In the second of a four-part series offering a step-by-step guide to approaching credit analysis in FINPACK, we focus on the Financial Analysis tools in the software with the information required for each and the purpose and use of each tool. Subsequent posts will look at Projections and Credit Analysis. See our previous post on Data Sources and analysis preparation here.
Once we have our data sources entered into FINPACK, the next step is to decide which Financial Analysis tool(s) you are going to use. These tools are used to analyze the past performance of the particular client. FINPACK has specific Financial Analysis tools available for agricultural and commercial customers.
Let’s first review the agricultural tools available, which include Net Worth Analysis, Schedule F Cash to Accrual Analysis, or Global Cash Flow. You will likely be working with a customer prepared balance sheet that has assets valued at a mix of cost and market values. and the income statement provided is likely a Schedule F tax form for the farm business.
Earned Net Worth Analysis (ENWA)
The Earned Net Worth Analysis tool allows you to differentiate net worth change attributed to earnings versus net worth change coming from asset valuation changes.
Information Required
- Beginning balance sheet for the analysis period. This can be dated at any point in the year, so does not have to be a fiscal year-end balance sheet.
- Ending balance sheet for the analysis period. (It is best if this is about a year later.)
- Information on any capital purchases made during the analysis period.
- Information on any capital sales made during the analysis period.
The ENWA tool does NOT require the balance sheets to be fiscal year-end. This means you can analyze periods other than the fiscal year of the client’s operation.
Purpose of the Earned Net Worth Analysis (ENWA) Tool
ENWA is a flexible analysis tool allowing you to remove changes in market valuations from the total net worth change of the operation. This allows you to determine the amount of net worth change resulting from earnings of the business. Earned Net Worth change is often the best indicator of financial performance of a business, and is a proxy for profitability. Earned net worth can also be used to calculate repayment capacity of the farm business during the analysis period.
By entering a few more pieces of information, the Earned Net Worth Analysis also allows you to estimate net farm income for the analysis period.
Schedule F Cash to Accrual Analysis
The Schedule F Cash to Accrual Analysis uses the basic cash income and expense information received from the farm client, the Sch. F tax form, to arrive at an accrual adjusted net farm income for the fiscal year. This FINPACK analysis tool provides a more complete picture of past year’s farm financial performance.
Information Required
- Schedule F tax return(s) for the fiscal year you wish to analyze.
- Two fiscal year-end or ‘bookend’ balance sheets. For calendar tax year filers, this means December 31st or January 1st balance sheets.
- Information on any capital purchases made during the fiscal year.
- Information on any capital sales made during the fiscal year.
- Other related items that may not be listed on the Schedule F or may be on other Tax Forms, such as the 4797. This includes things like livestock cull income, feeder livestock purchases, hedging information, the value of labor and management, personal income, and family living expense estimates.
- Use this Schedule F Analysis Input Form to help with collecting this additional information from your clients.
Purpose of the Schedule F Cash to Accrual Analysis Tool
This tool allows you to take a cash-based Schedule F Tax Form from your client and calculate an accrual adjusted net farm income. Using accrual adjusted income in your analysis is important because it provides a more complete picture of the farm’s financial performance. Simply relying on the cash-based Sch. F income can be misleading given the tax laws related to farm income.
For example, say two farms (Farm A & Farm B) both have net incomes of $100,000 on their Schedule Fs. This makes it seem both farms had strong years. But if we make the necessary accrual adjustments (factoring in changes in inventories, prepaid expenses, and the like, and use economic depreciation methods), we learn the true profitability of the farm operations for the year. Farm A had a poor production year, with lower ending inventory values, leading to an accrual adjusted loss of $20,000 while Farm B made $210,000 of profit when factoring in good yields, more prepaid expenses, etc. Accrual adjustments give the full picture of profitability, showing the actual financial performance of these two farms.
Global Cash Flow Analysis (GCF)
Many businesses today have complex multi-entity structures. In agriculture you may see one operation with a land holding entity, a crop farming entity, a cattle backgrounding entity, and a trucking entity. Multiple entities can make it rather difficult to accurately analyze the cash flow performance of the business as a whole.
So, enter the Global Cash Flow tool to find out if Peter is robbing Paul or vice versa.
Information Required
- The appropriate tax return for each entity AND individual AND guarantor involved in the ‘global’ lending relationship of the business.
- Optional: Balance sheets for each entity, individual, and guarantor are optional data entry points.
Purpose of the Global Cash Flow Analysis (GCF)
The Global Cash Flow analysis tool in FINPACK Credit Analysis uses tax returns to evaluate the repayment ability for each business, individual, and guarantor involved in the global lending relationship. The analysis then calculates a global debt coverage for all of the businesses and individuals/guarantors included. This allows lenders to best evaluate more complex customers that have multiple entities and individuals involved in the total lending relationship.
Commercial Credit Analysis tools allow you to use the balance sheet and income statement information received from a commercial business client to analyze past performance. Tools available for commercial credits include: C & I Business Analysis, Commercial Real Estate Analysis, Earned Net Worth Analysis, and Global Cash Flow Analysis. Earned Net Worth Analysis and Global Cash Flow Analysis function exactly the same for agricultural or commercial credits.
C & I Business Analysis
C & I Business Analysis is a financial analysis tool which provides a financial comparison of a company internally and, optionally, to its peers, the industry at large. This analysis is used for production and service oriented businesses.
Information Required
- The appropriate tax return form or income statement for the commercial business being analyzed.
- Beginning balance sheet for the time-period being analyzed.
- Ending balance sheet for the time-period being analyzed.
Purpose of the C & I Business Analysis
The C & I Business Analysis tool in FINPACK provides the user with the ability to analyze an operation to itself internally, and externally to others in the same industry at large. The internal comparison looks at the balance sheets and income statements on a common sized and percent change basis. The analysis includes ratios and financial measures which provide insight into a company’s: liquidity, asset management, debt coverage capability, financial leverage/debt position, and operating performance.
This analysis also generates a UCA (Uniform Credit Analysis) cash flow analysis, a Statement of Equity report, and a Cash Driver’s report to help further analyze the business.
Note that the industry comparisons are available ONLY if your organization is subscribed to the option of including industry data provided by the Risk Management Association (RMA). To inquire more about this subscription option, please feel welcome to contact us!.
Commercial Real Estate Analysis (CRE)
The Commercial Real Estate Analysis tool is designed to provide lenders with the ability to determine whether a specific investment property will be able to meet debt obligations.
Information Required
- An appropriate tax form or income statement for the property to be analyzed.
- If it is a new investment property or a property with no income history, an option of “New Property, No Income History” is available to select from the drop down.
- General information including the type of property (multi-family, retail, etc.), and the location details of the property.
- Stress testing factors you want to include in the analysis. This includes items such as maximum loan to value, minimum debt service coverage ratio, and increases in interest rate.
Purpose of the Commercial Real Estate Analysis (CRE)
The CRE tool is designed to provide you with an efficient, reliable and insightful means of analyzing income producing, investor-owned real estate properties. Output generated by this tool provides information such as vacancy rate thresholds, two different supportable loan amount, as well as a standard income and expense summary.
Also, perhaps the most insightful section of the output of the CRE is the stress testing report. This is the section which demonstrates the impact of various events such as increased vacancy, basis point increases in interest rates, and decreased rental rates.
When to Use Which Tool?
As demonstrated in the sections above, FINPACK provides users with a wealth of financial analysis tools to choose from. So, how exactly do you determine which tool to use in a particular situation. Below we provide a couple of questions you can ask yourself to aid in this decision making process.
Which Type of File Are You Working In?
The specific tools available for use depend on whether you are working in an agricultural file or a commercial file in FINPACK.
In agricultural files, you have the following available:
- Earned Net Worth Analysis
- Schedule F Cash to Accrual Analysis
- Global Cash Flow Analysis
In commercial files, you have the following available:
- C & I Business Analysis
- CRE (commercial real estate analysis)
- Global Cash Flow Analysis
What Information or Data Sources do I have Available?
In order to utilize a tool, you need to make sure you have the necessary information. See each tool description to verify you have the correct data needed for the analysis you are trying to accomplish.
In Summary
FINPACK Credit Analysis provides users with a variety of tools to analyze both agricultural and commercial clients past financial performance. While each tool requires a different combination of data sources and information, each of them generate insightful and informative output to assist in your credit analysis and decision process. To determine which tool may be most appropriate or beneficial for a particular situation, you can narrow down the options by the type of file you are working with and what information or data sources you have available to you.
Connect with FINPACK
Don’t forget to follow FINPACK on Facebook, Twitter, and Instagram, or connect with us on LinkedIn, and be sure to subscribe to FINPACK News email updates.
