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Evaluating Farm Financial Performance and Position

How’s Business?. Evaluating Farm Financial Performance and Position. True or False?. It is possible for a farm business to be unable to pay bills but solvent at the same time. It is possible for a farm business to be able to pay bills but not be making a profit.

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Evaluating Farm Financial Performance and Position

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  1. How’s Business? Evaluating Farm Financial Performance and Position

  2. True or False? • It is possible for a farm business to be unable to pay bills but solvent at the same time. • It is possible for a farm business to be able to pay bills but not be making a profit.

  3. Measuring Financial Performance and Position • Liquidity • Solvency • Profitability • Financial efficiency • Repayment capacity

  4. Liquidity The ability to generate cash to meet financial obligations

  5. Measuring Liquidity Current ratio = Total current farm assets Total current farm liabilities Current ratio < 1 indicates potential liquidity problems.

  6. Solvency The ability to meet long-term commitments as they come due.

  7. Measuring Solvency Debt/asset ratio = Total farm liabilities Total farm assets D/A > 0.5 means less than 50 percent of assets are contributed by owners. D/A > 0.7 means financial stress is likely. D/A > 1 signals insolvency.

  8. Profitability Financial performance of the farm over a period of time usually a year Return to land, labor, capital & management

  9. Measuring Profitability Net Farm Income = Gross farm revenue - all farm operating expenses incurred to create those revenues +/- gains/losses on sale of capital assets

  10. Measuring Profitability • Rate of Return on Farm Assets = (Net farm income from operations + farm interest expense - value of unpaid labor & management) (Average total farm assets) • Is the rate of return higher than the cost of capital?

  11. Measuring Profitability • Rate of Return on Farm Equity = (Net farm income from operations - value of unpaid labor & management) (Average total farm equity) • National average for farms is typically 2-4% • Compare to rate of return on alternative investments

  12. Repayment Capacity Ability to generate funds to repay term debt

  13. Repayment Capacity • Lenders use various debt service coverage ratios • Look at a cash flow plan • Evaluate interest expense ratio

  14. Interest Expense Ratio • Reflects the extent to which gross farm revenues are spent on interest = Total farm interest expense Gross farm revenues • Ratio > 15% indicates potential payment problems.

  15. Financial Efficiency Important part of evaluating profitability. Determines if assets are used efficiently to generate income.

  16. Asset turnover ratio Ratio = Gross farm revenues Average total farm assets

  17. Keys to Successfully Using Financial Measures • Develop measures annually • Be consistent in how the measures are developed • Note reasons for “unusual” measures • Use information to deal with potential problems before they get out of hand

  18. True or False? • You should analyze the short-term cash flow implications of making a major change in your farm business before deciding to make the change, even though the long-range plan says it should work.

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