Farmers who have a large investment in land, machinery, livestock, and equipment need to keep informed about the financial condition of their operations. Some useful measures of financial performance can be calculated from information found in most farm record books and accounting programs.
These measures can help farmers assess the profitability, debt capacity, and financial risk currently faced by their businesses. The measures presented in this publication are based on guidelines of the Farm Financial Standards Council.
Types of Measures
Five different areas of financial condition are measured.
Liquidity refers to the degree to which debt obligations coming due in the next 12 months can be paid from cash or assets that will be turned into cash. This is measured by the current ratio and the amount of working capital. A more thorough analysis of liquidity can be made with a cash flow budget. Extension publication FM 1792 or AgDM File C3-15, Twelve Steps to Cash Flow Budgeting, explains this in detail.
Solvency refers to the degree to which all debts are secured, and the relative mix of equity and debt capital used by the farm. The total debt-to-asset ratio is one of several ratios used to measure solvency, all of which are based on the same relationship of assets, liabilities and net worth. It is also useful to measure how much net worth the farm has for each crop acre farmed, especially for cash grain farms. The average in Iowa is a little over $2,000.
Profitability refers to the difference between income and expenses. One important measure of profitability is net farm income. Annual rates of return on both equity capital and total assets also can be calculated and compared to interest rates for loans or rates of return from alternative investments.
Financial efficiency ratios show what percent of gross farm revenue went to pay interest, operating expenses, and depreciation, and how much was left for net farm income. The asset turnover ratio measures how much gross income was generated for each dollar invested in land, livestock, equipment, and other assets.
Repayment capacity measures show the degree to which cash generated from the farm and other sources will be sufficient to pay principal and interest payments as they come due.
Using Performance Measures
Values for the farm financial measures should be calculated for several years to observe trends and to avoid making judgments based on an unusual year. Typical historical values for most of these measures can be found in the tables at the end of this publication. They are based on data obtained from the Iowa Farm Business Associations. Values will vary according to the major enterprises carried out, farm size, location, and the type of land tenure. Other comparable data can be found in the annual annual Iowa Farm Costs and Returns (FM 1789).