The rate of return on farm assets measures how many dollars you make for every dollar of assets a farm owns. It helps show how efficient a farm or ranch is when generating income.
The rate of return on farm assets ratio is one of the key profitability ratios used in farm financial analysis.
Rate of Return on Farm Assets 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 rate of return on farm assets can vary significantly depending on various factors such as the type of farm, location, size, efficiency of operations, market conditions, and management practices.
Generally, the rate of return on farm assets is calculated as the ratio of net income to total assets.
The rate of return on assets provides a percentage that indicates how many dollars of earnings are generated for every dollar of assets owned. For instance, a ROA of 5% means that for every $100 in assets, the farm earns $5 in profit.
Calculating the Rate of Return on Farm Assets
In the simplest terms, the rate of return on farm assets is calculated by dividing the Net Farm Income by the Total Farm Assets owned by the farm, ranch or agribusiness operation.
Rate of Return on Farm Assets = Net Income ÷ Total Assets
To calculate this ratio, you will need to locate both Net Farm Income and the Total Assets.
Net Farm Income is the farm’s total income after expenses have been deducted.
Total Farm Assets is calculated by taking the sum of the assets at the beginning and end of the period and dividing by two, to get an average value over the measurement period.
The challenge with the example above is that the income statement measures performance of the farm or ranch over a period of time, where as the balance sheet measures financial metrics at a specific point in time.
For this reason, many financial analysts, business owners and lenders take the average total assets as this helps to anchor the equation over a period of time.
Rate
of Return on Farm Assets = Net Income ÷ Average Total Assets
To get the average total assets, one must average the sum of the prior period total assets and the current period.
These two periods are typically found by taking the income statement period start date as the prior period and the income statement period end date as the current period.
Rate of Return on Farm Assets = Net Income ÷ ((Prior Period Total Assets + Current Period Total Assets)/2)
Confused? You aren’t alone! Walk through the example below to better understand how this works.
A few final notes: sometimes interest expense is added back when measuring the rate of return on farm assets. So are wages. See below for more on when this may be the case.
Guided Example
To understand the Operating Profit Margin Ratio, please review the example below.
To understand the formula, walk through the following example.
Assume that John, a farmer, has the following financial information in his balance sheet and income statement:
- A 12 month period income statement ending December 31st, 2025. The income statement indicates net income of $250,000.
- A balance sheet dated December 31st, 2024 with total assets of $1,000,0000. Note that the balance sheet date begins the period of the income statement, above.
- A balance sheet dated December 31st, 2025 with total assets of $1,200,0000. Note that the balance sheet date is dated at the end of the period of the income statement, above.
To calculate the Rate of Return on Farm Assets, start by taking our formula:
Rate of Return on Farm Assets = Net Income ÷ ((Prior Period Total Assets + Current Period Total Assets)/2)
Then, plug in the Net Income, Prior Period Total Assets and the Current Period Total Assets.
Rate of Return on Farm Assets = $250,000 ÷ (($1,000,000 + $1,200,000)/2)
Simplified:
Rate of Return on Farm Assets = $250,000 ÷ ($1,100,000)
Using our formula, we arrive at 22.7% as the rate of return on farm assets.
22.7% = 0.22727 = $250,000 ÷ $1,100,000
What this tells us is that John is making a 22.7% return on his average total assets. This is good!
Ideal Rate of Return on Farm Assets
The rate of return on farm assets can vary widely depending on the type of operation.
Based upon benchmarks within the agriculture industry, a good rate of return on farm assets should exceed 4%. A margin of 8% or higher puts the farmer into a strong position.
A commonly cited target for many businesses, including farms, is to achieve a rate of return that exceeds the cost of capital. The cost of capital includes the interest rate on borrowed funds and the expected return on equity capital. For example, if the overall cost of capital for a farm is around 5%, the farmer would aim for a rate of return on farm assets above this level to ensure the farm is not only covering its costs but also generating profit.
Low-Risk Operations: Farms with lower risk, possibly due to diversified income sources, strong demand for their products, or lower operating costs, might be satisfied with a lower rate of return, perhaps in the 2-5% range, because their risk-adjusted return is favorable compared to other investments.
Higher-Risk Operations: Farms in higher-risk categories, such as those dependent on volatile commodity prices or those in areas prone to adverse weather conditions, might aim for higher rates of return, potentially 5-10% or more, to justify the increased risk.
Growth Stage: The stage of the farm’s business cycle can also impact the target rate of return. New or expanding farms might accept lower initial returns or even operate at a loss as they invest in growth, while established farms might seek higher returns as a reflection of their stability and maturity.
Over a period of time, it has been shown that a good rate of return on farm assets should be in the range of 4% or more, with exceptionally run farm operations generating rates of return of 8% or greater.
Given the complexity of farming operations and the variability in what different farmers prioritize, there is no one-size-fits-all answer. Each farmer must consider their unique circumstances, goals, and the current economic environment to determine their ideal rate of return on farm assets.
How to Improve your Rate of Return on Farm Assets
Improving the rate of return on assets (ROA) in farming involves enhancing the efficiency with which assets are used to generate income. In short, generate more revenue while improving the ability of the owned assets to create that revenue. This can be achieved through a combination of increasing revenue and managing, or reducing, expenses.
Here are several strategies farmers can employ to improve their ROA:
Increase Revenue
There are a multitude of approaches a farm or rancher can use to improve revenue. Each strategy is different, however, here are some of the strategies to consider.
- Diversify Production. Introducing new crops or livestock can open additional revenue streams, reduce risk associated with market fluctuations, and make better use of existing assets
- Improve Product Quality. Higher quality products can often be sold for a higher price, improving income.
- Adopt Advanced Technologies. Precision agriculture, automation, and other technological advancements can increase yield and product quality.
- Market Directly to Consumers. Direct sales through farmers’ markets, CSA programs (Community Supported Agriculture), or online platforms can increase profit margins by bypassing intermediaries.
- Value-added Products. Transforming raw agricultural products into processed goods (e.g., cheese from milk, jam from fruits) can significantly increase their value and market appeal.
Reduce Expenses
Similar to improving revenue, there are also a multitude of approaches a farm or rancher can use to decrease expenses. Remember, however, that some expenses are well worth the eventual revenue those expenses generate. Be careful not to cut costs to far!
- Efficient Use of Inputs: Optimizing the use of seeds, fertilizers, water, and energy can reduce costs while maintaining or even increasing yields.
- Control Labor Costs: Automating processes and efficiently managing labor can help control one of the most significant farm expenses.
- Lease Underutilized Assets: Leasing out land or equipment that is not fully utilized can turn dormant assets into income sources.
- Reduce Waste: Implementing practices to reduce waste can save costs on inputs and improve overall efficiency.
- Bulk Purchasing: Buying inputs in bulk or collaborating with other farmers to purchase supplies can lead to significant savings.
Asset Management & Financial Management
Asset management and financial management ultimately help the farmer to better position and maintain those assets and liabilities they can control. A few key things to keep in mind:
- Refinance Debt: Lowering interest rates on existing debt through refinancing can reduce financial costs and improve net income.
- Effective Asset Management: Regularly reviewing asset performance and disposing of underperforming or unnecessary assets can improve the asset base’s efficiency.
- Government Programs and Grants: Taking advantage of government subsidies, grants, or tax incentives can provide financial benefits and support specific improvements or initiatives.
How the Rate of Return on Farm Assets is Used
The rate of return on farm assets is a crucial financial metric used by agricultural businesses, as well as businesses across various industries, to assess their efficiency and financial health.
Performance Evaluation
It helps in assessing the efficiency and profitability of a farm operation by comparing the income generated from the assets to the value of those assets. A higher rate of return indicates more efficient use of assets to generate income.
Decision Making
Farmers and farm managers use this metric to make informed decisions about expanding, diversifying, or downsizing their operations. It can guide investments in new technologies, land, or equipment by showing the potential return on these investments.
Benchmarking
By comparing the rate of return on farm assets across different farms or industry averages, farmers can benchmark their performance. This can highlight areas for improvement or strategies that are working well.
Securing Financing
Financial institutions may evaluate the rate of return on farm assets when farmers apply for loans or credit lines. A healthy rate of return indicates a profitable operation, which can lead to more favorable loan terms or interest rates.
Investor Analysis
Investors interested in agribusiness or direct farm investment examine the rate of return on farm assets to assess the viability and profitability of their investment. It helps them understand the potential income relative to the amount of capital invested.
Strategic Planning
Long-term strategic planning for a farm’s growth and sustainability can be informed by understanding the returns on current assets. It helps in prioritizing areas where investment can lead to increased profitability.
Risk Management
Analyzing the rate of return alongside other financial metrics can help farmers understand their risk exposure. For instance, a farm heavily reliant on borrowed capital might see significant fluctuations in its rate of return due to interest rate changes or economic downturns.
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/