If you keep financial records for your farm business and can develop annual financial statements (balance sheet, income statement and statement of cash flow), why don’t you use that data to see how your farm is doing?

The Center for Farm Financial Management at the University of Minnesota has developed a Farm Financial Scorecard that you can complete annually to help you see trends in your farm business. The scorecard uses a set of financial ratios that help you translate your information into a value that you can use to assess your farm’s performance. Ratios also have the advantage of allowing you to benchmark your performance against other farms.

The ratios measure:

Liquidity – Your ability to pay bills without needing to sell assets or take on debt. Helps to answer the question “Does the business generate enough cash to pay routine expenses in a timely fashion?” Ratios to Evaluate Liquidity: Current Ratio; Working Capital as % of Gross Revenue; Working Capital as % of Operating Expense.

Solvency – How much of your business is owned by you vs your creditors? Helps to answer the question “Could you pay off all your debts if the farm was sold today?” Ratios to Evaluate Solvency: Debt to Asset Ratio; Equity to Asset Ratio; Debt to Equity Ratio.

Profitability – The difference in the value of goods produced and the cost of resources used in their production. Helps to answer the question “How much do you earn from sales compared to what you spent to produce the goods you sold?” Ratios to Evaluate Profitability: Rate of Return on Assets; Rate of Return on Equity; Operating Profit Margin Ratio; Asset Turnover Ratio.

Repayment Capacity – Helps to answer the question, “How easily can you pay back debt on time?”. Ratios to Evaluate Repayment Capacity: Debt Coverage Ratio; Replacement Coverage Ratio; Term Debt and Finance Lease Coverage Ratio

Financial Efficiency – How efficiently do you spend money to earn revenue? Ratios to Evaluate Financial Efficiency: Operating Expense Ratio; Depreciation Expense Ratio; Interest Expense Ratio; Net Farm Income Ratio

For each ratio you calculate, the score card evaluates your result as Green (strong); Yellow (ambiguous); or Red (vulnerable). Results in the yellow category are ambiguous, meaning you should look at the bigger picture to interpret your situation. Maybe you just took out a large loan to make an investment which affected your solvency, but it was part of a planned strategy. Maybe you had an unexpected one-time event that reduced your profits. The scorecard also tells you what the desired direction (change in ratio over time) is. For some ratios getting higher numbers over time is better and for other ratios lower numbers are better.

The Farm Financial Scorecard is intended to be used annually to see trends over time. Unless you are in an industry that has good benchmarking the best use of the ratios is not to compare your farm to other farms, but rather to see how your farm’s financial health is changing over time. Knowing your ratios can help you focus your efforts on improving areas where your business is not performing well. It can help you determine if you need to increase cashflow, reduce debt, manage overhead or try to refinance for lower interest rates.

 

Example of a Ratio

Working Capital as a % of Gross Farm Revenue (a Liquidity Ratio)

 

Financial Records Needed: Balance Sheet and Income Statement.

Working Capital = Total Current Farm Assets – Total Current Farm Liabilities (these numbers are sourced from your balance sheet)

Ratio Calculation = Working Capital ÷ Gross Farm Revenue (from your income statement) = ???

Results

If < 10% vulnerable
If 10%-30%, more info needed, have there been significant asset or liability changes this year? Why (purchase of equipment or infrastructure? Lower prices or loss of markets? Higher input costs?). Are these changes that are due to investments or changes that are due to addressing problems.
If > 30% strong

If your ratio puts you in the vulnerable region or you see issues that are concerning, watch the video: How to Improve Working Capital (Center for Farm Financial Management)

 

If you need help interpreting the ratios, the Center has provided a set of videos that walk you through interpreting them with suggestions to improve your situation. You can access them at this link