UNDERSTANDING FINANCIAL MANAGEMENT SKILLS NEEDED …oer.ui.edu.ng/sites/default/files/Okoruwa presentation.pdf · UNDERSTANDING FINANCIAL MANAGEMENT SKILLS NEEDED FOR FARMING Victor

UNDERSTANDING FINANCIAL

MANAGEMENT SKILLS NEEDED FOR FARMING

Victor O. Okoruwa (Ph.D)

Professor of Agricultural Economics

University of Ibadan

Wednesday, 22 November 2017

1

Outline of presentation

❖Preambles

❖Financial Management

❖Farm Record and Accounting

❖Financial Management and Agricultural

Enterprises

❖Tips for Preparing Feasibility Report

❖Conclusion


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Preambles

Although resources are scares some are available to the farmer to use in order to maximize his income and other welfare objectives.

However, farmer has to make constant decisions for several reasons :

• The environment where he operates is dynamic ( input and output price change)

• Not limited to a choice; as there are several alternative ways of combining resources and must identify the one that maximizes his income.

• The farm manager/financial manager needs to raise funds at acceptable interest rates which depends on a good maintenance of the financial records and accounts.


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Preambles Cont’d

As a business person, you engage in various activities

whereby money flows through your business.

Essentially, you have money coming into your

business and money going out of your business.

These money flows are called transactions.

Money will flow into your business from four main

sources, and it will flow out of your business for four

main reasons – each is essentially the opposite of the

other.Wednesday, 22 November 2017

4

Financial Management Cont’d

Financial management refers to:

Wise management of a business/ its

finances or funds

✓A prudent management of farm capital

resources is a major determinant of the

farm’s success

✓Good financial management is

required for the following reasons:

- Capital is scarce.

- It is crucial in profit maximization a

major goal of privately owned farms.

- Aids access to investment capital

from financial houses

✓It is a decision making process which

involves:

Objectives, problem, information,

analysis, decision, implementation,

responsibility, evaluationWednesday, 22 November 2017

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Financial Management Cont’d

In order to protect all parties, transactions are

supported by documents recording their

details, hence farm management involves:

➢Farm Records and Accounting

➢Agric Finance and Credit

➢Farm Project Management


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Farm Record and AccountingFarm record is the sine qua non of effective farm management

and the backbone of farm enterprises aiming at profit

maximization.

Most important reason for good records keeping is that it’s a

legal requirement. Others include:

Monitor the health of your business- to evaluate the

performance of your farm or farm enterprise within a

given period of time and be able to make sound business

decisions e.g, by keeping track of debtors and creditors

To aid in making farm management decisions e.g control of

labourers , machineriesWednesday, 22 November 2017

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Farm Record and Accounting

For credit purposes -demonstrate your financial position

to banks and other lenders, and also to prospective

buyers of your business

For taxation and insurance purposes- to manage your

cash flow so you can pay your tax when it falls due

For planning purposes- These include farm maps and

grazing, irrigation, fertilizer use, crop yield, areas

and management operations records


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Farm RecordsTypes of Farm Records

Type and number of farm records kept by the farmer depends on what he/she considers to be relevant to the business.

✓Inventory records

✓Production records

✓Expenditure and income records

✓Special or supplementary recordsWednesday, 22 November 2017

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Farm Records Cont’d

Inventory Records

The complete count and evaluation of all assets and

liabilities on the farm at a specified date. (Assets/

Liabilities should be defined)

Shows the net worth and stock of the farm at a point in

time.

Records the expenses due to depreciation.

An inventory is taking by first the physical count of

assets (fixed and working) and liabilities and listing

them; and secondly making a valuation of the listed

items.Wednesday, 22 November 2017

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Production Records

• Physical records of quantities of inputs used in the production process and the outputs obtained from the business (crops and livestock husbandry must be recorded)

• Labor input records for each enterprise in either mandays or man hours fall into this category.

• Machinery and other service recordsWednesday, 22 November 2017

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Farm Records Cont’dExpenditure and Income Records• They are derived from production records;

designated in monetary terms.• They contain basically purchases and expenses and

sales.

Supplementary or Special Records• They include maps (soil, farm) and legal document

soft the farm.• Farm layout and soil map are necessary for

consistent planning and economical use of the land.


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Farm Records Cont’dMeasures derivable from farm records used assessing the

farm business include-Aggregate; Ratio measures andEfficiency measures

➢Aggregate measures include:

✓Networth statement or the balance sheet

✓Income statement or profit and loss statement

➢ Ratio measures used to compare farms of all sizes arepreferred because it is unitless and derived from theNetworth statement:

✓Net Capital Ratio (NCR) -ratio of total assets to total liabilitiesmeasures the farm’s degree of financial safety


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This

determine the

overall

performance

of a farm

within a

specified

period- total

value of asset

less total

value of

liabilities

NETWORTH STATEMENT OF A MIXED FARM

ASSETS LIABILITIES

Item Value

Current Assets (Naira)

Cash in Hand 500

Stocks for Sale 1,500

Accounts Receivable 1,200

Working Assets

Feed in Stock 500

Supplies 200

Harvested Crops 9,000

Fixed Assets

Land (including crops on land) 3,000

Buildings 10,000

Machinery and Equipment 15,000

Dairy Cows and breeding stock 15,000

Total Assets 55,900

Item Value

Current Liabilities (Naira)

Debts due for payment 500

Medium Term Liabilities

Debts due for payment in a 12,000

to two

Long Term Liabilities

Mortgages 5,000

Debts due for payment in a

long term

Total Liabilities 37,500

Networth 18,400

Net Capital Ratio (NCR) = 55,900

37,500 = 1.49

Working Capital Ratio (WCR) = 12,900

12,5𝑂𝑂 = 1.03

Current Capital Ratio (CCR) = 3,200

500 = 6.40 Wednesday, 22 November

201714

INCOME STATEMENT OF A MIXED FARM

EXPENDITURE (DEBITS) INCOME (CREDITS)

Item Value

Operating Expenses (Naira)

Machinery and equipment 400

Upkeep

Labour hired 2,200

Fertilizers and other chemicals 650

bought

Seeds and planting materials 1,000

Bought

Livestock feed bought 1,300

Medicines bought 200

Supplies bought 50

Total Operating Expenses 5,800

Fixed Expenses

Taxes paid -

Interest payments 500

Insurance payments -

Management expenses -

Total Fixed Expenses 500

Total Cash Expenses 6,300

Item Value

Crop Sales (Naira)

Rice 5,000

Maize 3,000

Yam 2,000

Beans 2,500

Other crops 1,200

Total crop sales 13,700

Livestock Sales

Cattle -

Milk 1,500

Pigs -

Poultry (chicken) 1,600

Eggs 2,200

Other livestock sales -

Total livestock sales 5,300

Other Receipts

Receipts from hired-out machinery 500

Gross Cash Income 19,500

A snapshot of the

production

cycle’s

performance and

shows areas

where

expenditure is

high and which

enterprise is

bringing in high

revenue


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✓Working Capital Ratio (WCR)- ratio of the sum of

working capital and current assets to the sum of

medium term and current term liabilities and

measures the degree of financial safety of the farm

over an immediate period of time.

✓Current Capital Ratio (CCR) - ratio of the sum of

current assets to sum of current liabilities and

measures the degree of immediate solvency of the

farm, that is, the ability of the farm to meet current

obligation.


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Other measures computed farm records

✓Yield per hectare

✓Crop yield indices

✓Gross margin

✓Fertilizer input per hectare

✓Eggs per hen

✓Number of pigs weaned per litter etc

✓Gross Margin


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Criteria for record keeping

➢They must be useful

➢Must be kept in such a form that they can be

easily converted into information

➢Keeping systems must be simple

➢Duplication must be avoided as much as possible

➢Must lead to actions being taken

Financial Management in Agricultural

EnterprisesFinancial management refers to the management of the

farm’s capital resourcescapital resources are grouped as:✓ Fixed Capital/Assets✓Working Capital/Assets✓ Current Capital/Assets

Farm Networth Statement, Income Statement as well asthe Farm Cash flow are the basis for farm FinancialManagement. Four categories of ratios can becomputed from these which will aid farm financialdecisions. They include: Liquidity ratio, leverage ratio,acidity ratio and profitability ratio


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Financial Management in Agricultural Enterprises

Liquidity Ratios-measure the capacity of the farm to

meet short term obligations

The Current Ratio (discussed earlier)

Current Assets Current Liabilities

The Quick Ratio also called the acid test is given by

Current Assets – InventoriesCurrent Liabilities


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Enterprises Cont’dLeverage Ratios: -measure the ability of the farm business to honour short and long

term obligations. A highly leveraged farm is not in any good position to pay off debts;

a a business should aim at low leverage ratios. The ratios include:

Total Debt/Total Assets Ratio = 1 OR Total Debt(Liabilities)

NCR Total Assets

Debt/Equity (Net worth Ratio) = Total Debt (liabilities)

Equity (Net worth)

measures ability to honour long term obligations

Times Interest Earned Ratio (TIER) measures the ability to honour its

interest and tax payments given by:

EBIT (Earnings Before Interest and Taxes )

Interest and Taxes to be paid

If the ratio is unity -the farm has just earned enough to pay interest and taxes.Wednesday, 22 November 2017

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Enterprises Cont’d

Activity Ratios-measure the intensity of use of assets on the farm; they include the

following:

Inventory Turnover (I.T) measures rate at which inventories are sold given by

Total Sales

Average of Inventories

Fixed Asset Turnover (FAT) measures the intensity of fixed assets used

Total Sales

Fixed Assets

The higher the ratio the more fixed assets are being used up in the

production process.

Total Assets Turnover (TAT) measures the rate at which total assets are used up in

the production and sale of goods and services and given by:

Total Sales

Total AssetsWednesday, 22 November 2017

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Enterprises Cont’d

Average Collection Period (ACP) measures the time lag between sales and cash

received from buyers given by:

Accounts Receivable

Average Sales Per day

It is important in taking decisions because it partly determines the ability to

meet monetary obligations. An increasing ACP over times indicates the need

to tighten credit sales.

Profitability Ratios-gives an indication of whether the business is getting more

profitable or less profitable over time and the factors responsible for the increase or

decrease

Net Operating Margin (on Sales) (NOM) an indicator of ‘good’ or ‘bad’ business

given by:

Operating Income

SalesWednesday, 22 November 2017

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Enterprises Cont’dOperating income refers to sales less the cost of goods sold and

operating (marketing) expenses. It is also called ‘profit’. An

increasing NOM show indicates a good business and vice versa

Profit Margin on Sales (PMS) indicates the relationship between

profit and sales given by:

Net ProfitSales

Net profit refers to operating income less fixed expenses such as

insurance charges, depreciation, interest expenses and taxes.Wednesday, 22 November 2017

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Preparing Feasibility Reports

✓This is necessary when requesting a loan from abank.

✓It involves being able to evaluate a project andmaking financial plans for it.

✓The amount of equity capital, loan capital andincome as well as its sources should be stated indetail.

✓The loan repayment schedule the use to which theloan will be put and the overall csh flow for theinvestment period should be included


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Conclusion

The success of any farm business depends on its financial strength and for this to happen there is a need for proper record keeping of every activity taken placing within the business and the available resources used for carrying out these activity. Record keeping is a veritable way of ensuring a business is sound and would attract ore investment for expansion.


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Documents

UNDERSTANDING FINANCIAL MANAGEMENT SKILLS NEEDED …oer.ui.edu.ng/sites/default/files/Okoruwa presentation.pdf · UNDERSTANDING FINANCIAL MANAGEMENT SKILLS NEEDED FOR FARMING Victor