The asset turnover ratio in farm financials tells us how many dollars of revenue is generated for each dollar of assets. This ratio helps understand how efficient the farm is in generating revenue from the assets owned.
The asset turnover ratio is one of the key profitability ratios used in farm financial analysis.
Asset Turnover Ratio Formula
Rate of Return on Farm Assets = Net Income ÷ Total Assets
This article is a part of our series on Farm Financial Performance Ratios.
Description
The asset turnover ratio in farm financials measures how efficiently a farm utilizes its assets to generate revenue. It assesses the farm’s ability to generate sales relative to the value of its assets.
A higher asset turnover ratio indicates that the farm is generating more revenue per unit of assets, suggesting greater efficiency in asset utilization and higher productivity.
Conversely, a lower asset turnover ratio suggests that the farm is not generating as much revenue relative to its asset base, indicating the operation may not be as efficient in asset utilization or underperformance in revenue generation.
Calculating the Asset Turnover Ratio
The asset turnover ratio is calculating by dividing the total revenue by the total assets of the farm operation.
To calculate this ratio, you will need to locate both the Total Revenue and the Total Assets of the farm operation.
Total Revenue is the total income generated by the farm from selling agricultural products, including crops, livestock, and any other sources of revenue. Total Revenue is also known as Gross Revenue or Total Income. These terms are used interchangeably.
Total Assets include all assets owned by the farm. This includes land, buildings, crops, livestock and more.
A full breakdown of Total Revenue, take a look at our section outlining farm income statement. For an understanding of Total Assets, review our section on the farm balance sheet.
Guided Example
To understand a working example of the asset turnover ratio, consider the following example. A farmer has total annual revenue of $500,000. The farmer also has total assets of $1,000,000.
With both of these numbers, we can figure out the asset turnover ratio.
To calculate the asset turnover ratio, start by taking our formula:
Asset Turnover Ratio = Total Revenue ÷ Total Assets
Next, plug the total revenue and total assets variables into the equation.
Asset Turnover Ratio = $500,000 ÷ $1,000,000
Asset Turnover Ratio = 0.5
Asset Turnover Ratio = 50%
What this tells us is that the farmer is generating 50 cents of revenue for every dollar in assets, which is very good!
Ideal Rate of Return on Farm Assets
The ideal asset turnover ratio can vary depending on factors such as the type of farming operation as well as industry and economic conditions. However, in general, a higher asset turnover ratio is preferred as it indicates greater efficiency in asset utilization and revenue generation.
Based upon overall industry benchmarks, an ideal asset turnover ratio for farmers and ranchers is typically in the range of 30% or higher, with very profitable operations achieving a ratio of 50% or higher.
However, this can vary widely depending on various factors such as the type of crops or livestock produced, market conditions, and operational efficiency. It’s important to note that the ideal ratio may differ across different agricultural sectors.
For example, some highly specialized or value-added agricultural operations may have higher asset turnover ratios due to their ability to generate more revenue per unit of assets. Conversely, commodity-based farming operations may have lower ratios due to lower revenue generation relative to their asset base.
Farm managers should aim to achieve a ratio that reflects efficient asset utilization and revenue generation while maintaining profitability and sustainability.
Regular monitoring and analysis of the asset turnover ratio can help farmers assess performance, identify areas for improvement, and make informed decisions to optimize asset utilization and revenue generation.
How to Improve your Rate of Return on Farm Assets
Improving revenue or improving efficiency are the two ways to build a better Asset Turnover Ratio. Below are some common strategies that can be used to effectively achieve these results. It is important to understand that each operation is different and the business owner must determine what is best suited for their farm or ranch operation.
Increase Revenue Generation
- Product Diversification. Explore opportunities to diversify product offerings or add value to existing products to attract higher-paying markets and increase overall revenue.
- Market Expansion. Invest in marketing efforts to reach new customers or expand into new geographic markets, thereby increasing sales volume.
- Focus on High-Value Crops/Livestock. Prioritize products with higher profit margins to maximize revenue potential per unit of assets.
Enhance Operational Efficiency
- Streamline Operations. Identify and eliminate inefficiencies in production processes to reduce costs and improve productivity, allowing for more output per unit of assets.
- Invest in Technology. Implement technology solutions such as automation or precision agriculture to improve efficiency and reduce labor costs, leading to higher productivity.
- Improve Supply Chain Management. Optimize supply chain processes to minimize delays and reduce lead times, ensuring timely delivery of products to customers.
Optimize Asset Utilization
- Maximize Asset Usage. Ensure that all assets are utilized to their fullest potential, avoiding idle or underutilized equipment, land, or other resources.
- Asset Sharing or Leasing. Explore opportunities to share or lease assets during idle periods to generate additional revenue and increase asset turnover.
- Asset Maintenance. Regularly maintain and upgrade assets to maximize their lifespan and productivity, ensuring optimal performance and efficiency.
Reduce Non-Performing Assets
- Asset Rationalization. Assess the asset base and consider divesting non-performing or underperforming assets that do not contribute to revenue generation, thereby reducing the asset base.
- Leaseback Arrangements. Explore leaseback arrangements for certain assets to generate revenue while reducing the asset base on the balance sheet.
- Outsource Non-Core Activities. Consider outsourcing non-core activities to external vendors rather than maintaining in-house resources, reducing the asset base and associated costs.
How the Asset Turnover Ratio is Used
The asset turnover ratio is a crucial metric in gauging farm performance. First and foremost, this is an efficiency metric which provides insights into how effectively the farm utilizes its assets to generate revenue. It helps identify areas where assets are underutilized or where operational improvements can enhance efficiency.
However, this ratio alone may not tell the whole picture. Each farm operation is different and some types of farms may be more efficient at turning assets into revenue than others. Investors, lenders and business managers often use this information to benchmark the operation against other peers in the industry. As such, it is a comparative tool to understand how well the operation is run.
Finally, the asset turnover ratio helps farmers, ranchers and stakeholders make better informed decisions about resource allocation and investment priorities. It guides decisions on asset acquisition, expansion, or divestment based on their impact on revenue generation.
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/