Financial Analysis and Financial Ratio Analysisthomasc/bus_anal/ratio_explain_dairy.pdfMichigan Dairy Farm Business Analysis Michigan Dairy Farm Business Analysis1 Financial Analysis

Michigan Dairy Farm Business Analysis

Michigan Dairy Farm Business Analysis1

Financial Analysis and Financial Ratio Analysis

I. Balance Sheet: assets and debts of the business. Liabilities (debts) are assets owned by creditors; net worth or equity are assets owned by the farm business.

Farm Assets (Ave.): Equals beginning total farm assets plus ending total farm assets divided by

two. Represents total capital in the farm business. (Figure 1)

1995-2004 AverageAverage Farm Assets

$8,807$8,152

$7,477

$2,000

$4,000

$6,000

$8,000

$10,000

$12,000

Low 25% Ave. High 25%

Dairy

$/co

w

Figure 1: Average Farm Assets ($/cow).

Farm Liabilities (Ave.): Equals beginning total farm liabilities plus ending total farm liabilities

divided by two. Represents total capital in the farm business owned by creditors. (Figure 2)

1995-2004 AverageAverage Farm Liabilities

$3,681

$2,763

$2,308

$1,000

$2,000

$3,000

$4,000

Low 25% Ave. High 25%Dairy

$/co

w

Figure 2: Average Farm Liabilities ($/cow).

Net Worth Change: Equals total gain for the current year in assets owned by the farm

business. (Figure 3)

Prepared by: Dr. Craig Thomas, MSU-Extension 1


1995-2004 AverageNet Worth Change

$22

$462$712

($400)

$0

$400

$800

$1,200

$1,600


Dairy

$/co

w

Figure 3: Net Worth Change ($/cow).

II. Liquidity: measures the ability of the farm business to meet its financial obligations as they come due.

Current Ratio: indicates the ability of the farm business to meet its current debt obligations (including current portion of intermediate and long term debts). (Figure 4)

sLiabilitieCurrentTotalFarmAssetsCurrentTotalFarmRatioCurrent =

1995-2004 AverageCurrent Ratio

1.1

1.9

2.8

0.0

1.0

2.0

3.0

4.0

5.0


Dairy

Cur

rent

Rat

io

Figure 4: Current Ratio.

Working Capital: indicates the ability of the farm business to meet its current debt obligations (including current portion of intermediate and long term debts). (Figure 5)

LiabilitesCurrentTotalFarmAssetsCurrentTotalFarmCapitalWorking −=



1995-2004 AverageWorking Capital (Ending)

$88

$512

$780

($400)

$0

$400

$800

$1,200


Dairy

$/co

w

Figure 5: Working Capital ($/cow, ending).

III. Profitability: is the difference between the value of goods produced and the cost of the resources used to produce them.

Net Cash Farm Income: includes all cash farm income less cash farm expenses. (Figures 6 and

7)

1995-2004 AverageNet Cash Farm Income (per cow)

$362

$655

$827

$0

$400

$800

$1,200


Dairy

$/co

w

Figure 6: Net Cash Farm Income ($/cow).

1995-2004 AverageNet Cash Farm Income (per cwt)

$1.95

$3.21$3.75

$0.00

$2.00

$4.00

$6.00


$/cw

t

Figure 7: Net Cash Farm Income ($/cwt).

Net Farm Income: represents returns to the farm operator’s unpaid labor, management, and

owner equity. It is the reward for investing in unpaid family labor, management, and farm net



worth instead of investing elsewhere. Net Farm Income (NFI) is the amount the farm produced toward net worth growth during the year. To increase net worth through earnings, NFI plus nonfarm income must exceed family living expenses and income taxes. (Figures 8 and 9)

1995-2004 AverageNet Farm Income (per cow)

$104

$640

$937

($400)

$0

$400

$800

$1,200


Dairy

$/co

w

Figure 8: Net Farm Income ($/cow).

1995-2004 AverageNet Farm Income (per cwt)

$0.56

$3.14

$4.25

($2.00)

$0.00

$2.00

$4.00

$6.00


Dairy

$/cw

t

Figure 9: Net Farm Income ($/cwt). Return on Assets: is, in effect, the interest rate your farm earned in the past year on all money

invested in the business. (Figure 10)

InvestmentFarmAverageAssetsFarmonReturn

assetsonReturn =

Where:

.Mgmt&LaborsOperator'ofValueInterestFarmNFIAssetsFarmonReturn −+=

WorthNetFarmonInterestNFIMgmtLaborsOperatorofValue −=.&'

%6=WorthNetFarmonInterestofvalueDefault And:

( )2

AssetsFarmTotalEndingAssetsFarmTotalBeginningInvestmentFarmAverage +=



When assets are valued at market value, ROA represents the “opportunity cost” of investing money in the farm instead of alternative investments. When assets are valued at cost, ROA represents the actual return on the average dollar invested in the business. Goal should be to attain a ROA that is higher than your average interest rate on borrowed money. If ROA achieves this you are putting your borrowed capital to good use. However, you still must compare ROA to alternative investments with approximately the same level of risk.

1995-2004 AverageReturn on Assets (market)

0.9%6.8%

11.8%

-30%

-20%

-10%

0%

10%

20%

30%


Dairy

Perc

ent R

OA

Figure 10: Return on Assets (market).

Return on Equity: is, in effect, the interest rate you as the owner earned from the business (equity) in the past year. (Figure 11)

( )WorthNetFarmAverage

EquityFarmonReturnROEEquityonReturn =

Where:

.tMgm&LaborsOperator'ofValueNFIEquityFarmonReturn −=

WorthNetFarmonInterestNFIMgmtLaborsOperatorofValue −=.&'

%6=WorthNetFarmonInterestofvalueDefault

Where:

06.02

×⎟⎠⎞

⎜⎝⎛ +

=WorthNetFarmEndingWorthNetFarmBeginningWorthNetFarmonInterest

And:

2WorthNetFarmEndingWorthNetFarmBeginningWorthNetFarmAverage +

=

When assets are valued at market value, ROE can be compared to returns available if the owned assets were liquidated and invested in alternative investments. When assets are valued at cost, ROE represents the actual return to equity capital in the business. Goal should be to attain a ROE that is higher than your average interest rate on borrowed money and higher



than ROA. Such an ROE is indicative of the “positive” use of financial leverage. If ROE is lower than your average interest rate, there is negative financial leverage.

1995-2004 AverageReturn on Equity (market)

-3.2%

7.0%

14.1%

-30%

-20%

-10%

0%

10%

20%

30%


Dairy

Perc

ent R

OE

Figure 11: Return on Equity (market).

Operating Profit Margin: is a measure of operating efficiency of your farm business. It indicates the average percentage operating profit margin per dollar of farm production. (Figure 12)

ProductionFarmofValueAssetsFarmonReturn

MarginProfitOperating =

Where:

),,,,(

livestockbreedingandincomeotherreceivableaccountslivestockmarketfeedandcropschangesinventoryfeedpurchased

purchaseslivestockfeederincomecashgrossoductionPrarmFofValue+

−−=

Operating profit margin measures how effectively you are controlling operating expenses relative to the value of output. Low prices, high operating expenses, or production problems are all possible causes of low operating profit margin.

1995-2004 AverageOperating Profit Margin Ratio

2.8%

19.5%

29.3%

-40%

-20%

0%

20%

40%


Dairy

OPM

Rat

io

Figure 12: Operating Profit Margin Ratio.



IV. Repayment Capacity:

Term Debt Coverage Ratio: measures whether your operation generated enough cash over the past year to cover principal and interest payments on term (intermediate and long term) debt. If enough cash was generated to cover payments on term debts, the term debt coverage ratio will be greater than 100 percent. A ratio of less than 100 percent is a sign of liquidity (cash flow) problems. (Figure 13)

)).,.((

erestintprincipaleiPaymentsDebtTermTotalTaxesIncomeExpenseLivingFamilyExpenseInterestIncomeFarmCashNetRatioCoverageDebtTerm

+÷−−+=

1995-2004 AverageTerm Debt Coverage Ratio

64%

143%

231%

0%

100%

200%

300%


Dairy

TDC

Rat

io

Figure 13: Term Debt Coverage Ratio. Capital Replacement Margin: is the amount of money remaining after all operating expenses,

taxes, family living expenses, and scheduled debt payments have been made. It is the cash generated by the farm business that is available for financing capital replacement (e.g., machinery and equipment). (Figure 14)

1995-2004 AverageCapital Replacement Margin (cash)

($161)

($400)

($200)

$153

$370

$0

$200

$400

$600


Dairy

$/co

w

Figure 14: Capital Replacement Margin (cash, $/cow).

V. Solvency: is the ability of the farm business to pay all of its debts if it were liquidated. Solvency is a key measure for evaluating the farm business’s ability to bear financial risk and indicates the future borrowing capacity of the farm business.



Debt:Asset Ratio: measures the proportion of the farm’s total assets that are owned by creditors. (Figure 15)

AssetsFarmTotalAveragesLiabilitieFarmTotalAverageRatioAssetDebt =:

1995-2004 AverageDebt:Asset Ratio (Ending)

42%33% 30%

0%

20%

40%

60%

80%

100%


Dairy

Deb

ts:A

sset

s

Figure 15: Debt:Asset Ratio (ending).

Equity:Asset: measures the proportion of the farm’s total assets that are owned by the farm business. (Figure 16)

AssetsFarmTotalAverageWorthNetTotalAverageRatioAssetEquity =:

1995-2004 AverageEquity:Asset Ratio (Ending)

58%67% 70%

0%

20%

40%

60%

80%

100%


Dairy

Equi

ty:A

sset

s

Figure 16: Equity:Asset Ratio (ending).

Debt:Equity Ratio: measures the farm debt relative to farm equity. Measures the amount of borrowed capital being employed for every dollar of equity. (Figure 17)

WorthNetFarmTotalAveragesLiabilitieFarmTotalAverageRatioEquityDebt =:



1995-2004 AverageDebt:Equity Ratio (Ending)

73%

52%45%

0%

20%

40%

60%

80%

100%


Deb

ts:E

quity

Figure 17: Debt:Equity Ratio (ending).

VI. Efficiency:

Asset Turnover Ratio: is a measure of efficiency in using capital. It measures the amount of gross revenue produced per dollar of investment. (Figure 18)

InvestmentFarmAverageductionProFarmofValueRatioTurnoverAsset =

Where:

),,,,(

livestockbreedingandincomeotherreceivableaccountslivestockmarketfeedandcropschangesinventoryfeedpurchased

purchaseslivestockfeederincomecashgrossoductionPrarmFofValue+

−−=

If your farm business has a high level of production given your capital investment Asset Turnover Ratio will be high. If Asset Turnover Ratio is low your capital investment, or assets, are not “fully employed”, your assets are not working as hard as they should be in generating gross revenue. You should look to increase production efficiency and/or sell low returning assets.

1995-2004 AverageAsset Turnover Ratio

26.4%34.3%

40.2%

0%

25%

50%

75%

100%


Dairy

Ass

et T

urno

ver R

atio

Figure 18: Asset Turnover Ratio (market).



Operating Expense Ratio: Reflects the percentage of gross accrual income to pay operating expenses. (Figure 19)

( )IncomeFarmGross

ExpenseInterestFarmExpenseOperatingFarmTotalRatioExpenseOperating −=

1995-2004 AverageOperating Expense Ratio

84.2%75.4% 71.0%

0%

25%

50%

75%

100%


Dairy

Ope

ratin

g Ex

pens

e R

atio

Figure 19: Operating Expense Ratio.

Depreciation Expense Ratio: Reflects the percentage of gross accrual income to cover

depreciation and other capital adjustments. (Figure 20)

IncomeFarmGrossonDepreciatiRatioExpenseonDepreciati =

1995-2004 AverageDepreciation Expense Ratio

12.3%

7.9%6.2%

-10%

-5%

0%

5%

10%

15%


Dairy

Dep

reci

atio

n Ex

pens

e R

atio

Figure 20: Depreciation Expense Ratio. Interest Expense Ratio: Reflects the percentage of gross accrual income to pay interest

expenses. (Figure 21)

IncomeFarmGrossExpenseInterestFarmRatioExpenseInterest =



1995-2004 AverageInterest Expense Ratio

7.7%

5.0%3.9%

0%

5%

10%

15%


Inte

rest

Exp

ense

Rat

io

Figure 21: Interest Expense Ratio.

Net Farm Income Ratio: Reflects the percentage of gross accrual income remaining after all expenses. (Figure 22)

IncomeFarmGrossIncomeFarmNetRatioIncomeFarmNet =

1995-2004 AverageNet Farm Income Ratio

-4.1%

11.7%

18.9%

-10%

0%

10%

20%

30%


Dairy

NFI

Rat

io

Figure 22: Net Farm Income Ratio.

VI. Profile Data: information concerning the size, production capacity, and other key data from surveyed dairy farms (Figures 23-27).

1995-2004 AverageNumber of Cows

156.5 188.9284.3

0

200

400

600

800

1,000

1,200


Dairy

No.

Cow

s

Figure 23: Size (milk cows per farm).



1995-2004 AverageMilk Sold Per Cow

18,57220,407

22,060

15,000

20,000

25,000

30,000


Dairy

Lbs.

Milk

Figure 24: Milk Sold Per Cow (lbs/cow/year).

1995-2004 AverageAverage Milk Price

$14.15 $14.21 $14.24

$10.00

$12.00

$14.00

$16.00

$18.00

$20.00


Dairy

$/cw

t

Figure 25: Average Milk Price ($/cwt).

1995-2004 AverageTotal Crop Acres

569 654891

0

1,000

2,000

3,000


Dairy

Acr

es

Figure 26: Total Crop Acres.



1995-2004 AverageMilk Income

82.1% 83.6% 85.1%

0%

20%

40%

60%

80%

100%


Dairy

Perc

ent o

f Cas

h Fa

rm

Inco

me

Figure 27: Milk Income (percentage of cash farm income from milk sales).

VII. Expense Analysis: information concerning key expense items for surveyed dairy farms (Figures 28-51).

Purchased Feed:

1995-2004 AveragePurchased Feed Expense

$791 $801$865

$400

$600

$800

$1,000

$1,200


$/co

w

Figure 28: Purchased Feed Expense ($/cow).

1995-2004 AveragePurchased Feed Expense

$4.26

$3.92 $3.92

$3.00

$3.50

$4.00

$4.50

$5.00


Dairy

$/cw

t

Figure 29: Purchased Feed Expense ($/cwt).



Hired Labor:

1995-2004 AverageHired Labor Expense

$443$494 $526

$200

$400

$600

$800

$1,000


$/co

w

Figure 30: Hired Labor Expense ($/cow).

1995-2004 AverageHired Labor Expense

$2.38 $2.42 $2.38

$1.50

$2.00

$2.50

$3.00

$3.50


Dairy

$/cw

t

Figure 31: Hired Labor Expense ($/cwt).

Repairs:

1995-2004 AverageRepair Expense

$193 $195$185

$120

$140

$160

$180

$200

$220


Dairy

$/co

w

Figure 32: Repair Expense ($/cow).



1995-2004 AverageRepair Expense

$1.04$0.96

$0.84

$0.50

$0.75

$1.00

$1.25


Dairy

$/cw

t

Figure 33: Repair Expense ($/cwt).

Interest:

1995-2004 AverageInterest Expense

$248

$177$151

$80

$120

$160

$200

$240

$280

$320


Dairy

$/co

w

Figure 34: Interest Expense ($/cow).

1995-2004 AverageInterest Expense

$1.33

$0.87$0.69

$0.40

$0.80

$1.20

$1.60

$2.00


Dairy

$/cw

t

Figure 35: Interest Expense ($/cwt).



Livestock Marketing:

1995-2004 AverageLivestock Marketing Expense

$118$128 $131

$80

$120

$160

$200

$240


$/co

w

Figure 36: Livestock Marketing Expense ($/cow).

1995-2004 AverageLivestock Marketing Expense

$0.64 $0.63$0.59

$0.40

$0.50

$0.60

$0.70

$0.80

$0.90


Dairy

$/cw

t

Figure 37: Livestock Marketing Expense ($/cwt).

Livestock Supplies:

1995-2004 AverageLivestock Supplies Expense

$134 $140 $145

$40

$60

$80

$100

$120

$140

$160

$180


Dairy

$/co

w

Figure 38: Livestock Supplies Expense ($/cow).



1995-2004 AverageLivestock Supplies Expense

$0.72$0.68 $0.66

$0.20

$0.40

$0.60

$0.80


Dairy

$/cw

t

Figure 39: Livestock Supplies Expense ($/cwt).

Veterinary:

1995-2004 AverageVeterinary Expense

$108 $109 $115

$80

$120

$160

$200

$240


Dairy

$/co

w

Figure 40: Veterinary Expense ($/cow).

1995-2004 AverageVeterinary Expense

$0.58$0.53 $0.52

$0.20

$0.40

$0.60

$0.80


$/cw

t

Figure 41: Veterinary Expense ($/cwt).



Utilities:

1995-2004 AverageUtilities Expense

$77 $73$69

$60

$80

$100

$120

$140


Dairy

$/co

w

Figure 42: Utilities Expense ($/cow).

1995-2004 AverageUtilities Expense

$0.41

$0.36

$0.31

$0.20

$0.30

$0.40

$0.50


Dairy

$/cw

t

Figure 43: Utilities Expense ($/cwt).

Fuel & Oil:

1995-2004 AverageFuel & Oil Expense$79 $76

$68

$20

$30

$40

$50

$60

$70

$80


Dairy

$/co

w

Figure 44: Fuel & Oil Expense ($/cow).



1995-2004 AverageFuel & Oil Expense

$0.42$0.37

$0.31

$0.00

$0.25

$0.50


$/cw

t

Figure 45: Fuel & Oil Expense ($/cwt).

Breeding:

1995-2004 AverageBreeding Expense

$20

$26$31

$10

$20

$30

$40

$50

$60


Dairy

$/co

w

Figure 46: Breeding Expense ($/cow).

1995-2004 AverageBreeding Expense

$0.11$0.13 $0.14

$0.00

$0.05

$0.10

$0.15

$0.20

$0.25


Dairy

$/cw

t

Figure 47: Breeding Expense ($/cwt).



Total Cash Farm Expense:

1995-2004 AverageTotal Cash Farm Expenses

$2,911 $2,920 $2,968

$2,000

$2,500

$3,000

$3,500

$4,000


Dairy

$/co

w

Figure 48: Total Cash Farm Expense ($/cow).

1995-2004 AverageTotal Cash Farm Expenses

$15.67

$14.31$13.45

$10.00

$12.00

$14.00

$16.00

$18.00

$20.00


Dairy

$/cw

t

Figure 49: Total Cash Farm Expense ($/cwt).

Total Accrual Adjusted Farm Expense:

1995-2004 AverageTotal Accrual Adjusted Farm Expenses

$3,169$2,935 $2,858

$2,000

$2,500

$3,000

$3,500

$4,000


Dairy

$/co

w

Figure 50: Total Accrual Adjusted Farm Expense ($/cow).



1995-2004 AverageTotal Accrual Adjusted Farm Expenses

$17.06

$14.38

$12.96

$10.00

$12.00

$14.00

$16.00

$18.00

$20.00


$/cw

t

Figure 51: Total Accrual Adjusted Farm Expense ($/cwt).

1Data for all of the graphs were taken from the annual Michigan Farm Business Analysis Summaries for Dairy Farms performed by the Michigan State University Agricultural Economics Dept. These data represent financial analyses performed on, depending on the year, 69-158 Michigan dairy farms. Very importantly these data are not a random, statistically valid sample. Therefore, the data should be interpreted accordingly. Farms participate on a voluntary basis and all individual farm data is kept strictly confidential. References 1995 Nott, S. B. and R. E. Hepp. Michigan Farm Database New Directions for 1995, Mich. State.

Univ. Agr. Econ. Dept. Staff Paper #96-86, September 1996. 1996 Nott, S. B. Business Analysis Summary for Dairy Farms, Mich. State Univ. Agr. Econ. Dept. Staff

Paper #97-31, July 1997. 1997 Nott, S. B. 1997 Business Analysis Summary For Dairy Farms, Mich. State Univ. Agr. Econ.

Dept. Staff Paper #98-29, October 1998. 1998 Nott, S. B. 1998 Business Analysis Summary For Dairy Farms, Mich. State Univ. Agr. Econ.

Dept. Staff Paper #99-37, July 1999. 1999 Nott, S. B. 1999 Business Analysis Summary For Dairy Farms, Mich. State Univ. Agr. Econ.

Dept. Staff Paper #2000-24, July 2000. 2000 Nott, S. B. 2000 Business Analysis Summary For Dairy Farms, Mich. State Univ. Agr. Econ.

Dept. Staff Paper #2001-29, August 2001. 2001 Nott, S. B. 2001 Business Analysis Summary For Dairy Farms, Mich. State Univ. Agr. Econ.

Dept. Staff Paper #2002-21, August 2002. 2002 Wittenberg, E. and C. Wolf. 2002 Michigan Dairy Farm Business Analysis Summary. Mich.

State Univ. Agr. Econ. Dept. Staff Paper #03-14, November 2003. 2003 Wittenberg, E. and C. Wolf. 2003 Business Analysis Summary For Dairy Farms, Mich. State

Univ. Agr. Econ. Dept. Staff Paper #04-19, November 2004. 2004 Wittenberg, E. and C. Wolf. 2004 Business Analysis Summary For Dairy Farms, Mich. State

Univ. Agr. Econ. Dept. Staff Paper #2005-10, September 2005.


Documents

Financial Analysis and Financial Ratio Analysisthomasc/bus_anal/ratio_explain_dairy.pdfMichigan Dairy Farm Business Analysis Michigan Dairy Farm Business Analysis1 Financial Analysis