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Tropical Research and Education Center Agricultural Economics Extension Home

Farm Financial Check-up

Financial Check-up


           

FARM ASSETS Cost Valuea Market Valueb FARM LIABILITIES Market Value
Checking & Savings Accounts Accounts Payable (owed)
Crops held for sale or feed Farm taxes due
Investment in growing crops Short-term notes and credit lines
Commercial feed on hand Accrued interest
Prepaid expenses Other accrued expenses
Market livestock    
Accounts Receivable    
Supplies on hand (feed, fuel, chemical)    
Other    
Total Current Assets Total Current Liabilities
 
Breeding livestock Notes payable  
Time certificates    -Machinery
Farm securities    -Breeding livestock
Machinery and Equipment Other
Other    
Total Intermediate Assets Total Intermediate Liabilities
 
Buildings/Improvements Real Estate Debt
Farmland Other
Other    
Total Long-Term Assets Total Long-Term Liabilities
 
A. Total Farm Assets B. Total Farm Liabilities
 
PERSONAL ASSETS Market Value PERSONAL LIABILITIES Market Value
Bank accounts, stocks, bonds Credit card, charge accounts
Automobiles, boats, etc. Automobile loans
Household goods, clothing Other loans, taxes due
Real estate Real estate, other long-term loans
Other Other
C. Total Personal Assets D. Total Personal Liabilities
     

aAssets are valued at their original purchase cost less depreciation (i.e. book value)
bCapital assets are valued at their estimated current market value

INCOME EXPENSES
Cash Income Cash Expenses
Sale of livestock Livestock purchased
Sale of crops Feed purchased
Agricultural program payments Breeding fees
Crop insurance proceeds Car and truck expenses
Other cash income Chemicals
A. Total Cash Income     Conservation expenses
Income Adjustments At start of year At end of year Custom hire
Crops held for sale or feed Employee benefits
Livestock held for sale Fertilizer and lime
Accounts receivable Freight, trucking
Breeding livestock Gasoline, fuel, oil
Other Insurance
B. Net change in Income Adjustments Interest paid
C. Estimated value of home-used production Labor hired
D. Gross Farm Revenue Pension and profit-share plans
Sales of farm capital assets Rent of land, buildings, equipment
   -Machinery Repairs, maintenance
   -Land Seeds, plants
   -Other Storage, warehousing
Cost of capital assets sold (book value) Supplies purchased
   -Machinery Taxes (farm)
   -Land Utilities
   -Other Veterinary fees, medicine
E. Capital Gain of Loss     Other cash expenses
  E. Total Cash Expenses
  Expense Adjustments At start of year At end of year
  Investment in growing crops
  Prepaid expenses
  Supplies on hand (feed, fuel, chemical)
  Other expense adjustments (assets)
 
  Accounts payable (owed)
  Farm taxes due
  Accrued interest
  Other accrued expenses
  Other expense adjustments (liabilities)
  G. Net Change of Expenses Adjustments
  H. Depreciation
  I. Gross Farm Expenses
  
Financial Analysis
Balance Sheet
Current farm assets
Current farm liabilities
Total farm assets
Total farm liabilities
Income Statement
Gross farm revenue (accrual)
Net farm income from operations (accrual)
Farm capital gains and losses
Farm interest expense (accrual)
Farm depreciation expense
Farm taxes expense

LIQUIDITY MEASURES

CURRENT RATIO

Definition: The current ratio indicates the extent to which current farm assets, if liquidated, would cover current farm liabilities.
Interpretation: If the ratio is greater than 1, the farm is considered liquid. If the ratio is less than 1, the farm is considered not liquid, indicating some degree of cash flow risk. In general, the higher the ratio, the greater the liquidity. Although the preferred rates will vary from business to business, lenders tend to favor a ratio greater than 1.5. Note, however, too high a ratio could indicate that the business is sacrificing income by focusing on low-yielding current assets, such as cash or saving account, rather than investing in higher paying investments. In general some simple rules of thumb for evaluating your current ratio are as follows:

Favorable More than 1.5%
Caution Between 1% and 1.5%
Vulnerable Less than or equal to 1%

WORKING CAPITAL

Definition: Working Capital indicates the amount of cash left to purchase inputs and inventory items if the business sold all its current assets and paid all its current liabilities. Stated differently, it is the absolute amount remaining after subtracting total current liabilities from total current assets.
Interpretation: In general working capital should be positive, but the amount needed depends on the type and size of the business. Negative working capital indicates a potential liquidity problem that should be investigated.

SOLVENCY MEASURES

DEBT-TO-ASSET RATIO

Definition: The debt-to-asset ratio measures the proportion of total farm assets owed to creditors. Stated differently, it indicates whether the business would be able to cover all its liabilities if it were to shut down and the proceeds from the sales of all assets were used to pay creditors.
Interpretation: High debt-to-asset indicates financial stress. In general lenders like to see a ratio that is less than 30% which implies that creditors are contributing less than 30% of the farm assets. It indicates a strong solvency position. A ratio greater than 30% but less than 60% raises a caution flag and suggests that there is the need to do some serious financial planning to assure, as much as possible, that their net worth position is not going to continue to erode. Lenders might be still willing to work with them but may not be willing to lend enough money to make major changes to the farm operation or purchase machinery. A ratio in excess of 60% raises a huge red flag, indicating that the business is in a vulnerable solvency position and it will be extremely difficult to borrow additional funds. In other words, the business is essentially owned by the bank. In such cases, the operator/owner might consider one or more of the following options: refinancing, improving operating efficiencies, reducing family living costs, adding non-farm income, exiting the business. In general some simple rules of thumb for evaluating your debt-to-asset ratio are as follows:

Favorable Less than or equal to 30%
Caution Between 30% and 60%
Vulnerable Greater than or equal to 60%

NET WORTH (OWNER EQUITY)

Definition: Net worth is the difference between the value of the assets owned by the farm business and the value of its liabilities. Stated differently, it is the financial claim by the owner of a business after all creditors have been paid.
Interpretation: Net worth indicates how much "skin" you have in the business. It is the easiest way to judge the overall financial health of the business as it allows you to track your financial improvement or deterioration over time.

Liquidity Measures
Current Ratio
Working Capital
Solvency Measures
Debt-to-Asset Ratio (%)
Net Worth
Profitability Measures
Net Farm Income
Return on Assets (%)
Operating Profit Margin Ratio (%)
Times Interest Earned Ratio
Financial Efficiency Ratios
Operating Expense Ratio (%)
Depreciation Expense Ratio (%)
Interest Expense Ratio (%)
Net Farm Income Ratio (%)

PROFITABILITY MEASURES

NET FARM INCOME ($)

Definition: Net farm income is a measure of the return to the equity (owner’s) capital, unpaid labor, and management contributed by the owner/operator to the farm business.
Interpretation: Since the net farm income is a dollar amount and not a financial ratio there is no established standard for comparison across farm operations. Suffice it is to say that it should be positive and should be sufficiently large to compensate the owner/operator for utilizing his/her labor, management, and equity capital in the farming operation.
Prescription: If your net farm income is negative you might consider doing one or more of the following options:

  1. Try to increase the volume of production
  2. Take actions to improve price received such as use alternative markets or improve product quality
  3. Improve production practices; use higher quality inputs
  4. Consider changing mix of enterprises, including eliminating unprofitable ones
  5. Try to expand the size of your operation (area farmed, capital and/or other inputs such as hired labor)
  6. If the operation cannot be expanded, take actions to reduce costs without necessarily reducing production such as substituting capital for labor, joining with other farmers to buy in bulk at discounted prices, or contacting other suppliers

RETURN ON ASSETS (%)

Definition: The rate of return on assets (ROA) measures the relative income generated by the assets of the farm business.
Interpretation: The higher the ROA, the more profitable the operation. In general if the ROA exceeds the cost of borrowed capital, then you could consider expanding your business by increasing leverage (debt load) as this is likely to contribute to additional growth. However, if ROA is less, then expanding your business with borrowed capital is not a wise decision as it will result in a reduction in the equity you have in the business. In general some simple rules of thumb for evaluating your return on assets are as follows:

Favorable More than 8%
Caution Between 3% and 8%
Vulnerable Less than 3%

OPERATING PROFIT MARGIN RATIO (%)

Definition: Operating profit margin ratio measures the return to capital per dollar of gross farm revenue/value of farm production.
Interpretation: There is no absolute standard for this profitability measure, but the higher the ratio, the more profitable the farm business. A low margin can be the result of several factors, including high expenses, low prices, or inefficiencies in the operation. In general some simple rules of thumb for evaluating your operating profit margin ratio are as follows:

Favorable More than 25%
Caution Between 15% and 25%
Vulnerable Less than 15%

TIMES INTEREST EARNED RATIO

Definition: Time interest earned ratio measures how many times the farm business could pay interest with its before tax net income.
Interpretation: The larger the number, the more favorable the farm operation is viewed by lenders since it indicates the ability of the business to meet its interest expenses. A value of 10, for example, indicates that the income is ten times greater than the business interest expenses.

FINANCIAL EFFICIENCY MEASURES

OPERATING EXPENSE RATIO (%)

Definition: The operating expense ratio indicates the extent to which gross farm revenues are expended on farm operating inputs, excluding depreciation and interest.
Interpretation: In general the lower the ratio, the more efficient the operation. As a simple rule of thumb, ratios in the 40% to 60% range are considered to be relatively efficient; those in the 60% to 75% reflect average efficiency, and those above 75% are considered to be marginally efficient. In general some simple rules of thumb for evaluating your operating expense ratio are as follows:

Favorable Less than or equal to 60%
Caution Between 60% and 80%
Vulnerable Greater than or equal to 80%

DEPRECIATION EXPENSE RATIO (%)

Definition: The depreciation expense ratio measures the proportion of gross farm revenue represented by the depreciation expense.
Interpretation: It should be recalled that depreciation is a "non-cash" expense (opportunity cost), meaning that a cash payment is not made but that the funds should be set aside to facilitate replacement of the asset. While the depreciation ratio will vary depending on the type of business, a relatively low depreciation expense ratio suggests two things: the business can easily replace capital assets or the business has outdated assets. Conversely, a relatively high ratio indicates that a substantial amount of gross revenue is required to be set aside to replace the capital base in the future. That is, although the business can survive in the short run without meeting these expenses, it could be difficulty to cover these expenses in the long run. In general some simple rules of thumb for evaluating your depreciation expense ratio are as follows:

Favorable Less than or equal to 5%
Caution Between 5% and 15%
Vulnerable Greater than or equal to 15%

INTEREST EXPENSE RATIO (%)

Definition: The interest expense ratio measures the proportion of gross farm revenues needed to offset the farm’s interest expense.
Interpretation: In general, large interest expense ratios indicate that the business is highly leveraged. If the return on assets is much higher than the borrowing rate, then this might not be a problem. However, if this is not the case, then too high a ratio could raise a red flag. In situations where the ratios raise suspicion, the operator might consider one or more of the following options: seeking alternative financing which would reduce interest rates; reducing borrowed capital with revenues from non-farm sources; delaying any anticipated capital purchases that would require any additional purchases. In general some simple rules of thumb for evaluating your interest expense ratio are as follows:

Favorable Less than or equal to 5%
Caution Between 5% and 10%
Vulnerable Greater than or equal to 10%

NET FARM INCOME RATIO (%)

Definition: The net farm income ratio measures the proportion of gross farm revenue that remains after covering operating expenses. In simple terms, it suggests the fraction of each dollar in gross sales that is available to the operator to go toward paying any unpaid operator or family labor, management, and owner capital (equity in the business).
Interpretation: In general the higher the net farm income ratio, the more profitable will be the farm business and the greater the chance that the operator’s net worth (owner equity) will increase over time. In general some simple rules of thumb for evaluating your net farm income ratio are as follows:

Favorable More than or equal to 20%
Caution Between 10% and 20%
Vulnerable Less than or equal to 10%
 

 

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