AEC 3133 Exam 3 McKenzie Maples Spring 2023

Budget

a formal, written plan detailing how the firm will use it resources, what amount of sales are expected, and so on, during some future period

Enterprise budget

physical and financial plan for a specific crop or livestock enterprise, estimates expenses and receipts for a specified period of time

Cash flow budget

deals with cash, helps to establish cash needs of business over a specific planning period, usually a year, helps plan for repayment of loans, cash feasibility of a major capital purchase

Partial budget

evaluate the economic effect of minor adjustments in some portion of the business, many aspects of business are fixed and have fixed costs in the short run, can evaluate changes in resources uses that are not fixed or have variable costs

Whole farm budget

detailed list of resources of the entire business along with a plan to use these resources to achieve long-term goals, sets the direction the business will take and helps the manager attain long-term goals

Which budget is the first estimate for costs and income

enterprise budget

Enterprise budgets are developed based on

acre for crops or animal unit for livestock, but determining costs can be difficult and many people disagree over which costs to use

Variable costs (operating costs)

expenses that vary with output within a production period and results from the use of purchase inputs and owned assets

Fixed costs (ownership costs)

do not vary with the level of output and result from ownership of assets (do not change in the short run)

With enterprise budgets, depreciation should be calculated using the

straight line method based on actual years of use and typical salvage values

Total costs \=

variable cost + fixed cost

Income received may be less than total production costs, so should an operation continue?

Yes if returns are above variable costs and it’s a short term condition

Breakeven price formula

projected total cost / expected yield

Breakeven yield formula

projected total costs / expected price

Which budget does not estimate net income or profit?

Cash flow budget

Why are cash flow budgets a useful tool?

Forces you think through your farming plans, Tests your plans (Will you have enough income to meet all of your needs?), Projects how much operating credit you will need and when loans can be repaid, Provides guide against which you can compare your actual cash flows, Helps you communicate your needs to your lender

Uses for a Partial Budget

often the best way to analyze a change in operations involving several different enterprises, provides a formal and consistent method for calculating the expected change in profit from a proposed change in the farm business, form of marginal analysis

Additional Costs

costs that do not exist at current time but will be incurred if the change is made

Reduced Revenue

revenue that is currently received but which will be lost or reduced if the change is made

Additional Revenue

revenue to be received only if the alternative is adopted

Reduced Costs

costs that are now incurred which would be eliminated if the change is made

Sensitivity analysis

computing the partial budget several different times, using different price and yield figures each time, use low, average, and high values for prices and yields

Limitations of Partial Budget

can only compare the present management plan with one alternative at a time, uses one set of price and yield expectations. If these are variable, cash flow may be a problem in some years, doesn’t account for changes in value of money over time

Capital budgets

takes time value of money into account, long term investments in which assets involved have useful lives of multiple years, a method of estimating the financial viability of capital investments over the life of the investment, focuses on cash flow rather than profits

Capital budgeting steps

identify long term goals, identify potential investments for meeting the goals, estimate and analyze relevant cash flows of the investment proposal, determine financial feasibility, choose projects to implement, implement projects, monitor projects to see how they meet projections and make adjustments where needed

Capital budgeting decisions involved

evaluating the profitability of the firm’s potential investments in capital purchase

Managers need a way to make decision for capital budgeting situations that

1\.Fully accounts for the timing and amount of capital required for the investment, 2. Fully accounts for the timing and amount of added benefits likely to result over the life of the investment, 3. Can objectively evaluate capital budgeting decisions so management can maximize long-term profits

A good investment has 4 characteristics:

positive long term net profit to the firm, provides the highest long term net profit to the firm, benefits occur sooner rather than later, lowest risk

Payback method

evaluates budgeting opportunities by determining the number of periods required for the sum of benefits to be equal to the investment

Payback period formula

initial investment / cash inflow per period

Average rate of return method

measures the annual percentage of the capital invested in a project, choose the project with the highest rate of return, advantage of using all of the investment’s return in analysis, disadvantage is the size-disparity problem

In capital budgeting, the opportunity cost of money is called

the time value of money

The TVM can be found in 2 ways:

compounding and discounting

Compounding

calculating how much a dollar put into savings account today would be worth years from now

Discounting

the reverse of compounding – that is the value of tomorrow’s money today

Formula for compounding

FV = VN (1 + i/n)^N

Formula for discounting

VN = FV / (1 + i/n)^N

Net present value

discounting stream of future cash flows back to present values, the amount by which the PV of cash inflows exceeds the PV of cash outflows, a positive NPV means that the rate of return on the investment is greater than the discount rate used in the analysis

Discount rate

the cost of capital (borrowing money or using internal funds) and next best alternative (investing that money)

A firm should invest if the NPV is

positive

Benefit/Cost Ratio Method

measures relative profitability rather than total net benefits, may be preferred to NPV because it gives a measure of the benefits generated for each dollar invested

Internal rate of return method

the discount rate that makes the present value of an investment’s benefits equal to the present value of its costs, the discount rate that makes NPV zero

The essence of managerial expectations is found in

basic accounting ARTS

basic accounting ARTS

accurate, relevant, timely, simple

The Accounting Equation

assets \= liabilities + owners equity

Two group can make claims against the business

creditors and owners

\____ are legally entitled to the first claim against the business

creditors

\____ get what’s left after the creditors take what they were owed.

Owners

Assets

goods owned by the company and accounts receivable

Tangible assets

real estate and inventory

Intangible assets

intellectual property

Current Assets

either cash or an item that will become cash within the accounting period

Fixed assets

something the firm owns or uses that will not turn into cash within the next accounting period

Liabilities

obligation to pay a debt

Current Liabilities

must be paid within 1 year, accounts payable and taxes payable

Long Term Liabilities

obligations that are due after 1 year, long term notes and contracts

Liquidity

the speed and ease with which an asset can be converted to cash, has two components: ease of conversion and loss of value

A highly liquid asset is one that

can be sold quickly without a significant loss of value

An illiquid asset is one that

cannot be quickly converted to cash without a significant loss of value

The more liquid a business is, the

less likely it is to experience financial distress

Owner’s equity

estimate of the value of the firm that would be transferred to owners if all liabilities were repaid

Debits

represent an increase in asset and expense accounts or a decrease in liabilities, always listed on the left hand side of the T account

Credits

represent an increase in items such as business liabilities, owner’s equity, and revenue accounts, or a decrease in assets, always listed on the right hand side of the T account

Debits and credits are components of a

dual entry accounting system

For every credit, there is an

equal and opposite debit

For every debit, there is an

equal and opposite credit

Accounting

the process of recording, classifying, and summarizing business transactions

\____ and \___ are the starting points of most financial analysis

the balance sheet and the profit-and-loss statement

Components of the Balance Sheet

assets, liabilities, and equity

The \____ is a snapshot in time, as it is a static picture of the firm’s financial condition as of that date.

Balance sheet

How do you value crops in the field?

Accumulated costs of the crop

Why do we value crops by the accumulated costs?

Lower valuation so less risky and provides safety margin for yield loss and price risk

Income statement

financial summary of the firm’s operating results during a specified period, also called a profit-and-loss statement,

Which financial statement shows what happened between the balance sheets?

Income statement

An income statement on an accrual basis reports

revenues when earned and expenses when incurred

An income statement on a cash basis reports

revenues when received and expenses when paid

COGS

cost of goods sold

Is figuring out COGS easier for a retail firm or manufacturing firm?

A retail firm since they purchase final products while the manufacturing firm purchases raw materials and has direct manufacturing costs

Gross margin

the difference between sales and COGS

How do you raise Gross Margin?

Increase price thus increasing sales or decrease COGS

Operating expenses

costs associated with production and operation of the business (variable and fixed expenses)

Examples of operating expenses

wages, commissions, advertising, insurance, rent, repairs, utilities, depreciation

As fixed assets are “used up”, they become an expense to the business through

depreciation

Straight line depreciation method

(acquisition cost – residual value) / expected life

Which statement ties together the income statement and previous and current balance sheets?

Statement of cash flows

Components of the Statement of Cash Flows

cash flow from operating activities, cash flow from investment activities, cash flow from financing activities

Cash flow from operating activities

your everyday operations of the farm, inflows include cash from farm production and government payments, outflows include farm expenses, income taxes, and family living withdrawals

Cash flow from investing activities

capital purchases and long term investments, inflows include sale of capital, savings deposit withdrawals, and sale of personal assets, outflows include purchase of capital and deposit of savings

Cash flow from financing activities

how do you obtain money, inflows include obtaining a loan, outflows include payment of debt and capital lease payments

Ratio analysis

involves methods of calculating and interpreting financial ratios to analyze and monitor the firm’s performance

Financial ratios can be used to

benchmark against other firms

Benchmarking

comparing the firm’s financial ratio values to those of the industry average, key competitors or firms that is wishes to emulate

Solvency

the ability of a firm to meet its long term financial commitments, sometimes called leverage

Comparative Statement Analysis

compares two statements, examined for any significant changes that could affect the financial conditions of the firm

Net Working Capital

the difference between current assets and current liabilities expressed on the balance sheet, the amount of cash available to meet day to day and unexpected expenses

Inadequate working capital means the firm may

have trouble paying bills, taking advantage of business opportunities, and meeting emergencies

Net working capital formula

current assets – current liabilities

Activity Ratios

The level of activity of the business relative to its inventory levels, customer credit repayments, and its own bill payments

Accounts receivable turnover ratio

measures how long a firm must wait to receive money from sales made on credit

Accounts Payable turnover ratio

measures how fast a firm pays its own bills