Farm Business
Analysis—Ch.18
 What
are the strengths and
weaknesses of the farm
business?
 How can we measure how well
the farm is doing?
Which farm would you prefer?


Farm A
Net worth $400,000
Operator Labor 12 mo.

Net income $50,000



Farm B
Net worth $800,000
Operator Labor 24 mo.
Net income $80,000
What Affects Net Farm
Income and Cash Flow?
 Size
 Efficiency
Size or Scale
of the Farm
Resources
Acres
Cows or sows
No.of layers
Total assets--$
Number of workers
Production
Pigs sold
Cattle fed out
Bushels sold
Lbs. of milk
Gross sales--$
Efficiency = production
per unit of resources
 Physical
 bushels
efficiency
per acre
 lbs. milk per cow
 pigs per sow per year
 lambs per ewe
 pounds of feed per lb. of gain
Economic Efficiency
(value of product
per unit of resource)
 Crop value per acre--$
 Asset turnover ratio--%
=
gross income / total assets
 Livestock
returns per $ of feed
 Gross income per person (FTE)
Economic efficiency also
depends on:
Value of Product
(marketing)
 Sale price
 Quality
 Time
 Place
Cost of Resources
 Seed, chemicals
 Cash rent
 Machinery, fuel
 Wages
 Feed
Economic Efficiency
= Units of output x selling price
Units of resource x purch. price
Ex.: livestock production per $ feed
1 lb. gain x $.50/lb. price = $.50
3.0 lb. feed x $.08/lb. cost = $.24
= $2.08 per $ feed fed
1 lb. gain x $.50/lb. price = $.50
4.0 lb. feed x $.08/lb. cost = $.32
= $1.56 per $ feed fed
1 lb. gain x $.40/lb. price = $.40
3.0 lb. feed x $.12/lb. cost = $.36
= $1.11 per $ feed fed
Economic Efficiency Depends on:
 Physical
 Selling
 Cost
efficiency
price (marketing)
of resources
Standards of Comparison
 Budgets
 Historical
records for the same
farm
 Current records from comparable
farms
Financial Analysis
Solvency
Liquidity
Profitability
SOLVENCY: Comparing
assets to liabilities

Net worth - $

Debt-to-asset ratio (or other ratio)

Debt-to-asset ratios of 30 % to 40 %
are typical, though many farms have no
debt.
Leverage: degree in debt

Total debt-to-asset ratio

<---10%-------20%--------40%------60%-->
low
average
high
High leverage means the farm net worth will
grow faster when margins are high and lose
equity faster when margins are low.
Liquidity
(having cash when needed)
 Current
ratio = current assets
current
liabilities
 Working capital =
(current assets - current liabilities)
LIQUIDITY

Current ratio should be 2.0 or better

Farms with continuous sales can have
1.5, but farms with infrequent sales
may need 3.0

Working capital typically equals 25 %
to 35 % of total expenses (annual)
Profitability - $
(income and expenses)
 Net


farm income
value of unpaid labor ($/year)
interest on owner equity
(% interest rate x net worth)
= Return to management
These are opportunity costs
Net Farm Income also depends
on how many of your resources
you contribute yourself.
Operator labor instead of hired labor.
 Net worth capital instead of debt.
 Owned land instead of rented.
 Net Farm Income is a return to
operator labor, net worth and
management.

Example
Net farm income
- value of unpaid labor
(15 months @ $3,000)
- value of owner equity
($600,000 net worth @ 4%)
= Return to management
$80,000
$45,000
$24,000
$11,000
Profitability--%
Return on Equity (ROE)--%
= (NFI – unpaid labor) / farm net worth
Example:
($80,000 - $45,000) / $600,000 =
$30,000 / $600,000 = 5.0 %
Profitability--%

Return on debt capital (interest) =
Interest paid for the year / total liabilities
Example:
interest expense = $28,000
liabilities = $400,000
Average interest rate = 7.0%
Return on Assets (ROA)
ROA is the combined return on
equity and debt capital
= (NFI – unpaid labor + interest expense)
(net worth + liabilities) or total assets
= ($80,000 - $45,000 + $28,000)
($600,000 + $400,000)
= $63,000 / $1,000,000 = 6.3 %
Return on assets (ROA) is an
average of the ROE and interest rate
Example: farm capital is 60% equity and
40% debt
ROE = 5 %
Interest rate = 7%
ROA = (.60 x 5%) + (.40 x 7%) = 6.3 %
PROFITABILITY
Return on assets (ROA)

<---0%-------4%--------8%--------12%--->
low
average
good
Return on Assets for Iowa Farms
20%
ROA
ROE
15%
15%
10%
8% 7%
5%
6%
6%
2%
8%
6%
5% 5%
5%
2%
0%
19
95
19
96
19
97
19
98
19
99
20
00
20
01
20
02
20
03
20
04
20
05
20
06
20
07
-2%
-5%
-10%
07
20
06
20
05
20
04
20
03
20
02
20
01
20
00
20
99
19
98
19
19
19
20%
18%
16%
14%
12%
10%
8%
6%
4%
2%
0%
-2%
-4%
-6%
-8%
-10%
-12%
96
%
97
Return on Assets for Iowa Farms
High Third Average, Low Third Average
Other ratios


Gross revenue can be divided into:

operating expense (60 to 70 %)

depreciation (5 to 10 %)

interest (5 to 10 %)

net farm income (15 to 20 %)
High profit farms may keep 25 to 30
% of their gross revenue as net
income
FINANCIAL PERFORMANCE
MEASURES
1.
Compare to similar farms.
2.
Look at trends over several years.
3.
Supplement ratios with production
data and enterprise analysis.