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Measuring Financial Performance: How Do I Measure It?. Objectives. Introduce the measures of financial performance: Liquidity, Solvency, Profitability and Financial Efficiency Describe the calculations used Interpret the measures using benchmarks.

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objectives
Objectives
  • Introduce the measures of financial performance: Liquidity, Solvency, Profitability and Financial Efficiency
  • Describe the calculations used
  • Interpret the measures using benchmarks
measures of financial position and performance

Measures of Financial Position and Performance

Profitability

Liquidity

Solvency

Financial efficiency

Repayment capacity

four questions
Four Questions
  • Are the returns adequate?
  • How liquid is the business?
  • How is the business financed?
  • How efficient is the business?
benchmarking
Benchmarking
  • Comparing our business to those that are the best to learn how they achieve success
  • Minimum performance is above average
  • Financial benchmarks can come from
    • past performance
    • projected performance
    • performance of similar farms
benchmark data
Benchmark data
  • Farm business associations are good sources of benchmarks
    • Illinois, Iowa, Kentucky, Tennessee and others
  • Know your data source
    • methods for summarization
    • period in which data was collected
    • calculations used for performance measures
profitability
Profitability
  • Measures the extent to which a business generates a profit from the use of land, labor, management, and capital.
  • Measured by
    • Net farm income from operations (NFIFO)
    • Rate of return on farm assets (ROA)
    • Rate of return on farm equity (ROE)
    • Operating profit margin (OPM)
net farm income from operations
Net farm income from operations
  • Net revenues available from normal operations after fixed and variable expenses have been deducted
  • For accuracy, calculate on an accrual basis
  • For a sole proprietor farm operation, this income is available to compensate unpaid family labor, management, and equity capital
rate of return on assets

NFIFO + Interest expense – Unpaid labor compensation

Ending Total Assets

x 100

Rate of return on assets
  • Net income generated by all assets, after labor has been compensated but before interest payments
  • Operating profitability per dollar of assets
  • Allows comparison between different sizes and types of businesses
rate of return on equity
Rate of return on equity
  • The return after all labor and interest expenses
  • Measures the return to the owner of the business for their capital investment
  • Can be compared to alternative investments
operating profit margin
Operating Profit Margin
  • Proportion of earnings or revenues that is operating profit
  • Reflects ability to generate revenues and control costs
  • Revenue available to compensate debt and equity capital
net farm income
Net Farm Income

Gross Revenue $___________

Interest Expense - ___________

Other Expense - ___________

Net Farm Income $___________

liquidity
Liquidity
  • Ability of a farm business to meet financial obligations as they come due in the short term, without disrupting the normal operations of the business.
  • Measured by
    • Current ratio
current ratio

Current assets

Current liabilities

Current ratio
  • Basic indicator of short-term debt servicing and/or cash flow capacity.
  • Indicates the extent to which current assets, when liquidated, will cover current obligations
solvency
Solvency
  • Gauges the farm’s ability to
    • pay all financial obligations if all assets are sold
    • continue viable operations after financial adversity
  • Measured by
    • Debt to asset ratio
    • Debt to equity ratio
    • Equity to asset ratio
debt to asset ratio

Total liabilities

Total assets

x 100

Debt to asset ratio
  • Proportion of total assets owned by creditors
solvency score

Total liabilities

Total assets

x 100

Solvency Score

x 100

financial efficiency
Financial Efficiency
  • Measures the intensity with which a business uses its assets to generate gross revenues and the effectiveness of production, purchasing, product pricing, financing decisions
financial efficiency measures
Financial Efficiency Measures
  • Measured by
    • Asset turnover ratio
    • Operating expense ratio
    • Depreciation expense ratio
    • Interest expense ratio
    • Net farm income ratio
asset turnover ratio

Gross revenue

X 100

Total assets

Asset turnover ratio
  • Reflects how efficiently farm assets generate revenue
  • Indicates the volume of business generated by the asset base
revenue per full time laborer

Gross revenue

Number of full time laborers

Revenue per full-time laborer
  • Reflects the productivity of labor
  • Indicates if revenue generated is sufficient for full-time employment
operating expense ratio

Total operating expenses - depreciation

X 100

Gross revenue

Operating expense ratio
  • Proportion of total revenues absorbed by operating expenses
depreciation expense ratio

Depreciation expense

X 100

Gross revenue

Depreciation expense ratio
  • Proportion of total revenues absorbed by depreciation
interest expense ratio

Total farm interest

X 100

Gross revenue

Interest expense ratio
  • Proportion of total revenues absorbed by interest expense
net farm income ratio

NFIFO

X 100

Gross revenue

Net farm income ratio
  • Proportion of total revenue that remains as net income after all expenses have been paid
  • Income that remains for unpaid labor compensation and equity capital
account for each dollar of gross revenue

Sum to 1

Account for each dollar of gross revenue

Operating expense ratio

Depreciation expense ratio

Interest expense ratio

Net farm income ratio

summary
Summary
  • Key financial measures assess
    • Profitability
    • Liquidity
    • Solvency
    • Financial efficiency
  • Calculations
  • Interpretation
references
References
  • Boehlje, Michael, Craig Dobbins, Alan Miller, Dawn Miller, & Freddie Barnard, Measuring and Analyzing Farm Financial Performance, Department of Agricultural Economics, Purdue University, EC-712, 1999 (pages 7-10), <www.agecon.purdue.edu/ext/finance>
  • Dobbins, Craig, Michael Boehlje, Alan Miller, Freddie Barnard, “Financial Performance: Measurement and Analysis”, Purdue Agricultural Economics Report, March 2000, pages 14-18.
  • Oltmans, Arnold W. Danny A. Klinefleter, and Thomas L. Frey, AFRA - Agricultural Financial Reporting and Analysis, Doane Agricultural Services Company, St. Louis, 1998.
  • Miller, Alan, Michael Boehlje, Craig Dobbins, Key Financial Performance Measures for Farm General Managers, Department of Agricultural Economics, Purdue University, ID-243, June 2001.