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These ratios are recommended by the Farm Financial Standards Council.
Computation:
Gross revenues (or VFP)
÷ Average total farm assets
= Asset Turnover Ratio
Interpretation:
The asset turnover ratio is a measure of how efficiently farm assets are being used to generate revenue. A farm business has two ways to increase profits - either by increasing the profit per unit produced or by increasing the volume of production (if the business is profitable). A relationship exists between the rate of return on farm assets, the asset turnover ratio, and the operating profit margin ratio. If the asset turnover ratio is multiplied by the operating profit margin ratio, the result is the rate of return on the farm assets. Consequently, the same asset valuation approach should be used to calculate the asset turnover ratio as is used to calculate the rate of return on farm assets. The higher the ratio the more efficiently assets are being used to generate revenue.
- Ratio is provided in the Farm Financial Standards and can be customized in Lending Cloud.
Computation:
Net farm income from operations
+ Total non-farm income
+ Depreciation
- Total income tax expense
- Family living (includes all personal liabilities)
= Capital replacement and term debt repayment capacity
- Principal pmt on current portions of term debt & capital leases
= Capital Replacement and Term Debt Repayment Margin
Interpretation:
This measure enables borrowers and lenders to evaluate the ability of the farm proprietor to generate funds necessary to repay debts with maturity dates longer than one year and to replace capital assets. It also enables users to evaluate the ability to acquire capital or service additional debt and to evaluate the risk margin for capital replacement and debt service. This measure assumes that credit obtained for current-year operating expenses will be repaid in one year as a result of the normal conversion of farm production to cash. Unpaid operating debt from a prior period should exclude lines of credit and debt for livestock purchased in that period for sale in the current period (if part of the normal course of business).
Computation:
Total current farm assets
÷ Total current farm liabilities
= Current Ratio
Interpretation:
This ratio (usually expressed as XX:1) indicates the extent to which current farm assets, if liquidated, would cover current farm liabilities. The higher the ratio, the greater the liquidity.
Computation:
Total farm liabilities
÷ Total farm assets
= Debt/Asset Ratio
Interpretation:
This ratio measures financial position. The debt/asset ratio compares total farm debt obligations owed against the value of total farm assets. This ratio expresses what proportion of total farm assets is owed to creditors. This ratio is one way to express the risk exposure of the farm business. It can be calculated using either the cost or market value approach to value farm assets. If the market value approach is used to value farm assets, then deferred taxes on the assets should be included as liabilities. This ratio is most meaningful for comparisons between farms when the market value approach is used to value farm assets. The higher the ratio, the more risk exposure of the farm business.
Computation:
Total farm liabilities
÷ Total farm equity
= Debt/Equity Ratio
Interpretation:
This ratio measures financial position and reflects the extent to which farm debt capital is being combined with farm equity capital. It can be calculated using either the cost or market value approach to value farm assets. If the market value approach is used to value farm assets, then deferred taxes on the assets should be included as liabilities. This ratio is most meaningful for comparisons between farms when the market value approach is used to value farm assets. however, due to the impact of fluctuations in market values of farm assets, it is most meaningful for comparisons between accounting periods for an individual farm operation when the cost approach is used to value farm assets. The higher the value of the ratio, the more total capital supplied by the creditors and less by the owner(s).
Computation:
Earnings before interest, taxes, depreciation and amortization (EBITDA) is calculated as:
Net farm income from operations
+ Interest expense
+ Depreciation expense
+ Amortization expense.
Net farm income from operations
+ Interest expense
= EBIT* Earnings before interest and taxes
+ Depreciation and amortization expense
= EBITDA* Earnings before interest, taxes, depreciation and amortization
* E = Earnings, B = Before, I = Interest, T = Income Taxes, D= Depreciation, A = Amortization
Interpretation:
EBITDA considers earnings prior to interest, income taxes depreciation and amortization. Commercial analysts often begin with EBITDA as the source of repayment capacity and then compare this to total interest payments or principal and total interest payments in arriving at a debt coverage ratio. Recurring withdrawals and/or income taxes are often subtracted from EBITDA to arrive at the repayment capacity for commercial analysts.
Computation:
Total farm equity
÷ Total farm assets
= Equity/Asset Ratio
Interpretation:
This ratio measures financial position. Specifically, it measures the proportion of total farm assets financed by the owner's equity capital. In other words, it is the owner's claims against the assets of a business. This ratio can be calculated using either the cost or market value approach to value farm assets. If the market value approach is used to value farm assets, then deferred taxes on the assets should be included as liabilities. This ratio is most meaningful for comparisons between farms when the market value approach is used to value farm assets. However, due to the impact of fluctuations in market values of farm assets, it is most meaningful for comparisons between accounting periods for an individual farm operation when the cost approach is used to value farm assets. The higher the value of the ratio, the more total capital supplied by the owner(s) and less by the creditors.
Computation:
Cash income from production of grain
+ or - Change in crop inventories
+ Cash income from production of livestock
+ or - Change in livestock inventories
+ Cash livestock product sales
+ or - Change in livestock product sales inventories
+ Government program payments
+ or - Change in value of raised breeding stock
+ or - Change in accounts receivable
+ Other farm income
= Gross Revenues
- Purchases of feeder livestock
- Cost of purchased feed/grain
= Value of Farm Production
- Cash farm op expenses (less interest or depreciation )
+ or - adjustments for growing crops, prepaid expenses & leases, supplies & other current assets, accounts payable, real estate taxes, other current liabilities
- Depreciation expense
- Cash interest paid
+ or - change in accrued interest
= Net Farm Income From Operations
Computation:
Cash income from production of grain
+ Cash income from production of livestock
+ Cash livestock product sales
+ Government program payments
+ Gain/Loss of raised breeding stock
+ Other farm income
= Gross revenues
- Purchases of feeder livestock
- Cost of purchased feed/grain
= Value of farm production
- Cash farm op expenses (less interest or depreciation )
- Depreciation expense
- Cash interest paid
= Net farm income from operations
Computation:
Net farm income from operations
+ Farm interest expense
- family living
÷ Gross revenues (or VFP)
= Operating Profit Margin Ratio
Interpretation:
This ratio measures financial efficiency in terms of return per dollar of gross revenue (or value of farm production - "VFP"). A farm business has two ways to increase profits - either by increasing the profit per unit produced or by increasing the volume of production (if the business is profitable). A relationship exists between the rate of return on assets, the asset turnover ratio, and the operating profit margin ratio. If the asset turnover ratio is multiplied by the operating profit margin ratio, the result is the rate of return on assets.
Four ratios reflect the relationship of expense and income categories to gross revenues (or VFP). The sum of the first three expresses total farm expenses per dollar of gross revenue (or VFP).
Operating Expense Ratio
Total Operating Expenses
- Depreciation /Amortization Expense
÷ Gross Revenues
= Operating Expense Ratio
Depreciation Expense Ratio
Depreciation /Amortization Expense
÷ Gross Revenues
= Depreciation Expense Ratio
Interest Expense Ratio
Total Farm Interest Expense
÷ Gross Revenues
= Interest Expense Ratio
Net Farm Income from Operations Expense Ratio
Net Farm Income From Operations
÷ Gross Revenues
= Net Farm Income From Operations Expense Ratio
Limitations:
Computation:
Net farm income from operations
+ Farm interest expense
- Family living
÷ Average total farm assets
= R.O.A.
Interpretation:
This ratio measures the rate of return on farm assets and is often used as an overall index of profitability. This ratio is most meaningful for comparisons between farms when the market value approach is used to value farm assets. However, due to the impact of fluctuations in market values of farm assets, it is most meaningful for comparisons between accounting periods for an individual farm operation when the cost approach is used to value farm assets. The higher the value, the more profitable the farming operation.
Computation:
Net farm income from operations
- Family living
÷ Average total farm equity
= R.O.E
Interpretation:
This ratio measures the rate of return on equity capital employed in the farm business. It is most meaningful for comparisons between farms when the market value approach is used to value farm assets, and deferred taxes on these assets are included as liabilities. However, due to the impact of fluctuations in market values of farm assets, it is most meaningful for comparisons between accounting periods of an individual farm operation when the cost approach is used to value farm assets. The higher the value of the ratio, the more profitable the farming operation.
Computation:
Capital debt repayment capacity
÷ (Total uses of repayment capacity + Replacement allowance/unfunded capital expenditures)
Interpretation:
The ratio provides a measure of the ability of the borrower to cover all term debt and capital lease payments and recurring unfunded acquisitions. The greater the ratio over 1:1, the greater the margin to cover the payments.
Computation:
Net farm income from operations
+ Total non-farm income
+ Depreciation
+ Interest on term debt and capital leases
- Total income tax expense
- Family living
÷ Annual principal /interest pmts. on term debt
= T.D.C.L.C.R.
Interpretation:
The ratio provides a measure of the ability of the borrower to cover all term debt and capital lease payments. The greater the ratio, over 1:1, the greater the margin to cover the payments.
Computation:
|
Interest rate increases by: = |
Margin after debt servicing / (beginning balance sheet: current notes payable ours & other + current portion term debt ours & other + intermediate term debt ours & other + long term debt ours & other) |
Interpretation:
Sensitivity analysis determines how well a customer can handle increases or decreases in key financial sections of their operation before depleting debt servicing. Example: 1) A decrease in Farm Revenues (Debt Service Margin/Total Farm Revenue). 2) An increase in Farm Expenses (Debt Service Margin/Total Farm Expenses). 3) An increase in Interest Rate (Debt Service Margin/Sum of Operating, Intermediate, Long Term Loans).
Computation:
Total current farm assets
- Total current farm liabilities
= Working Capital
Interpretation:
Working capital is a theoretical measure of the amount of funds available to purchase inputs and inventory items after the sale of current farm assets and payment of all current farm liabilities. The amount of working capital considered adequate must be related to the size of the farm business.
Computation:
Working capital ÷ Gross revenues
Interpretation:
Working capital divided by Gross Revenues gives a relationship of the working
capital to the size of the farm business. The higher the ratio, the greater the liquidity.
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