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File C3-55 |
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Financial Performance Measures
William Edwards, extension economist, 515-294-6161, wedwards@iastate.edu
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 file are based on guidelines of the Farm Financial Standards Council.
A worksheet for computing financial performance measures is presented at the end of this file. Also included is a form for recording performance measures over a five year period so you can identify trends. These worksheets are also presented as Decision Tools Calculating Financial Performance Measures and Five Year Trends of Financial Performance Measures. Information on how to interpret these measures is found in Information File Interpreting Financial Performance Measures.
Types of performance 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. For information on cash flow budgeting see Information File Twelve Steps to Cash Flow Budgeting.
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. The primary measure of solvency is a net worth statement. For information on net worth statements see Information File Your Net Worth Statement.
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 can be calculated, also, and compared to interest rates for loans or rates of return from alternative investments. The primary measure of profitability is an income statement. For information on income statements see For information on cash flow budgeting see Information File Your Farm Income Statement.
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.
Information needed
The worksheet at the end of this publication shows the basic information needed to compute the financial measures. Asset and liability values should be recorded as close to the beginning and ending of the accounting year as possible. Include only farm assets and liabilities. Farm assets include any property or investments that generate returns which are included in farm income. For calculating the financial performance ratios, farm assets should be valued at their current fair market value, minus any potential selling costs and income tax payments.
Scheduled principal and interest payments on term debt include interest and principal that will have to be paid during the next year on intermediate and long term farm loans. Do not include operating or other short-term loans. For loans amortized on an equal annual payment schedule simply use the total payment due in the next year. For other loans add the principal portion due in the next year to the amount of interest that will have to be paid. Also include any long-term lease payments for machinery and equipment (but not land) that will come due.
Gross farm revenue refers to total farm sales and miscellaneous farm income. Cash income should be adjusted to reflect changes in inventories of crops, livestock, and accounts receivable. Gross farm revenue does not include non-farm income, loan funds received, nor income from sales of machinery, equipment, and real estate.
Net farm income from operations is the difference between gross revenue and total farm expenses, including interest and depreciation.
Farm capital gains and losses is the difference between the selling price of any depreciable asset sold during the year and its adjusted basis (depreciated value).
Interest expense is equal to the cash interest paid plus or minus the change in the amount of interest owed at the end of the year.
Depreciation expense should be the same value as used on the farm income statement, whether calculated for income tax purposes or by other accounting methods.
Non-farm income and family living and income tax expenditures can be estimated from personal records. Information file Family Living Expenditures provides data on family living and taxes. Common farm wage rates in the community can be used to value unpaid labor and management.