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Valuation, liquidity and regulatory issues may also add to foreign investment risk.
(3) Liquidity Risk
This is the risk that a given security or asset cannot be traded quickly enough in the market to prevent a loss or make the required profit. There are two (2) types of liquidity risk:-
(a) Asset Liquidity: An asset cannot be sold due to lack of liquidity in the market, essentially a sub-set of market risk.
(b) Funding Liquidity: Risk that liabilities cannot be met when they fall due, can only be met at an uneconomic price.
(4) Market Risk
This is the risk that the value of an investment portfolio or a trading portfolio, will decrease due to the change in market risk factors. The four (4) standard market risk factors are stock prices, interest rates, foreign exchange rates, and commodity prices (Equity Risk, Interest Rate Risk, Currency Risk, Commodity Risk).
(5) Operational Risk
These are the risks associated with the operational and administrative procedures of the particular industry.
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revenue. These two items represent sources of revenue that may be recognized in one accounting period even though cash will not be received until a later accounting period. When an inventory or account receivable is recognized as revenue, it is non cash revenue at that time, but something for which a cash payment typically will be received at a later date. However, payment may sometimes be received in the form of goods or services instead of cash. The non-cash payment should be treated in the same manner as a cash payment. The value of feed or livestock received in payment for custom work should be included in revenue, because a commodity was received in lieu of cash.
Table 2:- Condensed Income Statement Format
N Total Revenue
Less Total Expenses
Equals Net Farm Income from Operations
Plus or Minus Gain/Loss on Sale of Capital Assets Equals Net Farm Income
The gain or loss on the sale of a capital asset is an entry that often shows up in the revenue section of an income statement. It is the difference between the sale price and cost of a capital asset such as land. For depreciable assets such as machinery orchards, and purchased breeding livestock, it is the difference between the selling price and the asset‟s book value. Gain or loss is recognized only when an asset is actually sold. Before then, the market value or selling price is subject to considerable uncertainty.
Expenses incurred in producing that revenue may be either cash or non-cash expenses. Cash expenses include purchases of a payment for feed, fertilizer, seed, market livestock and fuel. Non cash expenses would include depreciation, accounts payable, accrued interest, and other accrued expenses.
There is also an adjustment for prepaid expenses. Depreciation is a non-cash expense that reflects decreases in the value of assets used to produce the revenue. Account payable, accrued interest and other accrued expenses such as property taxes are expenses incurred during the past accounting period but not yet paid. To properly match expenses with the revenue they helped produce, these expenses must be included on this year‟s income statement. They must also be subtracted from next year‟s income statement, when the cash will be expended for their payment. The difference in timing between the year in which the expenses was incurred and the one in which it will be paid creates the need for these entries.
Accounts payable and accrued expenses are paid for in an accounting period later than the one in which the products or services were used. This is
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opposite form prepaid expenses, goods and services paid for in one year but not used to produce revenue until pesticides and feed purchased and paid for in December to take advantage of price discounts, income tax deductions or to assure availability. However, because they will not be used until the next calendar year, the expense should be deferred until then to properly match expenses with the revenue produced by this expense. The timing of paying the expense and using the product is just opposite of an account payable, so the accounting procedure is opposite. Prepaid expenses should be subtracted from this year‟s expenses as they did not produce any revenue this year. They should then be included with next year‟s expenses, ensuring that the business records properly match expenses with their associated revenue in the same period.
Profitability is a measure of the efficiency of the business in using its resources to produce profit or net farm income. Six (6) measures of profitability include:-
(1) Net Farm Income
Net farm income is the amount by which revenue exceeds expenses, plus any gain or loss on the sale of capital assets.
(2) Rate of Return on Assets (ROA)
Rate of Return on Assets (%) = ( )
( )
Expressing return on assets as a percentage allow an easy comparison with the same values from other farms, over time for the same farm and with return from other investments. Return on assets is an average return and not a marginal return. It should not be used when making decisions about investing in additional assets where the marginal return is the important value.
(3) Rate of Return on Equity (ROE)
Rate of Return on Equity (%) ( )
( )
The ROE can be either greater or less than the return on assets, depending on the ROA‟s relation to the average interest rate on borrowed capital.
If ROA > , then ROE > ROA If ROA < , then ROE < ROA Where,
= interest rate on debt
(4) Operating Profit Margin Ratio
Operating Profit Margin Ratio =
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Farms with a low operating profit margin ratio should concentrate on improving this ratio before expanding production. It does little good to increase total revenue if there is little or no profit per dollar of revenue.
(5) Return to Labour and Management
Net farm income was described as the amount available to provide a return to unpaid labour, management and equity capital. Return to labour and management is a dollar amount that represents the part of net farm income from operations that remains to pay for operator labour and management after all capital (total asset value) is paid a return equal to its opportunity cost.
Adjusted Net Farm Income from Operations Less opportunity cost of all capital
Equals Return to Labour and Management (6) Return to Labour
Return to Labour and Management Less Opportunity Cost of Management Equals Return to Labour
Return to labour and management, with the opportunity cost of capital already deducted, the only step remaining to find return to labour is to subtract the opportunity cost of management.
(7) Return to Management
It measures how well the manager organized the other resources to generate a profit.
Return t o Labour and Management Less Opportunity Cost of Labour Equals Return to Management
A negative return means only that net farm income was not sufficient to provide a return to capital, labour and management equal to or higher than their opportunity costs. The net farm income may have been a substantial amount, particularly on a large farm or ranch. It just should have been better to provide labour, management, and capital a return equal to their individual opportunity costs.
Note:- Accrual concept of net profit is said to be the difference between revenue and expenses rather than cash receipt and expenses known as accrual concept.