Capital turnover ratio declines

I recently spoke at a conference about financial efficiency. It was two sessions actually.

I typically don’t get a lot of questions at the end of a presentation. Nor do I get a bunch of people coming up to me after I finish.

That makes sense because I don’t think financial management is exciting for most farmers. If it was, they might have chosen to be accountants instead of farmers. I digress.

But the recent presentations were different. Attendance was high. There were some questions but more significantly, there were many farmers wanting to talk to me about their situations when I was finished.

Things are different, financially, than they’ve been in the relatively recent past. Margins are down. Costs associated with capital investment continue to increase. This is nothing any farmer isn’t acutely aware of but, in part, it is contributing to a heightened awareness of the importance of financial management.

The accompanying illustration, taken from a dataset of farm financial information, speaks to the relationship between capital investment and gross revenue or sales. Ideally, it would be better if the trendline was increasing, or at least remaining flat — not decreasing.

All farms use the investment (capital) they have in land, buildings and equipment (breeding livestock and quota for some farms) to generate sales, or gross revenue. The capital turnover ratio is calculated by dividing gross revenue by capital assets.

The historical (past) trendline is declining. Capital investment is increasing at a rate that’s faster than the ability of farms to turn the investment they have into gross revenue. This won’t come as a surprise to most farmers. Still, the trendline illustration is troubling. For the trendline to increase, we’d have to have gross revenue (sales) increase and/or capital investment decrease. Perhaps the most likely scenario would see the trendline at least flatten or level off.

There’s another troubling aspect to the decline. It has to do with how the capital investment has been financed. The greater the amount of debt used to finance the capital investment, the greater the interest rate risk and the cash flow risk associated with principal repayment commitments.

What this has to do with financial efficiency

We’re seeing farms that are experiencing cash flow challenges. There can be several reasons why this might be happening on any given farm. It could be associated with the amount of cash needed to make principal payments on term loans, and where cash has been used for capital purchases that were made without a term loan. Cash comes from profit: profit, obviously, being the difference between gross revenue and expenses. Farms that are more financially efficient will have more profit left over after the expenses have been paid.

Here’s yet another troubling aspect. A great many farms will not know how financially efficient they are or where to begin to look to see what changes could be made that would make their businesses more financially efficient or which improvements result in optimizing levels of profit and ultimately available cash.

Given the current environment, I think farmers should pay close attention to the financial efficiency of their businesses. Ideally, farmers know what their financial efficiency strengths and weaknesses are. The ultimate accountability falls back to farmers themselves.

However, I realize that for most farmers, financial management is not an area of interest or expertise. Anyone reading this article with an interest in better understanding their financial efficiency, but lacking the knowledge of how and where to look, can look to resources that are available to them.

Terry Betker, PAg, is a farm management consultant based in Winnipeg. He can be reached at 204-782-8200 or terry.betker@backswath.com.

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