Instructions for Using the
Farm Financial Analysis Ratios
Downloading and Installing:
- Brief Description of download and installation procedure:
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Download the Self-extracting Zip File to your hard drive. Run the un-zip program (ratio.exe) which calls the set-up program.
Click on Farm Financial Ratios Software Auto Setup, a self-extracting zipped file with a setup routine. With most browsers, you will get a choice of saving it to your hard drive or opening it. Pick a directory in which to save the file (suggestions: c:\temp or c:\downloads) Save it to your hard drive. Remember in which directory you save it.
Go to the folder/directory in which you saved the file and double-click on "ratios.exe". It will create a folder called "c:\tempratio". You will get a message asking if it is okay to create the directory.
Select "Yes" to create the temporary directory. The program will then copy its files to to that directory and automatically start the set-up program. Follow the setup routine instructions.
Note to Windows 2000 Users:
When installing baled budgets, you may get a message saying there is no disk in the drive. (This is a small problem with the baling software and not a problem with your computer.)
Depending on the exact message you receive, you will need to press "ok" or "cancel". (The message may appear twice.) The program should continue to install.
Here is an example of the type of message that may appear. (The actual message you receive may vary slightly.)
To Create a Shortcut: After installing the program, you will see a program group with an icon. Right click on the icon that appears in the program group then click "Copy". Close the program group. Now, right click in the middle of the screen and click "Paste". This will copy and paste the icon.
Overview:
A completed set of farm financial statements offers a wealth of business information to the farm manager. However, no single statement or measure can show the whole picture. With completed beginning and ending year balance sheets, an income statement and a record book, a set of farmfinancial ratios can be completed for a better understanding of the financial health of the business.
The Baled Farm Financial Analysis Program can help the agricultural producer complete twelve important financial ratios. The ratios are divided into four different types: liquidity measurers, solvency measures, profitability ratios, and financial efficiency ratios. Beside each measure is a color bar of green, yellow, and red, with different numbers where the color changes from one to another. This color bar is provided to identify areas of financial health (green), caution (yellow), and danger (red) to the producer.
The liquidity measures indicate the farm's ability to meet financial obligations when they come due. The current ratio compares the dollar value of current assets the farm owns to the dollar value of current liabilities. A current ratio of 2.0 means that the farm has twice as many current assets as it has current liabilities. If the current ratio falls below one, then the farm does not have enough assets to cover its liabilities in the short term. Working capital measures the amount remaining if all current assets were sold and all current liabilities were paid. It calculates the amount of capital available for the farm to "work with" over the next year.
The solvency ratios measure the farm's equity standing. The debt to asset ratio reflects how much of the farm's assets are financed through debt. For example, a farm with a debt to asset ratio above 0.50 means that more than half of the farm's assets are financed through debt. The equity to asset ratio calculates how much of the farm's assets are financed though the owner's equity in the farm. The higher the equity to asset ratio, the more of the farm's assets are financed through equity. The final solvency ratio is the debt to equity ratio which shows how much debt capital is being combined with equity capital. If the debt to equity ratio is less than one, then the farm owner has more money in the farm than the lender. This measure is often referred to as the "leverage ratio" because it shows how much debt financing has been acquired (leveraged) per dollar of owner's equity.
The profitability measures calculate how well the business uses its resources to generate profit. The return on assets (ROA) ratio looks at the annual percent rate of return on farm assets. In other words, it is the interest rate being earned on the business's assets. The return on equity (ROE) ratio is the rate of return on farm equity. It represents the interest rate earned from the owner's equity in the farm business. For further analysis of ROA and ROE, compare the ratios to the interest paid on borrowed capital. If the ROA is greater than the interest rate, then that extra amount goes to equity, increasing the ROE. Therefore, ROE is greater than ROA. However, if ROA is less than the interest rate, this difference is "paid for" out of equity. Thus, ROE is less than ROA.
Financial efficiency ratios measure how well the business uses assets to generate income. They answer the question, "Are you using assets to their fullest potential?". The asset turnover ratio measures efficiency in using capital. A higher asset turnover ratio would be the result of generating a large level of farm production with a smaller investment of capital. If this ratio is lower, then there is a smaller level of farm production for the capital invested. The operating expense, depreciation expense, and interest expense ratios each show what percent of farm production goes towards paying operating expenses (minus depreciation), depreciation, and interest, respectively. The net farm income from operations (NFIFO) ratio shows how much of farm production is left after all expenses have been paid. For example, if the NFIFO ratio is 20%, the farm keeps $1 out of every $5 of farm production.
Together, these financial measures can help the farmer evaluate the financial performance of their farm business. The liquidity measures are indicators of the business's ability to stay "current" on its financial obligations. The solvency measures help track performance toward debt reduction or net worth goals. Profitability measures help compare the business's performance relative to alternative investment opportunities. Finally, financial efficiency measures are good indicators of how good the business is at turning production into profits.
Sources:
Farm Financial Ratios and Guidelines. Developed by Ken Becker (VT Economic Development Authority), Rick Wackernagel, Dennis Kauppila, and Glen Rogers (UVM Extension System). 1994.
Farm Financial Standards Council.
Kay, Ronald D. and William M. Edwards. Farm Management. Fourth Edition. McGraw_Hill: Boston. Copyright 1994.
University of Kentucky Farm Management Forms: Farm Financial Analysis.
For More Information
For additional information about the Farm Financial Analysis Ratios, please contact, Steve Isaacs.