FINANCIAL MANAGEMENT OF CATFISH FARMS
Catfish Growth-Cash flow Models
The two following Excel
spreadsheets may help you project future fish growth and monthly harvest and
feed costs to generate your cash flow budgets.
(User Manual)
- Model 1 (To DOWNLOAD this 11 MB Excel file, right-click here and select "Save Target As...".)
If you get in a situation where you don't have enough money to purchase all the feed you would need to feed all your fish to satiation, you need to allocate your limited amount of feed in a way that will maximize your sales and improve your cash flow. If you simply distribute your limited amount of feed equally among all your ponds, only a minimal amount of fish will be able to reach market size. The best way to approach the problem is to target the ponds that have large biomass of fish close to market size and feed those ponds more intensively to maximize sales.
Ideally, all ponds should be fed to satiation, but we don't always have the money to do so. This Excel spreadsheet may help you identify which ponds need to be fed to satiation and which ponds can be cut back on feed in order to maximize your fish sales and cash flow.
- Model 2 (To DOWNLOAD this 14 MB Excel file, right-click here and select "Save Target As...".)
This Excel spreadsheets may help you project short term fish growth and monthly harvest and feed costs to generate your cash flow budgets.
There are financial considerations that can be as important to the economic feasibility of a business as profitability. Positive cash flow can often make the difference between success and failure of an aquaculture business, especially in the early years of a business start up.
A cash flow budget is one of the most useful financial instruments. It provides critical insights into whether the business will have adequate cash available when needed to meet its financial obligations. It can be used to evaluate borrowing needs and to determine cash needed to repay any new loans.
Cash flow budgets can be structured differently depending upon the purpose for which the analysis is being developed. For detailed financial planning, monthly cash flow budgets are useful. Quarterly budgets can be used to develop estimates of cash flow needs over a several-year period. Annual cash flow budgets are used in investment analyses to determine cash flow over the life of the investment.
There are certain key principles to keep in mind when constructing a cash flow budget. As trite as it may seem, it is important to keep in mind that only cash inflows and outflows are considered. No non-cash revenue or non-cash expenses are considered. Thus, a cash flow budget cannot be used to measure profit. The enterprise budget or the income statement is used to measure profit, not the cash flow budget. For example, depreciation is not included in the cash flow budget, but payments of principal and interest on all loans is. Inventory values are not included, but the proceeds from sales of any capital assets are included.
A primary concern in the cash flow budget is the timing of receipt of revenue and of expenses. Each type of revenue or expense is charged during the specific period when it is incurred. Thus, if a major capital asset is purchased during a given period, it is charged at that time in its entirety.
The cash flow budget begins with a beginning cash balance or the amount of cash on hand at the beginning of the period. This is followed by each source of farm cash revenue generated by sales of the crop or of other capital assets. The cash revenue items are summed to generate total cash inflow for the time period.
Expenses are itemized first of operating expenses. This is followed by expenses associated with the purchase of capital assets such as equipment or breeding stock. When the cash flow budget is to be used for applying for financing for loan, family living expenses are also included. The next section on expenses includes principal and interest payments for each separate loan. All expenses are summed to calculate total cash outflow.
The difference between total cash inflow and total cash outflow is the cash available. If the cash available is negative, this means that there is insufficient cash generated during the period to meet all cash obligations and additional borrowing is needed for that time period. After adding in the new borrowing, the cash balance is obtained. Cash balance becomes the beginning cash available at the start of the next time period.
At the bottom of the cash flow budget, it is useful to keep an accounting of the debt outstanding for each loan. In this manner, principal payments in a time period can be subtracted out of the balance owed.
Presentation given by
Dr. Carole Engle (March 23, 2004)
(click
here to see the PowerPoint Presentation)
Topics covered: price cycles, financial indicators, options on how to improve profitability, catfish market, and marketing.
OTHER MANAGEMENT TOOLS
The purpose of a business is to make money, or to generate profits. This would seem to be a simple and straight forward concept. Efficient management of a catfish farm can make the difference between profits and losses especially in years with unfavorable prices and costs. However, farm management involves more than just taking care of the biological processes involved; it includes paying close attention to economic and financial measures of the farm business. There are three key statements that are used for the financial analysis of a business: Income statement, balance sheet, and cash flow statement.
This CD provides an overview of economic and financial indicators and analyses to use to better understand the performance of a catfish farm business. It also contains Excel spreadsheets with exercises to help you get familiar with the calculations. You may use the spreadsheets provided to calculate your own financial statements. This should assist farm owners and managers to make more informed management decisions.
Simply click on the yellow links to access the information and spreadsheets.
Monitoring Business Performance
Monitoring Profits (Income Statement)
The income statement, or profit and loss statement is used to monitor profits in a farm business from one year to the next. The income statement itemizes all farm income and all farm expenses. The fundamental indicators calculated in the income statement are net farm income from operations and net farm income.
Expenses are divided into cash and non-cash (depreciation) expenses. Thus, insurance and concession are included under Cash Operating Expenses along with variable costs. Accounts payable that have not been canceled and non-cash depreciation follow. Net Farm Income From Operations is obtained by subtracting Total Expenses from Revenue. Any gain or loss from the sale of capital assets such as machinery or land would be used to adjust Net Farm Income From Operations to calculate Net Farm Income.Monitoring Solvency and Liquidity (Balance Sheet)
Solvency and liquidity are important financial measures of the overall well-being of a business. Solvency refers to the value of the assets owned by the business as compared to the amount of liabilities. Assets, of course, refer to the value of anything owned by the business whereas liabilities refer to any debt obligations that the business has outstanding. Liquidity
refers to the ability of a business to meet cash flow obligations. Liquidity is critical to maintain smoothly running financial transactions of the business.
A financial instrument known as the balance sheet is used as the basis for measuring and monitoring solvency and liquidity in the farm business. The balance sheet lists all assets and liabilities for the business. Net worth is calculated on the balance sheet by subtracting the total value of all liabilities from the total value of all assets of the business. Net worth is also referred to as owner equity.
The current assets include the cash, supplies on hand, and accounts receivable for the farm. Noncurrent assets list owned equipment and farm infrastructure. Current liabilities include the payments due within a year. Noncurrent liabilities include the remainder of the equipment and pond construction loans.
Over time, the net worth should increase as the liabilities decrease and assets increase through equity gained with payments of principal.
To DOWNLOAD an example of an BALANCE SHEET with exercises, right-click here and select "Save Target As..."
Production and Input Use Efficiency
Production efficiency refers to biological measures that are maintained by most farms. The key variables to use here would include measures such as yield of foodfish per acre, survival, etc. Input use efficiency measures can also be used to evaluate farm efficiency. The feed conversion ratio is an important measure of input use efficiency, but similar measures can be calculated for labor, utility use, and other inputs. The farm manager should review these types of measures at least once a year and compare them with previous years. This manual will concentrate on economic and financial measures and will not go into production or biological efficiency measures.
Financial efficiency measures are designed to measure solvency and liquidity and to identify weaknesses in structure or mix of types of assets and liabilities. The primary sources of data to calculate financial measures are the balance sheet and the income statement.
Solvency refers to the value of assets owned by the business compared to the amount of liabilities owed. The source of data to calculate solvency is the balance sheet. Common measures of solvency include the following:
The debt/asset ratio is a common measure of business solvency. It is calculated by dividing total farm liabilities by total farm assets using current market values for each.
Debt/asset ratio = total farm liabilities
total farm assets
Smaller values are preferred to larger ones. Smaller values indicate a better chance of maintaining the solvency of the business should it be faced with a period of adverse economic conditions. Low debt/asset ratios may also indicate that a manager is reluctant to use debt capital to take advantage of profitable investment opportunities. Value less than 1 indicates a solvent business. High ratio is typical of new farm businesses. This indicator should decrease as equity in the business grows.The equity/asset ratio indicates what part of total assets is financed by the owner’s equity capital.
Equity/asset ratio = total equity
total assets
Higher values of the equity/asset ratio are preferred, but the value of this ratio cannot exceed 1. If the equity/asset ratio = 1, liabilities then must be 0. An insolvent business would have a negative equity/asset ratio because equity would be negative. Over time, as the loans are paid off, equity will increase in relation to the level of assets.The debt/equity ratio is also called the leverage ratio. The debt/equity ratio compares the proportion of financing provided by lenders with that provided by the business owner.
Debt/equity ratio = total liabilities
total equity
When the debt/equity ratio = 1, lenders and owner are providing an equal amount of financing. Smaller values of the debt/equity ratio are preferred. The debt/equity ratio will approach zero as liabilities approach zero. Very large values result from very low equity, which means an increasing chance of insolvency. High value indicates a relatively high level of financial risk in the early years of a business.A change in net worth indicates business growth, additional capital investment, and a greater borrowing capacity.
Net Worth = Total Assets – Total Liabilities
The owner would want to see net worth increase over time.Liquidity is the ability of a business to meet cash flow obligations. Liquidity is important to keep financial transactions of the business running smoothly. The source of data to calculate liquidity is the balance sheet. Common measures of liquidity include the following:
Current ratioThe current ratio is a quick indicator of a firm’s liquidity. Current assets will be sold or turned into salable products in the near future and will generate cash to pay debt obligations that come due.
Current Ratio = current farm assets
current farm liabilities
The higher the value of the current ratio, the more liquid. In future years, this value should increase because inventories will increase asset levels and payments on debt will lower liability levels.Working capital is the difference between current assets and current liabilities. It represents excess dollars available from current assets after current liabilities have been paid.
A business that is both solvent and liquid will not necessarily be profitable. Profitability is calculated generally by subtracting total costs from total revenue. It is measured from the income statement. However, net farm income can be further partitioned into returns or profits attributable to each of the four primary factors of production: land, labor, capital, and management. Returns to capital can be further partitioned into returns to equity capital (capital owned by the farmer).
Net Farm IncomeNet farm income measures the return to operator’s equity, capital, unpaid labor, and management. It is measured from the income statement. Net farm income is measured as follows:
Total revenue
Less total expenses
Equals net farm income from operations
Plus or minus the gain/loss on the sale of capital assets
Equals net farm income.The gross farm revenue “pie” can be divided among the parties who supply resources to the farm business.
Return to Labor and ManagementThe return to labor and management is what remains from net farm income after charging out returns for the use of all capital. Some businesses have more assets or borrow more money than others.
Return to labor and management is calculated as follows:
Net farm income from operations
Plus interest expenses
Equals adjusted net farm income
Less opportunity cost of capital.The returns to labor and management can be further partitioned into returns to either labor or returns to management. These measures indicate whether net farm income was sufficient to provide a return at least equal to the opportunity costs of labor and management.
Return to labor is calculated as:
Return to labor and management
Less opportunity cost of management
Equals return to labor.Return to management is that portion of adjusted net farm income remaining after opportunity costs of both labor and capital have been subtracted. It represents a residual return to the owner for the management input. Negative returns to management are not unusual, but positive net returns should be the goal. Returns to management are calculated as:
Return to labor and management
Less opportunity cost of labor
Equals return to management.Rate of Return on Farm Assets (ROA)
The Rate of Return on Farm Assets can be compared to rates of return on other long-term investments. It is calculated as follows:
Rate of return on assets (%) = return to assets x 100
average farm asset value
The ROA is independent of the type and amount of financing. It can be compared to other similar farms, returns from other investments, opportunity costs of the farm’s capital and past ROA’s for the farm to measure profitability.
Return to assets is calculated as follows:
Adjusted net farm income
Less opportunity cost of unpaid labor
Less opportunity cost of management
Equals return to assets.Rate of Return on Farm Equity (ROE)
The Rate of Return on Farm Equity is more indicative of the farm’s financial progress. It measures the percent return to owner’s net worth or equity. If the farm has no debt, the Return on Equity is equal to the Return on Assets. It is calculated as:
Rate of Return on Equity (%) = return on equity x 100
average equity
The return on equity is calculated as follows:
Net farm income from operations
Less opportunity cost of unpaid labor
Less opportunity cost of management
Equals return on equity.The operating profit margin ratio measures the proportion of gross revenues left after paying expenses. It is calculated as:
OPMR = return to farm assets
gross revenue of farm
The higher the value, the more profit the business is generating per dollar of revenue. For example, if the operating profit margin ratio is 0.268 it indicates that, for every dollar of revenue, 26.8 cents remained as profit after paying the operating expense needed to generate that dollar.Farms with large investments in fixed assets such as land and few operating expenses will show a higher OPMR. Farms with more rented assets will have a higher ROA but a lower OPMR. The only problem is if both ROA and OPMR are below average, then problems of profitability are evident.
A carefully prepared and well-thought out business plan is an essential step in either initiating or monitoring the financial performance of a business. There are two major components of a business plan: the marketing plan and the financial analysis.
The marketing plan is often the most overlooked component of a business plan. Many growers focus on the technical aspects of fish production and do not spend time considering market opportunities. Yet the most successful aquaculture businesses often are those that are market-oriented, have diverse markets, and are committed to their customers.
A potential producer should begin by talking to all local retail operations that handle the aquatic crop to be raised. Even if the grower intends to sell strictly to a processing plant, it is important to understand the product qualities and characteristics expected by the retail operators and end consumers. For those who intend to sell directly to a processing plant, some key considerations are:
1. Historical prices paid.2. Dockage rates (poundage or percentage deducted from the total delivery rate) for trash-fish, out-of-size product, etc.
3. Transportation charges.
4. Payment frequency to growers.
5. Delivery volume requirements.
6. Quality standards, procedures, and requirements including flavor scores, sizing, and meat quality.
7. Delivery quotas and scheduling patterns for delivering product.
8. Availability of delivery contracts.
The business plan should include a thorough discussion of the proposed production system. Stocking rates, post-larvae sources, anticipated feed rates, and aeration strategy need to be presented clearly and consistently. For example, the feed rate should be appropriate for the stocking rate; low stocking rates do not require intensive aeration. Possible production problems such as disease occurrence should be mentioned.
There are many excellent books on the preparation of a business loan proposal on farm management, and on the financial analysis of agricultural businesses.
The business plan should include the following financial statements:
1. Annual estimated costs and returns. Also known as an enterprise budget, this statement is described above.2. Estimate of required financing. The business proposal must clearly summarize financing requirements for the fish farm. Required financing should be divided into the following loan categories: operating, equipment, and real estate.
The amount of capital for an operating loan is based on the amount of variable cost required. Equipment loans cover the purchase of any new or additional equipment necessary, while a real estate loan covers the cost of constructing ponds, buildings, or other relatively permanent structures. Repayment schedules should be specified to demonstrate how revenues will cover debt payments.3. Proforma Balance Sheet. This statement is described above. Minimum standards used by lenders to evaluate the current ratio (also referred to as working capital on current position asset/liabilities) range from 1.3 to 1.5 with the higher level being preferred.
4. Proforma Income Statement. This statement is described above in detail.
5. Proforma Cash Flow Budget. This statement is described in detail above. Cash flow budgets need to be prepared for each year of the life of equipment that is financed. Family living expenses should be included in the cash flow budget to ensure that the need for income for family support does not conflict with business cash needs.
6. Personal financial statement. This is only required for business plans that will be used to request a loan.
7. Brief resume of borrower. This is only required for business plans that will be used to request a loan. Operating capacity and management skills will be critical to the success of the shrimp business. If the owner does not have these skills, the business proposal must include funds to hire a manager.
In evaluating a business plan and loan application, lenders will take into consideration several factors. The overall character and honesty of the individual is considered. Owner equity, the current ratio (from the balance sheet), the loan to appraisal value, and the value of farm production are key indicators for many lenders. Earnings will be examined in great detail along with repayment capacity. These will be viewed in terms of sustaining production over a three-year price cycle. Collateral and capital of the individual operator will also affect the level of the lender’s decision.
Capital on a farm or other business can be used in two general types of investments:
1. Operating inputs
2. Capital assets such as land, machinery, buildings, and orchards.
Analytical methods used to evaluate the two different types of capital use need to be different because timing of expenses and returns is different. Production inputs have expenses and returns typically within one year or less whereas investments in capital assets mean large initial purchases and then additional operating expenses and returns spread over a number of future time periods. Investment refers to the addition of intermediate and long-term assets to business. These types of assets have long-lasting consequences.
Three principle indicators of investment returns will be presented:
1. Payback period
2. Net present value
3. Internal rate of returnThe payback period is the number of years it would take for an investment to return its original cost through the annual net cash revenues it generates. If net cash revenues are constant each year, the payback period can be calculated as follows:
where = payback period in years
= amount of investment
= expected annual net revenue
Where annual net cash revenues are not equal, they should be summed year by year to find the year where the total is equal to the amount of the investment. The payback period can be used to rank investments according to the payback period (a shorter period is better). The payback has the advantage of being easy to use, and it quickly identifies investments with the most immediate cash returns. Disadvantages of the payback period are that it ignores any cash flows occurring after the end of the payback period and it ignores the timing of cash flows during the payback period. The payback period is more a measure of the investment’s contribution to liquidity than to profitability. It is not the best method for evaluating the profitability of an investment. According to the annual cash flow budget presented in Figure 8, the payback period for the 350-ha shrimp farm would be 0.58 years. This is calculated from the average net cash flows over the 10-yr useful life of the ponds. Nevertheless, the cash flow budget shows that it would be well into the second year before this level of investment would be paid off.Net present value (NPV) is also known as the discounted cash flow method. Net present value is equal to the sum of the present values for each year’s net cash flow less the initial cost of the investment. Present value (PV) is equal to the current value of a sum of money to be received or paid in the future. It is found using a process called discounting (future value discounted back to the present to find the present value). It is equal to the sum of present values for each year’s net cash flow less the initial cost of the investment. It can also be viewed as that sum of money which would have to be invested now at the given interest rate to equal the future value on the same date (interest rate is called the discount rate). Compounding and discounting are opposite or inverse procedures. A present value is compounded to find its future value and a future value is discounted to find its present value. Mathematically, NPV is calculated as follows:
where = Net Present Value
= net cash flow in year n
= discount rate
= initial cost of investment
Investments with a positive net present value would be accepted; those with a negative NPV rejected and zero value makes the investor indifferent. With a positive NPV, the rate of return of the investment is higher than the discount rate used, and it is greater than the opportunity cost of capital used as the discount rate. The limitations of the NPV analysis are that it depends on the discount rate and that it does not determine the actual rate of return.The internal rate of return is the actual rate of return on the investment with proper accounting for the time value of money. It is also called the Marginal Efficiency of Capital or Yield on Investment. The equation used is that for the NPV, but the equation is solved for I, the interest rate when NPV = 0. This equation is actually difficult to solve. It requires trial and error, but it can be solved through Microsoft EXCEL and other programs. Its interpretation is that any investment with an IRR greater than the opportunity cost of capital is profitable. Some investors select an arbitrary cutoff point. Unlike the NPV, it can be used to rank investments which have different initial costs and lives. The limitation of the IRR is that it implicitly assumes that annual net returns or cash flows can be reinvested to earn a return equal to the IRR. If IRR is fairly high, this may not be possible and the IRR may overestimate the actual rate of return. The IRR calculated for the 350-ha shrimp farm in Figure 8 was 98%. Since this is higher than the 20% interest rate on savings accounts prevalent in Honduras (which would equate to the opportunity cost of capital), the conclusion would be that the investment in this farm operation would be a profitable investment.