Farmers urged to look at asset turnover ratios

Most farmers don’t use it, but most factory operators do.

However, the asset turnover ratio is a financial measure that makes sense for production agriculture and farmers should consider it, says Purdue University farm management expert Michael Langemeier.

Unlike metrics that look at revenue and expenses, or return on all forms of invested capital including debt, the asset turnover ratio looks at how well an operation employs its physical assets and facilities.

For factories, the measure is critical because so much capital is invested in manufacturing facilities. Maximizing the return on those is a key concern. Most industrial operators keep an eye on their asset turnover ratio in order to assess how well they are operating.

“Production agriculture is very capital intensive, so the same is true for our industry,” said Langemeier.

“The asset turnover ratio is one of the few ratios that focuses on the utilization of assets.”

Some types of business aren’t based on massive capital investments. Service providers are a type of business that typically rely less on land, buildings, machinery and land and mostly employ rare skills and labour in order to produce revenue. For those types of business, the asset turnover ratio isn’t necessarily a good gauge of how efficiently or effectively a business is operating.

Manufacturing facilities and other major industrial operations often involve huge amounts of capital invested in facilities.

Farming is moving away from a labour-based system into a capital-intensive system, with farmers replacing labour with bigger equipment operating over larger land bases to maximize efficiency.

That makes it important to understand how well that land and equipment is being used to produce a profit.

The measure itself is calculated by dividing the value of farm production by the farm’s average total physical assets. It’s one of the few ratios that comes from combining revenue numbers from the income statement and from the market-value balance sheet. Sometimes gross revenue is used to calculate the ratio because non-production revenue, such as government payments, crop insurance and miscellaneous revenue, can form a significant part of a farm’s returns and profitability.

Over the long run, an asset turnover ratio of 35 percent or higher is considered good, 25-30 percent is marginal and sub-25 percent falls into the red zone.

The ratio is affected by the amount of land owned by the farm. If a farm owns most of its land, its ratio will likely be significantly lower than for a farm that rents a major portion of its production base because rented land doesn’t count as an asset but is instead an expense.

A farm with mostly owned land will tend to have a lower asset turnover ratio and a higher profit margin than a farm that rents much or most of its land, and those different ways of looking at a farm’s efficiency need to be compared in order to get a holistic view of the farm as a business.

Certain types of farms also have different typical asset ratios, such as those with irrigation infrastructure, high tech production systems or barn complexes, versus those with few expensive facilities or systems.

Langemeier said he is promoting incorporating the asset turnover ratio in farmers’ basic self-assessment toolbox because it offers a valuable insight into farm operations that most farmers currently don’t generally employ.

“Farms do not look at the asset turnover ratio as much as they do expense ratios and the profit margin,” said Langemeier.

“I have been doing my small part in trying to change this fact.”

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