Financial ratios can also be used to help evaluate the financial efficiency of the business. The Farm Financial Standards Task Force,2 a national committee charged with suggesting uniform financial records, has recommended 16 measures including the following financial measures and definitions. Desirable ranges and guidelines vary substantially by type of farm, ownership pattern, time of year, and technology. Trends on each farm can identify management strengths and weaknesses. The 16 measures are grouped as follows: Liquidity, Solvency, Profitability, Repayment Capacity, Financial Efficiency.
| Table 11 | ||
|---|---|---|
| Measure | Definition | Range Desirable |
| Liquidity | ||
| 1. Current Ratio | Total Current Assets / Total Current Liabilities | 1.5-2.0 |
| 2. Working Capital | Total Current Farm Assets - Total Current Farm Liabilities | Positive, stable |
| Solvency | ||
| 3. Debt/Asset | Total Farm Liabilities / Total Farm Assets | Less than .4 |
| 4. Equity/Asset | Total Farm Equity / Total Farm Assets | Greater than .6 |
| 5. Debt/Equity Ratio | Total Farm Liabilities / Total Farm Equity | Less than .66 |
| Profitability | ||
| 6. Rate of Return on Total Farm Assets | Net Farm Income + Interest Expense - Unpaid Operator Labor & Mgmt. / Average Total Farm Assets (Market Value) | Over 4% ROR |
| 7. Rate of Return on Farm Equity | Net Farm Income - Unpaid Operator Labor & Mgmt. / Average Total Farm Equity | Greater than ROR on Total Farm Assets |
| 8. Operating Profit Margin | Net Farm Income + Interest Expense - Unpaid Operator Labor & Mgmt. / Gross Farm Revenue | 20-30% |
| 9. Net Farm Income | Cash Income +/- Change in Inventories +/- Change in Accounts Receivable - Operating Expenses +/- Changes in Accounts Payable - Interest Paid +/- Change in Interest Payable = Net Farm Income From Operations +/- Gain/Loss on Sale of Farm Capital Assets = Net Farm Income | No Standard |
| Repayment Capacity | ||
| 10. Term Debt & Capital Lease Coverage Ratio (T.D. & C.L.C. Ratio) | Net Farm Income From Operations + Non-Farm Income + Depreciation + Interest Paid - Income Tax Expense - Family Living Withdrawals / Scheduled Principal & Interest Payments on Term Debt + Capital Lease Payments = T.D. & C.L.C. Ratio | Greater than 1.25 |
| 11. Capital Replacement & Term Debt Repayment Margin (C.R. & T.D. R. Margin) | Net Farm Income + Non-Farm Income + Depreciation - Income Tax Expense - Family Living Withdrawals = C.R. & T.D.R. Capacity - Payment on Unpaid Operating Debt - Principal Payment of Term Debt - Capital Lease Payments - Payments on Personal Liabilities = C.R. & T.D.R. Margin | At least 25% more dollars than scheduled payments on debts and leases |
| Financial Efficiency | ||
| 12. Asset Turnover Ratio | Gross Revenues / Average Total Farm Assets | Greater than 25-30% |
| 13. Operational Expenses Ratio | Total Operating Expenses - Depreciation / Gross Revenues | Less than 65% |
| 14. Depreciation Expense Ratio | Depreciation/Amortization / Gross Revenues | Less than 15% |
| 15. Interest Expense Ratio | Total Farm Interest Expense / Gross Revenues | Less than 15% |
| 16. Net Farm Income From Operations Ratio | Net Farm Income From Operations / Gross Revenues | Greater than 15% |
| 2 Forbes, Stan, "Recommendations of Farm Financial Standards Task Force," 1992. | ||
The standards of comparison can be the business against itself, benchmarks, or industry averages.
All 16 of these factors have an impact on farm profitability. An accurate business analysis, emphasizing profitability, should be conducted annually to aide in making the transfer decision. The analysis can also point out other financial issues such as liquidity and risk. The recommended annual financial statements include:
Balance Sheet
Income Statement
Statement of Cash Flows
Statement of Owner Equity
Cash Flow Budget
Pro Forma Income Statement
An annual, consistent completion and analysis of these statements will indicate the economic viability of the business and the potential for transfer.