Presentation on theme: "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?"— Presentation transcript:
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 Labor12 mo. Net income $50,000 Farm B Net worth $800,000 Operator Labor24 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 efficiency bushels 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 efficiency Selling price (marketing) Cost of resources
Standards of Comparison Budgets Historical records for the same farm Current records from comparable farms
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 low averagehigh 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
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.