Overview of the Farm Financial Ratios
Measuring farm financial performance is a crucial aspect for any agricultural operation. To maintain a viable operation, farms, ranches and agribusinesses should keep accurate and up to date balance sheets and maintain an annual or yearly income statement.
However, measuring farm performance means more than reading these statements. You must understand the numbers.
Understanding the financial performance of a farm operation will aid in understanding the overall financial health, efficiency, and profitability.
Anyone with experience will be enabled to make better decisions about how to spend money, how to borrow money and understand how your farm or ranch compares to other’s within your industry.
REMEMBER: User’s and practitioners of these ratios should have a good understanding of balance sheet and income statements prior to using these ratios. See our free guides on balance sheets and income statements – it only takes a few minutes each to get a high-level understanding.
Read below to understand the various types of measurements and the ratios that support these measurements!
Helpful Resources
Farm Financial Ratios
Liquidity Ratios
Liquidity ratios help understand whether a farm or ranch can meet their short-term obligations. These ratios provide insight into a company’s liquidity position by comparing its current assets to its current liabilities.
In other words: will the farm or ranch have enough cash to cover their debts in the next twelve months.
Current Ratio
The current ratio measures the company’s ability to cover its short-term liabilities with its short-term assets. It is calculated by dividing current assets by current liabilities.
A ratio above 1 indicates that the company has more current assets than liabilities, suggesting it can meet its short-term obligations. Farmers and ranchers should strive to have a current ratio greater than 1, and at least 1.3 to provide a margin of safety.
Current Ratio = Current Assets ÷ Current Liabilities
The ideal range for the current ratio is above 1.3x.
Working Capital
The Working Capital Ratio provides a more conservative measure of liquidity by excluding inventory from current assets. It assesses the company’s ability to meet short-term liabilities using its most liquid assets. It is calculated by dividing quick assets (current assets minus inventory) by current liabilities.
Maintaining positive working capital indicates that the farmer can meet its short-term obligations.
The greater the working capital, the better.
Working Capital = Current Assets – Current Liabilities
Ideally, farmers and ranchers maintain enough working capital to pay debts coming in the coming year.
Quick Ratio
The quick ratio, also known as the acid-test ratio, is a financial metric used to evaluate a company’s short-term liquidity and its ability to cover immediate liabilities with its most liquid assets. Liquid assets include cash and cash equivalents, marketable securities, and accounts receivables.
The higher the quick ratio, the more likely it is that the farmer will be able to pay upcoming debts with the most liquid assets.
Quick Ratio = (Cash & Cash Equivalents + Marketable Securities + Accounts Receivables) ÷ Current Liabilities
The ideal range for the quick ratio is above 10%.
Solvency Ratios
Solvency ratios are farm financial performance metrics used to assess a company’s ability to meet its long-term debt obligations and remain financially stable over time.
In other words: will the farm or ranch have enough cash to cover their debts in the next twelve months.
Measuring the ability to cover debts can take a number of different forms. As such, there are several key solvency ratios at your disposal. These ratios provide insights into a company’s financial leverage, capital structure, and ability to generate sufficient cash flows to cover its long-term liabilities.
Debt to Asset Ratio
The debt to asset ratio is a financial metric used to measure the proportion of a farmer or rancher’s assets that are financed by debt. It provides insights into the extent to which a company relies on debt financing to support its operations and investments.
The debt to asset ratio is typically
presented as a percentage.
A higher debt to asset ratio indicates that a larger portion of the company’s assets is financed by debt, while a lower ratio suggests a lower level of financial leverage and reliance on debt financing.
Debt to Asset Ratio = Total Debt ÷ Total Assets
Farmers should strive to maintain a debt to asset ratio lower than 60%.
Equity to Asset Ratio
The equity to asset ratio, also known as the equity ratio or net worth ratio, is a farm financial performance metric used to measure the proportion of a farmer or rancher’s assets financed by equity. It provides insights into the company’s financial leverage and the extent to which owners’ equity contributes to the company’s total assets.
In other words, what proportion of your assets are truly owned, as opposed to financed.
The Equity to Asset ratio is usually expressed as a percentage. The higher the equity to asset ratio, the better.
A higher equity to asset ratio is considered favorable, as it indicates a lower level of financial risk and a higher degree of financial stability.
Equity to Asset Ratio = Total Equity ÷ Total Assets
The ideal range for the equity to asset ratio is above 40%.
Debt to Equity Ratio
The debt to equity ratio is a financial metric used to measure the proportion of a company’s financing that comes from debt compared to the proportion that comes from equity.
It provides insights into a company’s financial leverage and risk exposure, indicating the extent to which it relies on debt financing to fund its operations and investments.
In other words, the debt to equity ratio helps understand how much of your operation is financed versus truly owned.
The Debt to Equity Ratio is usually expressed as a ratio (i.e. 1.5x) or a percentage (i.e. 150%).
A higher debt to equity ratio is considered favorable, as it indicates a lower level of financial risk and a higher degree of financial stability.
Debt to Equity Ratio = Total Debt ÷ Total Equity
The ideal range for the quick ratio is above 1.5x.
Profitability Ratios
Profitability ratios are financial metrics used to evaluate a company’s ability to generate profits relative to its revenue, assets, equity, or other factors.
These ratios help assess the efficiency and effectiveness of a company’s operations and management in generating profits.
Operating Profit Margin Ratio
The operating profit margin, also known as the “operating profit ratio”, is a farm financial performance metric that measures a company’s operating efficiency and profitability by expressing its operating income (also known as operating profit) as a percentage of its revenue.
The operating profit margin is usually expressed as a percent.
The operating profit margin indicates the proportion of revenue that a company retains after covering its variable and fixed operating costs, before considering non-operating items like interest and taxes.
A higher operating profit margin typically signifies better operational efficiency and profitability, as the company is able to generate more profit from each dollar of sales. Conversely, a lower operating profit margin may indicate higher operating expenses relative to revenue, potentially impacting overall profitability.
Operating Profit Ratio = (Operating Profit ÷ Revenue) * 100%
The ideal range for the quick ratio is above 1.5x.
Note: Operating profit is derived by subtracting operating expenses, such as cost of goods sold, selling, general, and administrative expenses, from gross profit.
Return on Farm Assets Ratio
Return on Assets (ROA) is a farm financial performance ratio that measures a company’s profitability relative to its total assets.
It shows the percentage of net income generated for each dollar of average total assets. It indicates how efficiently a company utilizes its assets to generate profit. This ratio combines accounts from both the income statement and balance sheet.
A higher ROA indicates that a company is more efficient in utilizing its assets to generate profit, while a lower ROA suggests less efficiency.
Please note that the average total assets requires knowing the total assets during the current period and prior period. Check out our article link below to learn more about how to obtain this number.
Return on Farm Assets = Net Farm Income ÷ Average Total Assets
Then ideal Return on Farm Assets is greater than 4% per year.
Return on Farm Equity Ratio
Return on Equity (ROE) is a farm financial performance ratio that measures a farmer or rancher’s profitability relative to its owner’s equity. ROE measures the efficiency with which a company generates profits from the equity invested by its shareholders.
It shows how much profit a farm or business generates with the money invested by shareholders.
This ratio combine accounts from both the income statement and balance sheet.
The Return on Farm Equity is usually expressed as a percentage.
A higher ROE indicates that a company is more effectively using shareholders’ equity to generate profit, while a lower ROE may suggest less efficiency.
Return on Farm Equity = (Net Income ÷ Owner’s Equity)
The ideal rate of return on farm equity is greater than 3% per year.
Asset Turnover Ratio
The asset turnover ratio for farm operations is a farm financial performance metric used to assess how efficiently a farm utilizes its assets to generate revenue.
It measures the amount of revenue generated for each dollar of assets employed in the farming operations. In other words, how many
Total Revenue can be found on the farm income statement and is the sum of all income from operations, before expenses. Total assets is found on the farm balance sheet and is one of the three main components to a balance sheet.
A higher asset turnover ratio indicates better efficiency in asset utilization, while a lower ratio may suggest inefficiencies or underutilization of assets.
Asset Turnover Ratio = Total Revenue ÷ Total Assets
The ideal asset turnover range for farmers is above 30% per year.
Repayment Capacity Ratios
Repayment capacity ratios in agricultural finance are financial metrics used to assess a farmer’s ability to meet their debt obligations.
Debt Coverage Ratio
The Debt Coverage Ratio (DCR) is a farm financial metric used to evaluate a company’s ability to cover its debt obligations with its operating income.
In short, it provides insight into whether a farm or ranch generates sufficient cash flow to meet its debt service requirements.
The debt service coverage ratio is usually expressed as a number such as 1.25 or 2x.
Lenders often use the debt coverage ratio to assess the creditworthiness of a company when considering loan applications. It is important to remember that lenders use different variations of this formula (the author has seen at least 12!).
Some differences include various interpretations of debts, leases, and exclusions for non-cash expenses such as amortization and depreciation.
Debt Coverage Ratio = Net Operating Income ÷ Total Debt Service
The ideal Debt Coverage Ratio is above 1.25.
Farmers should ALWAYS have a debt service coverage of 1 or more, indicating that you are generating enough money to cover your debt payments. Having 1.5 to 1.75x (or greater) is ideal!
Replacement Coverage Ratio
The Replacement Coverage Ratio (RCR) in farming is a financial metric used to assess a farm’s ability to cover the replacement cost of its assets, particularly capital assets such as equipment, machinery, and buildings.
It measures the extent to which a farm’s net farm income can support the replacement or depreciation of its capital assets.
The replacement coverage ratio is usually expressed as a number, such 1.25x.
A ratio greater than 1 indicates that the farm’s net income is sufficient to cover its depreciation and capital costs, allowing for asset replacement and maintenance.
A ratio less than 1 suggests that the farm may not generate enough income to adequately maintain and replace its capital assets, potentially leading to deterioration of the farm’s infrastructure and productivity.
Replacement Coverage Ratio = Net Farm Income ÷ Depreciation and Capital Costs
Farmers should strive to have a replacement coverage ratio of at least 1.1x and ideally have a replacement coverage ratio greater than 1.5x.
Term Debt & Lease Finance Coverage Ratio
The Term Debt and Finance Lease Coverage Ratio is a farm financial metric used to assess a company’s ability to cover its term debt and finance lease obligations with its operating income.
In other words, can the the farmer of rancher pay their term debt and lease expenses with the operating income generated.
Term Debt and Finance Lease Coverage Ratio is usually expressed as a number, such as 1.25x.
Remember that Net Operating Income (NOI) is the company’s operating income, typically calculated as revenue minus operating expenses. T
Total Debt Service on Term Debt and Finance Leases includes all payments required to service term debt (such as loan repayments) and finance lease obligations (payments for leases that effectively transfer ownership of the asset to the lessee).
Term Debt and Finance Lease Coverage Ratio = Net Operating Income ÷ (Total Term Debt Expenses + Lease Finance Expenses)
The ideal Debt Coverage Ratio is above 1.25.
Farmers should ALWAYS have a debt service coverage of 1 or more, indicating that you are generating enough money to cover your debt payments. Having 1.5 to 1.75x (or greater) is ideal!
Financial Efficiency Ratios
Financial efficiency ratios are a set of financial metrics used to evaluate how effectively a farm or ranch utilizes its resources to generate profits and manage its assets and liabilities.
Operating Expense Ratio
The Operating Expense Ratio on a farm is a financial metric used to assess the proportion of revenue that is consumed by operating expenses.
It measures how efficiently a farm manages its operational costs relative to its total revenue.
The operating expense ratio is usually expressed as a percentage, such as 75%.
The Operating Expense Ratio indicates the percentage of revenue that goes towards covering operating expenses.
A lower ratio suggests that the farm is more efficient in managing its operating costs, leaving a higher percentage of revenue available for other purposes such as debt repayment, investment, or profit.
Operating Expense Ratio = Total Operating Expenses ÷ Total Revenue
Farmers and ranchers should look to keep their operating expense ratio below 80%.
Anything above this level indicates low efficiency which will impact earnings.
Depreciation Expense Ratio
The Depreciation Expense Ratio is a farm financial performance metric used to assess the proportion of a farm or ranch’s revenue that is allocated to depreciation expenses.
It measures how efficiently a farm manages its operational costs relative to its total revenue.
The depreciation expense ratio is usually represented as a percentage. For example 4.5%.
Depreciation is the accounting method
used to allocate the cost of tangible assets over their useful lives.
The Depreciation Expense Ratio indicates the percentage of revenue that is used to cover the depreciation of tangible assets, such as buildings, machinery, vehicles, and equipment.
A higher ratio suggests that a larger portion of revenue is being allocated to depreciation expenses, which may impact the company’s profitability and cash flow.
Depreciation Expense Ratio = Depreciation Expense ÷ Total Revenue
Farmers should strive to have a depreciation expense ratio of less than 10%. Ideally this number is much lower at 5% or smaller.
Interest Expense Ratio
The Interest Expense Ratio is a farm financial metric used to assess the proportion of a farm or ranch’s revenue that is used to cover interest expenses.
Interest expenses arise from the cost of borrowing funds, such as interest payments on loans, bonds, or other forms of debt.
The interest expense ratio is usually expressed as a percentage.
A higher ratio suggests that a larger portion of revenue is being used to service debt, which may indicate a higher financial risk for the company, especially if the interest expense becomes burdensome relative to its revenue.
Interest Expense Ratio = Interest Expense ÷ Total Revenue
Farmers and ranchers should aim for an interest expense ratio of less than 10%. Ideally this number is much lower at 5% or smaller.
Net Farm Income Ratio
The Net Farm Income Ratio is a financial metric used in agriculture to assess the profitability of a farm operation.
It measures the proportion of a farm’s revenue that represents net farm income, which is the profit generated from farming activities after deducting all expenses, including operating costs, depreciation, interest, taxes, and other non-operating expenses.
The Net Farm Income Ratio is usually expressed as a percentage.
A higher ratio suggests that a larger portion of farm revenue is being converted into profit, which reflects a more profitable and efficient farm operation. Conversely, a lower ratio may indicate lower profitability or higher expenses relative to revenue.
Net Farm Income Ratio = (Net Farm Income ÷ Total Revenue) x 100
Farmers and ranchers should have a net farm income ratio of 10% or greater. 20% or higher is ideal.