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Farm Business Analysis—Ch.18
What are the strengths and weaknesses of the farm business?
How can we measure how well the farm is doing?
Which farm would you prefer?
Farm A Net worth $400,000 Operator Labor 12
mo. Net income $50,000
Farm B Net worth $800,000 Operator Labor 24
mo. Net income $80,000
What Affects Net Farm Income and Cash Flow?
SizeEfficiency
Size or Scale of the Farm
Resources
Acres
Cows or sows
No.of layers
Total assets--$
Number of workers
Production
Pigs sold
Cattle fed out
Bushels sold
Lbs. of milk
Gross sales--$
Efficiency = production per unit of resources
Physical efficiencybushels per acrelbs. milk per cowpigs per sow per yearlambs per ewepounds of feed per lb. of gain
Economic Efficiency(value of product
per unit of resource)Crop value per acre--$Asset turnover ratio--%
= gross income / total assetsLivestock returns per $ of feed Gross income per person (FTE)
Economic efficiency also depends on:
Value of Product (marketing)
Sale priceQuality TimePlace
Cost of ResourcesSeed, chemicalsCash rentMachinery, fuelWagesFeed
Economic Efficiency= Units of output x selling price
Units of resource x purch. price
Ex.: livestock production per $ feed
1 lb. gain x $.50/lb. price = $.50
3.0 lb. feed x $.08/lb. cost = $.24
= $2.08 per $ feed fed
1 lb. gain x $.50/lb. price = $.50
4.0 lb. feed x $.08/lb. cost = $.32
= $1.56 per $ feed fed
1 lb. gain x $.40/lb. price = $.40
3.0 lb. feed x $.12/lb. cost = $.36
= $1.11 per $ feed fed
Economic Efficiency Depends on:
Physical efficiencySelling price (marketing)Cost of resources
Standards of Comparison
BudgetsHistorical records for the same
farmCurrent records from comparable
farms
Financial Analysis
SolvencyLiquidityProfitability
SOLVENCY: Comparing assets to liabilities
Net worth - $
Debt-to-asset ratio (or other ratio)
Debt-to-asset ratios of 30 % to 40 % are typical, though many farms have no debt.
Leverage: degree in debt Total debt-to-asset ratio
<---10%-------20%--------40%------60%-->
low average high
High leverage means the farm net worth will grow faster when margins are high and lose equity faster when margins are low.
Liquidity(having cash when needed)
Current ratio = current assets current
liabilitiesWorking capital =
(current assets - current liabilities)
LIQUIDITYCurrent ratio should be 2.0 or better
Farms with continuous sales can have 1.5, but farms with infrequent sales may need 3.0
Working capital typically equals 25 % to 35 % of total expenses (annual)
Profitability - $ (income and expenses)
Net farm income value of unpaid labor ($/year) interest on owner equity (% interest rate x net worth)
= Return to managementThese are opportunity costs
Net Farm Income also depends on how many of your resources you contribute yourself.
Operator labor instead of hired labor.Net worth capital instead of debt.Owned land instead of rented.Net Farm Income is a return to
operator labor, net worth and management.
Example
Net farm income
- value of unpaid labor (15 months @ $3,000)
- value of owner equity
($600,000 net worth @ 4%)
= Return to management
$80,000
$45,000
$24,000
$11,000
Profitability--%Return on Equity (ROE)--%
= (NFI – unpaid labor) / farm net worth
Example:
($80,000 - $45,000) / $600,000 =
$30,000 / $600,000 = 5.0 %
Profitability--%Return on debt capital (interest) =
Interest paid for the year / total liabilities
Example: interest expense = $28,000
liabilities = $400,000
Average interest rate = 7.0%
Return on Assets (ROA)ROA is the combined return on
equity and debt capital= (NFI – unpaid labor + interest expense)
(net worth + liabilities) or total assets
= ($80,000 - $45,000 + $28,000)
($600,000 + $400,000)
= $63,000 / $1,000,000 = 6.3 %
Return on assets (ROA) is an average of the ROE and interest rate
Example: farm capital is 60% equity and 40% debt
ROE = 5 %
Interest rate = 7%
ROA = (.60 x 5%) + (.40 x 7%) = 6.3 %
PROFITABILITY
Return on assets (ROA)
<---0%-------4%--------8%--------12%--->
low average good
Return on Assets for Iowa Farms
8% 7%6%
-2%
2%
6%
2%5% 5% 5%
8%
15%
6%
-10%
-5%
0%
5%
10%
15%
20%ROAROE
Return on Assets for Iowa FarmsHigh Third Average, Low Third Average
-12%-10%
-8%-6%-4%-2%0%2%4%6%8%
10%12%14%16%18%20%
%
Other ratiosGross revenue can be divided into:
operating expense (60 to 70 %)
depreciation (5 to 10 %)
interest (5 to 10 %)
net farm income (15 to 20 %)
High profit farms may keep 25 to 30 % of their gross revenue as net income
FINANCIAL PERFORMANCE MEASURES
1. Compare to similar farms.
2. Look at trends over several years.
3. Supplement ratios with production data and enterprise analysis.