The net farm income ratio measures how much net income a farmer earns after accounting for any and all expenses.
The net farm income ratio is one of the key financial efficiency ratios used in farm financial analysis.
Net Farm Income Ratio Formula
Net Farm Income Ratio = (Net Farm Income ÷ Total Revenue) x 100
This article is a part of our series on Farm Financial Performance Ratios.
Description
The net farm income ratio in farm financials is a key financial metric that measures the proportion of a farm’s revenue that represents net farm income after accounting for all expenses, including operating expenses, depreciation, interest expenses, and other costs. This ratio provides insights into the profitability and financial performance of the farm operation. By monitoring and managing this ratio, farmers can assess profitability, optimize financial performance, and ensure long-term sustainability in their farming operations.
A higher net farm income ratio indicates that a larger proportion of total revenue is retained as net farm income after accounting for expenses. This suggests higher profitability and financial performance.
A lower net farm income ratio suggests that a smaller proportion of total revenue is retained as net farm income, which may indicate lower profitability or higher expense levels relative to revenue.
Farmers should aim to achieve a net farm income ratio that allows them to generate sufficient profits to cover operating expenses, debt service payments, capital investments, and other financial obligations while also providing a return on investment and supporting long-term sustainability and growth.
Calculating the Net Farm Income Ratio
The net farm income ratio is calculating by dividing total net income by the total revenue.
Net Farm Income Ratio = (Net Farm Income ÷ Total Revenue) x 100
Net Farm Income represents the farm’s income after subtracting all expenses, including operating expenses, depreciation, interest expenses, taxes, and other costs, from total revenue.
Total Revenue represents the total income generated by the farm from sales of agricultural products, including crops, livestock, and any other sources of revenue. This is the amount earned before accounting for any operating or non-operating expenses.
For a full breakdown of Net Income and Total Revenue, take a look at our section outlining farm income statement.
Guided Example
To understand a working example of the net farm income ratio, consider the following example. In a given year, a farmer generates total revenue of $500,000 from the sale of crops and livestock. After deducting all operating expenses (such as feed, labor, chemicals and debt payment) the farm has earned a net income of $50,000.
With these numbers, we can find the Net Farm Income Ratio. Start by taking our formula:
Net Farm Income Ratio = (Net Income ÷ Total Revenue) x 100
Next, plug the variables into the equation.
Net Farm Income Ratio = $50,000 ÷ $500,000
Net Farm Income Ratio = 10%
What this tells us is that for every dollar earned, the farmer is attaining a net income of 10 cents, or 10% of total revenue. Generally, this would be considered a healthy level.
Ideal Rate of Return on Farm Assets
Each farm and ranch may be different. as such, the ideal net farm income ratio for farmers can vary depending on factors such as farm size, type of operation, industry norms, financial goals, and economic conditions. However, in general, a higher net farm income ratio is preferred as it indicates higher profitability and financial performance.
In general, farms and ranches should aim to attain a net farm income ratio of 10% or greater. Well run operations with higher profit margins or lower expenses can attain a ratio of 20% or higher.
It’s important to note that the ideal net farm income ratio may vary based on factors such as farm size, location, commodity prices, input costs, and market conditions. Therefore, farmers should assess their individual circumstances, benchmark against industry peers, and set realistic targets for the net farm income ratio based on their specific goals and objectives.
How to Improve your Net Farm Income Ratio
The two most practical ways to improve the net farm income ratio are to improve revenue, reduce costs, or a combination of both. Each farm or ranch operation will be different. As such, strategies should be tailored to the unique needs and circumstances that each farm faces.
Here are some examples where this can be accomplished:
Increase Revenue
- Diversify Revenue Streams. Explore opportunities to diversify farm income by adding value-added products, expanding market channels, or offering agritourism activities.
- Productivity Improvements. Implement practices to increase crop yields, improve livestock performance, or enhance product quality to boost revenue per unit of production.
- Market Development. Invest in marketing and promotion efforts to reach new customers, expand market reach, and capture higher margins for farm products.
Cost Reduction
- Operational Efficiency. Streamline farm operations, optimize resource utilization, and reduce waste to lower production costs and increase profitability.
- Input Cost Management. Negotiate better prices with suppliers, explore alternative input sources, and adopt cost-saving technologies to minimize input costs.
- Labor Efficiency. Improve labor productivity through training, automation, and process optimization to reduce labor costs and enhance overall efficiency.
Financial Management
- Debt Management. Refinance debt at lower interest rates, negotiate favorable loan terms, and prioritize debt repayment to reduce interest expenses and improve financial flexibility.
- Performance Monitoring. Regularly monitor key performance indicators, including the net farm income ratio, to track progress, identify areas for improvement, and adjust strategies accordingly.
- Budget Discipline. Develop comprehensive budgets, monitor expenses closely, and identify cost-saving opportunities to ensure efficient resource allocation and maximize profitability.
- Risk Management. Implement risk management strategies to mitigate financial risks, such as price volatility, adverse weather events, or market fluctuations, to protect farm income.
Asset Optimization
- Asset Utilization. Maximize the use of farm assets, such as machinery, equipment, and land, to increase productivity and generate higher returns on investment.
- Asset Replacement Planning. Develop a strategic asset replacement plan to retire aging or inefficient assets and invest in modern, cost-effective alternatives to improve efficiency and reduce depreciation expenses.
By implementing these strategies, farmers can gradually improve their net farm income ratio, enhance profitability, and ensure the long-term success and sustainability of their farming operations.
How the Net Farm Income Ratio is Used
The net farm income ratio is an important metric used to gauge farm performance. This metric is a key indicator of profitability, financial performance and expense management.
First and foremost, this ratio is critical in understanding the financial health of the farmer. The net farm income ratio provides insights into the farm’s profitability and financial health by measuring the proportion of total revenue retained as net farm income after accounting for expenses. A higher ratio indicates higher profitability and financial performance. Conversely, a lower ratio may suggest lower profitability or higher expense levels relative to revenue, which may be an indicator of a problem.
The net farm income ratio also helps farmers allocate resources effectively and also develop comprehensive budgets and financial plans. By setting realistic targets for the ratio, farmers can guide financial planning efforts and prioritize investments, expenses, and revenue-generating activities. With careful analysis, this can help farmers make informed decisions about resource allocation, investment priorities, and operational strategies. It helps prioritize actions to improve profitability and maximize returns on investment.
Further Reading
Farm Financial Standards Council – https://ffsc.org/
Basics of a Farm Balance Sheet, Ohio State University – https://ohioline.osu.edu/factsheet/anr-64
Farm Financial Analysis Series: Balance Sheet, Mississippi State University Extension – https://farms.extension.wisc.edu/articles/preparing-a-balance-sheet/