducted from. This is done using the simplediscounting formula (Equation 1):

Costs are calculated in a similar manner, as shownin Equation 11. Cost of pruning for five years:

n=5 in this case because pruning starts at the end ofyear three and continues through the final harvest at theend of year 7. (Equation 12)

Other operating costs for the seven years ofoperation are shown in Equation 13:

Total costs = Planting costs + pruning costs + otheroperating costs

= $200.00 + $622.02 + $1543.39=$2,365.41

Net Present Value= PV (revenues)-PV(Costs)= $3,576.91 - $2,165.41

=$1,211.50 per acre

To calculate the annual equivalent of thisinvestment we substitute the variables into the AEequation (Equation 14):

Investing in this project returns the equivalent ofclose to $214 per acre per year. This figure can now becompared to more readily available annual productionfigures like corn or tomatoes, or leasing the land.

Issues In Analysis of Your Enterprise

Risk and the Financial Analysis

Many factors influence the financial success ofinvesting in an alternative enterprise. The one that mostlikely has the greatest influence is uncertainty of thefuture prices. As mentioned earlier, price is determinedby supply and demand. A change in one or the otherwill change the average market price and profitabilityof the product. Often, when potential investments areinvestigated, a range of prices is studied to determine a"break-even" price. This is the lowest price yourproduct could bring and still earn the return yourequire. For example, in the Christmas tree exampleabove, trees are sold for $ 10 each. Assuming Rogersells 150 trees as before, he could sell them for as littleas $ 6.05 each and still make his required rate ofreturn. He could also sell as little as 90 trees per yearat the $10 rate. This is known as sensitivity analysisand it can be helpful in finding your production andprice targets. It is also helpful in setting goals for youralternative enterprise.

Including Taxes in the Financial Analysis

The Tax Payer Relief Act of 1997 shows theimportance of updating financial analyses. Landownersperforming analyses under the old laws must nowreevaluate their situations. To quantify how incometaxes will affect the NPV it is necessary to makeassumptions about the tax rate for your income. Sinceincome from most of these operations is presentlytaxed at the ordinary rate, revenues should be reducedin the year they occur before discounting. Although thenew laws have made income tax calculations easier,they have complicated the deduction of expensesrelated to the management of the business. The kinds



October 1998

and amounts now depend on the extent to which youparticipate in the project.

Certain tax breaks are still available and should beincorporated in any financial analysis. Reforestationexpenses, for example, are eligible for credit andamortization. A professional tax accountant withforestry/agricultural experience should be contacted forassistance when including taxes in financial analyses.Your county extension agent and forester should alsohave numerous publications on the tax laws and howthey relate to the management of forest resources.

Marketing

Marketing your product is one of the mostimportant steps in ensuring a profitable investment. Itis also one of the most difficult. The markets for manyalternative enterprises are relatively new in the south.Getting marketing information and prices and makingcontact with interested buyers can be frustrating andtime-consuming. Some products have better definedmarkets than others. These often have associations withnewsletters and price reports. Other markets dependsolely on word-of-mouth. Marketing expenses and riskscan be included in the sensitivity analysis (see above)rather easily. These depend on the individual and themarket. Try projects where markets are good (i.e., sellall or most of the product), and poor (i.e., sell little ornone of the product).

For advice in marketing and selling the product,contact local professionals and/or county agents andforesters. It is important to remember that the marketcan change very quickly. Don't be too greedy and holdout in hopes of higher returns, but on the other hand,don't be too stubborn when the market is not good.

Recordkeeping

The new tax laws are one reason it is important tokeep detailed records of your time, expenses, andreturns although there are many other reasons.Businesses that keep accurate records find thatdecision-making is easier, success can be detected in amore timely manner, loans can be acquired more easilyand paid off more quickly, cash flow management isbetter, and the "right" price can be better set based oncosts of doing business (Cotton, undated).

Although the alternative enterprise may be takenon as a hobby or part-time investment, if the landownerwishes to determine the financial success of theoperation he or she must keep good business records.Contact your local Small Business Development Centerfor more information on how to keep records.

Using the Computer in the FinancialAnalysis

Recent developments in personal computers havemade financial analysis relatively simple and quick.Although there are only a few programs specificallydesigned for forestry analysis many general programscan be modified for use. These programs can be usedto calculate growth and yield, present and futurevalues, return on investment, and other financialinformation. Recordkeeping and sensitivity analysescan also be accomplished much easier and with greateraccuracy on the computer. Also, when cash flowexpectations are not expected to be constant thecomputation of NPV can be difficult to impossible byhand. Financial calculators and computers handle thetask easily. As the supply of personal computersincreases, more specific programs should becomeavailable. It is important to remember that the results ofa computer analysis are only as accurate as the dataused.

Assistance

There is more assistance available to thelandowner wishing to begin a new enterprise. Countyextension agents, Florida Division of Forestry foresters,the Natural Resource and Conservation Service, anduniversity personnel, among other public agencies,offer advice and assistance. Often they provide anexcellent referral service to private forestry andfinancial consultants, and growers and marketingassociations.

When looking for assistance, check credentials andtalk with as many people as you can. Assistance is likeany product: there is good assistance and bad. Makesure to include any assistance costs in your financialanalysis.

It is also possible to receive financial assistance.Although cost-sharing is limited to certain agriculturaland forestry crops (for example, the EnvironmentalQuality Incentives Program, Forest StewardshipIncentives Program, Forestry Incentives Program, andConservation Reserve Program), low-cost loans may beavailable from government (U.S. Small BusinessAdministration) and private sources.

Summary

One of the major reasons new businesses fail isinadequate planning. A landowner interested in



October 1998

managing a forestry enterprise needs to develop a This publication was not designed to take the placethorough management plan. A major component of the of qualified professional advice and assistance. It isplan is the financial analysis. This analysis includes an hoped that an understanding of the concepts introducedestimate of the magnitude and timing of all costs and here will help the landowner communicate morereturns involved in production. effectively with those who provide assistance.

The usefulness of financial analysis becomesapparent when many costs and revenues are spread outover the production length of the enterprise. Without astructured method of analyzing the situation, theaverage landowner will have a difficult time determining if a $100 investment today is worth $1,000in 20 years. This publication was designed as anintroduction to the financial concepts involved inplanning and decision-making. Although the structurefor evaluating your forestry enterprise will remain thesame, each landowner must perform his or her owncustom analysis.

Literature Cited

Cotton, John. Keeping Records in Small Businesses. U.S. Small Business Admin., ManagementAssistance and Support Services, ManagementAids No.1.017.

Duryea, M.L. (Editor). 1988. Alternative Enterprisesfor Your Forest Land: Forest Grazing, ChristmasTrees, Hunting Lease, Pine Straw, Fee Fishing,and Firewood. Fla. Coop. Exten. Serv., IFAS,Univ. Fla., Gainesville. Circular 810. 32pp.


Documents

Estimating the Profitability of Your Non-Timber …ufdcimages.uflib.ufl.edu › IR › 00 › 00 › 18 › 13 › 00001 › fr01500.pdfEstimating the Profitability of Your Forestland