Sharpen your pencils, dust off the calculators and try these calculations to get started on the road of business planning.
The following calculations of a farm’s liquidity, solvency, profitability and financial efficiency can be measured against industry benchmarks to determine if there is cause for concern.
Douglas Stroh of Meyers Norris Penny said ratios are tools to help analyze a business.
“These are financial indicators, feedback to manage where the business is at,” he said.
“You should have 20 cents on the dollar left in your pocket. If not, you may ask the question, why,” he said, noting it can help point to areas that need attention and change.
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Viability analyses calculate the ability of a business to meet financial obligations as they come due in the course of business.
These indicators relate to cash and short-term risk.
Current assets divided by current liabilities equals the current ratio, with a ratio of 2:1 considered good and a ratio of 1.1:1 a concern.
Working capital is determined by subtracting current liabilities from current assets. Twenty-five percent is good, and 10 percent is a concern.
Current liabilities divided by total liabilities equals the debt structure ratio, which is considered good in the 20 percent range and a concern at 30 percent.
Current liabilities over equity equals a debt to equity ratio (or the total outstanding debt divided by the owners equity). It should be considered good at 0.4:1, with 1:1 considered a concern.
The debt servicing ratio is the debt servicing capacity over the annual term principal and interest. The debt servicing capacity is the net farm income before tax and interest on term debt and amortization or depreciation minus owners’s withdrawals and income tax paid.
A 2:1 ratio is considered good, while 1.1:1 is cause for concern.
In determining a business’s profitability, place gross income over total assets (owned and leased at fair market value) to find the asset (capital) turnover ratio.
That should be in the 40 percent range, with 10 percent a concern.
Divide total assets into net income (before tax) and interest paid minus unpaid family wages to determine returns on asset ratio. They should come in around four percent.
For returns on equity, net income (before tax) minus unpaid family wages divided by owner or shareholder equity should yield a value of 10 percent to be viable.
Finally, the extent to which a business uses its resources efficiently can be gauged with the following formulae.
Contribution margin (gross income minus variable expenses) over gross income equals a contribution ratio, which ideally should sit at 50 percent.
Net profit margin ratios are calculated by placing net profit margin (contribution margin minus fixed expenses) over gross revenue. That should be in the 20 percent range.
The ability of a farm to generate enough income for all the families involved can be calculated by placing the net farm and off-farm income over the number of independent households. That ratio is considered good at $50,000 and a concern at half that amount.
How does your farm rate?
