Farms with good liquidity typically have current ratios of at least 3.0 or higher. Dairy farms or other farms that have continuous sales throughout the year can safely operate with a current ratio as low as 2.0, however. Operations that concentrate sales during several periods each year, such as cash grain farms, need to strive for a current ratio as high as 3.0, especially near the beginning of the year.
The amount of working capital needed depends on the size of the operation. Records show that working capital measured at the beginning of the year is typically equal to about one-fourth to one-third of the farm’s annual gross revenue. For dairy farms, working capital can be as low as 25 percent of gross revenue, but cash grain farms may need as much as 50 percent.
Total debt-to-asset ratios tend to be higher for larger farms and for farms that specialize in livestock feeding. Ratios of 20 to 30 percent are common among Iowa farms, although many operate with little or no debt. A high debt load does not make farms less efficient, but principal and interest payments eat into cash flow. High efficiency farms are able to service a higher debt load safely.
Another guideline for controlling debt is to not let total liabilities exceed yearly gross income. High profit farms typically have total debts that are less than their gross income, while low profit farms have debt levels in excess of gross income.
Net farm income is highly variable from year to year, and is closely tied to the size and efficiency of the operation. It also depends on the amount of debt the farm is carrying. The rate of return on farm assets is quite variable, too, but average longterm rates of 6 to 8 percent have been common in Iowa. High profit farms may average more than 12 percent, however, while low profit farms often realize a return of only 2 percent or less.
The average rate of return on farm equity measures how fast farm net worth is growing, excluding changes in land and machinery values. It is usually a little lower than the return on farm assets. Highly leveraged farms may earn little or no return on equity when interest rates are high. On the other hand, if the farm’s overall return on assets is higher than the cost of borrowed money, the return on equity may be quite high and net worth will grow rapidly.
Operating profit margin ratios have averaged about 20 to 25 percent in the last decade. High profit farms have had ratios of 30 percent or more, while low profit farms have had ratios of less than 10 percent. Farms that hire or rent assets such as labor, land, or machinery will have a lower operating profit margin because operating costs are higher. However, they will usually generate a larger gross and net income. Farms with owned or crop share rented land will have a higher operating profit margin because they have fewer operating expenses.