financial benchmarks for...

Dr. Chris Peterson

Nowlin Chair of Consumer-Responsive Agriculture

Michigan State University

Financial Benchmarks for Cooperatives

2018 Michigan Cooperative Directors & Managers Conference

© Dr. H. Christopher Peterson 2018

Nowlin Chair of Consumer-Responsive Agriculture Michigan State University

Co-op Benchmarking: The Issues

Does a cooperative have good financial condition?

Are a cooperative’s financial benchmarks consistent with its business strategy?

Is a cooperative financially flexible enough to seize a strategic opportunity?

Are a cooperative’s control and risk management functions equal to the task?


Benchmarks Help the Board Know

Board needs to know enough to carry out its duties:

– Safeguard financial condition (fiduciary)

– Evaluate strategic options, returns and risks (current & future)

– Execute policy level review

– Exercise strategic control

– Carry out their “representation” function


Financial Condition Basics

Good financial condition arises from:

– Operating profitability

• Income statement

– Efficient asset management

• Left hand side of balance sheet

– Efficient capital structure management

• Right hand side of balance sheet

– Appropriate returns to owners

• Where do you find this for a cooperative?


Financial Condition Basics

A cooperative is in danger if:

– It can not pay its bills.

• Short-run liquidity

• Long-run solvency

– It can not make the “right” investments.

• Access and timing are everything!

– It can not pay members appropriate returns.

• Fair, sustainable, and competitive


Financial Benchmark: Compared to What?

What are the standards of comparison?

– Trends across time

– Comparison to long-range objectives and strategies:

PLANS!!!!!!

– Comparison to industry averages

– Comparison to “best in class”

• Competitors

• Firms/cooperatives in other industries doing the same function


Financial Benchmark: Compared to What?

Minimum Wall Street Rules of Thumb:

– Sales Growth 2-4 Times the Rate of Inflation

– Net Income Growth of 10 - 15% and Income Stability

– Annual Return on Equity At Least 12-15%

– Debt To Total Assets of 40-50%


TABLE 10—Combined financial ratios, U.S. ag co-ops, by operating type, 2015-2014

2015 2014

Measure Marketing Supply Service Total Total

Ratio

Current ratio 1.45 1.52 1.36 1.48 1.45

Debt-to-assets 0.56 0.52 0.40 0.54 0.57

Long-term-debt-to-equity 0.42 0.30 0.14 0.35 0.37

Times interest earned 10.27 8.79 25.46 9.70 8.11

Fixed asset turnover 8.59 8.20 0.08 8.37 11.2

Equity-to-assets 0.44 0.48 0.60 0.46 0.43

Expenses-to-gross revenue 0.74 0.80 0.80 0.76 0.80

Percent

Gross margin 11.49 8.93 11.30 10.32 8.37

Return on total assets 11.72 6.94 11.23 9.31 9.16

Return on member equity 40.09 19.39 31.55 29.01 28.77

Source:

Agricultural

Cooperative

Statistics 2015,

USDA


TABLE 11—Combined financial ratios, U.S. ag co-ops, by operating type, 2015-2014

2015

Measure Dairy Fruit/Veg Grains Sugar

Ratio

Current ratio 1.25 1.94 1.42 1.21

Debt-to-assets 0.68 0.52 0.53 0.53

Long-term-debt-to-equity 0.78 0.46 0.30 0.46

Times interest earned 4.62 11.47 8.64 23.53

Fixed asset turnover 14.06 5.88 7.31 4.78

Equity-to-assets 0.32 0.48 0.47 0.47

Expenses-to-gross revenue 0.93 0.66 0.85 0.68

Percent

Gross margin 7.14 26.02 7.25 27.83

Return on total assets 3.91 14.79 6.20 16.83

Return on member equity 13.35 36.87 26.02 57.27

Source:

Agricultural

Cooperative

Statistics 2015,

USDA


Other Ratios in USDA Ag Co-op Stats

Common size income statements and balance sheets by type of cooperative (line items as % of total)

– How do you compare in operating income generation

– How do you compare on composition of assets

– How do you compare on composition of liabilities and equity

Top 10 and Top 100 cooperative ratios

Ratios by sales size

– Farm supply has info on 11 classes by sales size running from < 1 million to > $500 million

Cooperative Benchmarking

Top 5 Cooperatives

February 2018

Local Income

0.00%

0.50%

1.00%

1.50%

2.00%

2.50%

3.00%

3.50%

A B C D E

Local Income

2015 Q3 2016 Q3 2017 Q3

Current Ratio

0.00

0.50

1.00

1.50

2.00

2.50

A B C D E

Current Ratio

2015 Q3 2016 Q3 2017 Q3

LTD to Local Equity

0.00

0.05

0.10

0.15

0.20

0.25

0.30

0.35

0.40

0.45

A B C D E

LTD to Local Equity

2015 Q3 2016 Q3 2017 Q3

Percent of Equity Attached to a Member

0.00%

10.00%

20.00%

30.00%

40.00%

50.00%

60.00%

70.00%

80.00%

A B C D E

Percent of Equity Attached to a Member

2015 2016 2017

Agronomy Gross Margin and Service Revenue

0.00%

5.00%

10.00%

15.00%

20.00%

25.00%

30.00%

A B C D E

Gross Margin and Service Revenue

2015 Q3 2016 Q3 2017 Q3

Fertilizer Gross Margin

0.00%

5.00%

10.00%

15.00%

20.00%

25.00%

A B C D E

Fertilizer Gross Margin

2015 Q3 2016 Q3 2017 Q3

Grain Margin and Service Revenue

0.00%

1.00%

2.00%

3.00%

4.00%

5.00%

6.00%

7.00%

8.00%

9.00%

A B C D E


2015 Q3 2016 Q3 2017 Q3

Personnel Expense/Gross Margin

0.00%

5.00%

10.00%

15.00%

20.00%

25.00%

30.00%

35.00%

40.00%

45.00%

50.00%

A B C D E

Personnel Expense/Gross Margin

2015 Q3 2016 Q3 2017 Q3

3 Year Summary ofMidwest Co-op Financial

Results

Local Income

0.00%

0.10%

0.20%

0.30%

0.40%

0.50%

0.60%

0.70%

0.80%

0.90%

1.00%

2015 2016 2017

Local Income • High• 2017 2.48%

• 2016 2.89%

• 2015 2.67%

• Low• 2017 (2.15%)

• 2016 (1.26%)

• 2015 (.86%)

Current Ratio

1.50

1.52

1.54

1.56

1.58

1.60

1.62

1.64

1.66

2015 2016 2017

Current Ratio • High• 2017 2.35

• 2016 2.33

• 2015 2.49

• Low• 2017 1.09

• 2016 1.05

• 2015 0.89

Personnel Expense/Operating Expense

45.40%

45.60%

45.80%

46.00%

46.20%

46.40%

46.60%

46.80%

47.00%

47.20%

47.40%

2015 2016 2017

Personnel Expense/Operating Expense • High• 2017 52.18%

• 2016 52.58%

• 2015 52.21%

• Low• 2017 39.60%

• 2016 39.36%

• 2015 39.70%

Grain Margin & Service Revenue

4.80%

5.00%

5.20%

5.40%

5.60%

5.80%

6.00%

6.20%

6.40%

2015 2016 2017

Gross Margin and Service Revenue • High• 2017 7.97%

• 2016 6.63%

• 2015 10.01%

• Low• 2017 3.81%

• 2016 3.92%

• 2015 4.60%

Agronomy Gross Margin & Service Revenue

• High• 2017 37.85%

• 2016 28.32%

• 2015 28.64%

• Low• 2017 16.12%

• 2016 10.85%

• 2015 14.99%

20.00%

21.00%

22.00%

23.00%

24.00%

25.00%

26.00%

2015 2016 2017


Energy Gross Margin & Service Revenue

0.00%

2.00%

4.00%

6.00%

8.00%

10.00%

12.00%

14.00%

16.00%

18.00%

2015 2016 2017

Gross Margin and Service Revenue • High• 2017 35.38%

• 2016 34.27%

• 2015 21.36%

• Low• 2017 6.56%

• 2016 8.67%

• 2015 3.55%

FoodCo-ops

Upper Quartile Median Sales 16,728,554 6,597,928Sales Growth 6.38% 1.73%Gross Margin 38.88% 37.48%Personnel 26.25% 24.40%Gross Wages 19.90% 18.56%Net Income 1.42% 0.20%Days Cash On Hand 39.23 24.51Cash over Accounts Payable 4.04 2.03Inventory Turnover 17.08 13.60Inventory Days 34.02 26.85Turns X Earns 3.59 2.51Total Debt to Equity 1.81 0.84Current Ratio 2.85 1.93Quick Ratio 1.93 1.12Return on Assets 5.08% 0.71%Debt Service Coverage Ratio 11.66 5.15Sales per Labor Hour 95.92 85.07

Rosemary Mahoney

[email protected]

434-962-0897

- or -

Stacey Webster

[email protected]

515-292-2667

For more information on how to participate in Cooperative Benchmarking, contact:

mailto:[email protected]

mailto:[email protected]


Additional Benchmarks (Grain/Farm Supply)

Banks– Local savings / total sales = 1.5-2%

– Net profit / total assets = 8%

– Labor expense / gross income = 40%

– Fixed expenses / gross Income = 30

– Net worth (Equity) > 50% of total assets

– Loan covenants often require specific ratio levels

Other common benchmarks– Turns x earns > 1 (10 asset turns x 1.5 profit margin = 1.5)

– Working capital: 1.5% of grain sales; 2.5% of farm supply sales

– Days receivable: 30-45 days

Source: Phil Kenkel, Bill Fitzwater Cooperative Chair, Oklahoma State– Financial ratio calculator: You enter your income statement and balance sheet

data and it calculates rations in a red light, green light or no light format


Benchmarks reflecting strategy!

Customer Perceived Benefits

Value =

Relationship Price

And your offer of customer value > the competition’s


Only two ways to increase customer value

and competitive advantage!

Low Cost Advantage

– Lowering price to increase customer value

– Market a commodity product

– For example, Cargill

Unique Benefits Advantage

– Increasing bundle of unique benefits to increase customer value.

– Market a differentiated product

– For example, John Deere


What Are the Returns and Risks?

Low Cost Advantage

– Customer values price more than benefits

– Returns: low margin, high volume

– Risk: Not being lowest cost

Unique Benefits Advantage

– Customer values benefits more than price

– Returns: high margin, captured customer

– Risk: Not being unique


Benchmarks should reflect strategy

The DuPont Formula– PM x TAT x EM = ROE

– Profit Margin (PM) =

Net Margin ÷ Total Revenue (Sales) [x100]

– Total Asset Turnover (TAT) =

Total Revenue ÷ Total Assets

– Equity Multiplier (EM) = Total Assets ÷ Equity

– Return on Equity (ROE) =

Net Margin ÷ Equity [x100]



DuPont Formula: PM x TAT x EM = ROE

– How do you interpret these ratios?• Absolute value

– For PM, TAT, and ROE, it depends on industry

– For EM, the range is 2 to 3 across many industries.

• Trend across time: up, stable, down? Consistency?

– All four keys to good financial condition!• operating profitability (PM)—income statement

• asset management (TAT)—balance sheet left side

• capital structure management (EM)—right side

• ownership profitability (ROE)—composite result



Three Ways to Generate 20% ROE?

– PM x TAT x EM = ROE

5% x 2 x 2 = 20% (ROI = 10%)

2% x 5 x 2 = 20% (ROI = 10%)

2% x 2 x 5 = 20% (ROI = 4%)

Let’s compare:

– Co-op A: 1% PM x 5.0 TAT x 2.96 EM = 14.8% ROE

– Co-op B: 1% PM x 2.5 TAT x 10.9 EM = 25.0% ROE



Key Benchmark Area Cost Adv. Benefits Adv.

Operating profitability

• Profit margin

• Key expense ratios

Lower

Lower

Higher

Adds to benefits

Efficient Asset Management

Total Asset Turnover

Key asset ratios (inventory turn, Days Rec)

Return on Investment

Higher

Cash quicker

Same*

Lower

Adds to benefits

Same*

Efficient Capital Structure Management

Equity Multiplier (TA/E)

Key ratios (e.g., Days Pay, D/E, TIER)

Same*

Same*

Same*

Same*

Return on Equity Same* Same*

*UNLESS THERE IS A STRATEGIC REASON WHY IT NEEDS TO BE DIFFERENT


Benchmarks in Strategic Control

Good control keeps the organization headed in the

“right” direction.

– This is what the board should care about

– Not managing daily operations

Process of correcting for variations from benchmarks.

– Business decisions are risky.

– Human behavior needs monitoring.

– Corrective response becomes essential.


Control Signals to Watch: Tracking Risk

Changes internal to the co-op

– Excessive changes in credit or inventory

– Excessive changes to benefits

– Exceptions to policy/procedure

– Progress with capital investment projects

– Member exit or level of complaints

– Anything tracking a critical internal function


Control Signals to Watch: Tracking Risk

Changes external to the co-op

– Interest rate and macroeconomic changes

– Customer profit/income changes

– Market growth rate changes

– Intensity of rivalry--direct or substitute

– Supply chain changes--forward or backward

– Anything tracking critical external changes


Board’s Role in Managing Risk

Monitor key risks.– Establish benchmarks– Establish triggers for action

Establish policies that empower management to manage risk.– Proper provision of insurance– Proper control of credit, inventory, & short-term liabilities– Proper use of risk management techniques

• Use of derivatives• Use of hedges and other market risk instruments

Monitor effectiveness of risk management policies.


Control Signals: Tracking Opportunities

Internal potential for profit

– Product/service R&D

– Process improvement R&D

External potential for profit

– Emerging products/markets

– Changing customer preferences

– Supply chain process improvements


Key Takeaway on

Co-op Financial Benchmarks

Benchmarks need to be consistent with:– Good financial condition– Desired business strategy– Needed flexibility to pursue opportunities– Control and risk management functions

Effective benchmarks arise from:– Internal history and strategic plan/goals– Industry averages/standards– “Best in class” comparisons

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