4

Financial Analysis
and Control

The financial accounting system established in the preceding chapter pro -

vides an information base for evaluating the profitability, liquidity, efficiency,
and risk of a farm business. Procedures for analysis and control according to
these performance criteria are developed in this . chapter. The emphasis here is
on analyzing the firm's past and projected performance in order to identify
strengths and weaknesses and to develop more fesible-financial plans for
the future. This chapter provides part of the analytical base for the methods of
financial planning that are discussed in later chapters. In the following sec -
tions, we establish the steps of a systematic financial control process; identify
various methods for evaluating profitability, liquidity, efficiency, and risk; and
apply them to case situations.

THE FINANCIAL CONTROL PROCESS

Financial control is facilitated by the process of measuring and monitor-
ing the performance of a business over time in order to maintain desired stan -
dards of performance. The process is a dynamic one; it involves the passage of
time and the use of new information that is fed back to the decision -making
unit for processing, analysis, and response. The control process provides an or-
derly framework for responding to an uncertain environment in which vari -
ous signals caused by events trigger the need for control and response. Hence,

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an important part of the control process is the design of information systems

and strategies for responding to risk.
The control process is systematically expressed by the following steps:

1. Identifying goals

The identification of goals, or performance criteria, is the first

step. The mix of goals, their ordering, and weights are important.
Profitability, liquidity, efficiency, and risk reduction represent one set
of goals for evaluating farm businesses.

2. Developing measures for the goals

Step 2 involves the selection of indices, indicators, or proxies to
measure the attainment of goals.

3. Determining-norms for the measures

The -reality of goal attainment involves norms, targets, or stan-
dards for evaluating the degree of firm performance. Often "maxi-
mization" or "satisfaction" is too abstract or impractical. Moreover,
some goals involve trade-offs in achievement levels; for example, at-
taining higher expected profits usually means accepting higher risk
and lower liquidity. Specific norms provide a tangible basis for ana-
lyzing multiple-goal attainment.

4. Setting tolerance limits on norms

Under risk and uncertainty, the norms for the various goal mea-
sures will seldom be exactly attained. Setting tolerance limits on de-
viations from norms allows for reasonable variations in performance
measures before corrective actions are needed.

5. Developing an ,information system

Periodic reports on the performance measures, based on a fi-
nancial accounting system, keep the decision maker informed of the
firm's progresS and help to identify corrective actions when toler -
ance limits on norms are exceeded.

6. Selecting and administering the analytical and diagnostic tools

The appropriate analytical and diagnostic tools need to be se-
lected and adapted to process the financial information to the firm.