Strategic Business Planning for Commercial Producers Measuring Financial Performance: How Do I Measure It?

Strategic Business Planning for Commercial Producers

Measuring Financial Performance: How Do I Measure It?

Strategic Business Planning for Commercial Producers

Objectives• Introduce the measures of financial

performance: Liquidity, Solvency, Profitability and Financial Efficiency

• Describe the calculations used• Interpret the measures using

benchmarks

Strategic Business Planning for Commercial Producers

Measures of Financial Position and Performance

•Profitability•Liquidity•Solvency•Financial efficiency•Repayment capacity

Strategic Business Planning for Commercial Producers

Four Questions

• Are the returns adequate? • How liquid is the business?• How is the business financed?• How efficient is the business?

Strategic Business Planning for Commercial Producers

Benchmarking• Comparing our business to those that

are the best to learn how they achieve success

• Minimum performance is above average• Financial benchmarks can come from

– past performance– projected performance– performance of similar farms

Strategic Business Planning for Commercial Producers

Benchmark data• Farm business associations are good

sources of benchmarks – Illinois, Iowa, Kentucky, Tennessee and

others

• Know your data source– methods for summarization– period in which data was collected– calculations used for performance

measures

Strategic Business Planning for Commercial Producers

Profitability• Measures the extent to which a

business generates a profit from the use of land, labor, management, and capital.

• Measured by – Net farm income from operations

(NFIFO)– Rate of return on farm assets (ROA)– Rate of return on farm equity (ROE)– Operating profit margin (OPM)

Strategic Business Planning for Commercial Producers

Net farm income from operations• Net revenues available from normal

operations after fixed and variable expenses have been deducted

• For accuracy, calculate on an accrual basis

• For a sole proprietor farm operation, this income is available to compensate unpaid family labor, management, and equity capital

Strategic Business Planning for Commercial Producers

Rate of return on assets

• Net income generated by all assets, after labor has been compensated but before interest payments

• Operating profitability per dollar of assets

• Allows comparison between different sizes and types of businesses

NFIFO + Interest expense – Unpaid labor compensation

Ending Total Assetsx 100

Strategic Business Planning for Commercial Producers

Rate of return on equity

• The return after all labor and interest expenses

• Measures the return to the owner of the business for their capital investment

• Can be compared to alternative investments

x100

Equity Total Endingoncompensatilabor unpaid - NFIFO

Strategic Business Planning for Commercial Producers

Operating Profit Margin

• Proportion of earnings or revenues that is operating profit

• Reflects ability to generate revenues and control costs

• Revenue available to compensate debt and equity capital

100Revenue Gross

oncompensatilabor Unpaid-Interest NFIFOx

Strategic Business Planning for Commercial Producers

Net Farm Income

Gross Revenue $___________ Interest Expense - ___________Other Expense - ___________Net Farm Income $___________

Strategic Business Planning for Commercial Producers

Return to assets

Net farm income $ ___________

Interest expense + ___________

Family living - ___________

Net return = ___________

Total assets ___________

Return to assets _________ %

Strategic Business Planning for Commercial Producers

Return to equityNet farm income $ ___________

Family living - ___________

Equity return = ___________

Total equity ___________

Return to equity __________%

Strategic Business Planning for Commercial Producers

Operating Profit MarginNet farm income $ ___________

Interest expense + ___________

Family living - ___________

Net income = ___________

Gross Revenue ___________

Operating profit margin

_________ %

Strategic Business Planning for Commercial Producers

Profitability ScoresBenchmark

MeasureAverag

eHigh Profit

Our Grade

Net Farm Income

Operating profit margin 16% 32%

Return on assets 7% 14%

Return on equity 6% 18%

Strategic Business Planning for Commercial Producers

Liquidity• Ability of a farm business to meet

financial obligations as they come due in the short term, without disrupting the normal operations of the business.

• Measured by – Current ratio

Strategic Business Planning for Commercial Producers

Current ratio

• Basic indicator of short-term debt servicing and/or cash flow capacity.

• Indicates the extent to which current assets, when liquidated, will cover current obligations

Current liabilitiesCurrent assets

Strategic Business Planning for Commercial Producers

Solvency

• Gauges the farm’s ability to– pay all financial obligations if all assets

are sold– continue viable operations after financial

adversity

• Measured by– Debt to asset ratio– Debt to equity ratio– Equity to asset ratio

Strategic Business Planning for Commercial Producers

Debt to asset ratio

• Proportion of total assets owned by creditors

Total liabilitiesTotal assets

x 100

Strategic Business Planning for Commercial Producers

Liquidity ScoreCurrent Ratio

Current assets = $

Current liabilities

=

$

___________

Strategic Business Planning for Commercial Producers

Liquidity Scores

Benchmark

MeasureAverag

eHigh Profit

Our Grade

Current Ratio 3.1 3.3

Strategic Business Planning for Commercial Producers

Solvency ScoreDebt-to-Assets Ratio:

= $

=

$

% ___________

Total liabilitiesTotal assets

x 100 x 100

Strategic Business Planning for Commercial Producers

Solvency ScoresBenchmark

MeasureAverag

eHigh Profit

Our Grade

Debt to Asset 32% 26%

Strategic Business Planning for Commercial Producers

Financial Efficiency

• Measures the intensity with which a business uses its assets to generate gross revenues and the effectiveness of production, purchasing, product pricing, financing decisions

Strategic Business Planning for Commercial Producers

Financial Efficiency Measures

• Measured by – Asset turnover ratio– Operating expense ratio– Depreciation expense ratio– Interest expense ratio– Net farm income ratio

Strategic Business Planning for Commercial Producers

Asset turnover ratio

• Reflects how efficiently farm assets generate revenue

• Indicates the volume of business generated by the asset base

Total assetsGross revenue

X 100

Strategic Business Planning for Commercial Producers

Revenue per full-time laborer

• Reflects the productivity of labor• Indicates if revenue generated is

sufficient for full-time employment

Number of full time laborersGross revenue

Strategic Business Planning for Commercial Producers

Operating expense ratio

• Proportion of total revenues absorbed by operating expenses

Gross revenueTotal operating expenses - depreciation

X 100

Strategic Business Planning for Commercial Producers

Depreciation expense ratio

• Proportion of total revenues absorbed by depreciation

Gross revenueDepreciation expense

X 100

Strategic Business Planning for Commercial Producers

Interest expense ratio

• Proportion of total revenues absorbed by interest expense

Gross revenueTotal farm interest

X 100

Strategic Business Planning for Commercial Producers

Net farm income ratio

• Proportion of total revenue that remains as net income after all expenses have been paid

• Income that remains for unpaid labor compensation and equity capital

Gross revenueNFIFO

X 100

Strategic Business Planning for Commercial Producers

Account for each dollar of gross revenue

Operating expense ratioDepreciation expense ratioInterest expense ratioNet farm income ratio

Sum to 1

Strategic Business Planning for Commercial Producers

Asset Turnover Ratio

= $

=

$

___________

Gross revenueTotal assets

x 100

Strategic Business Planning for Commercial Producers

Financial Efficiency Scores

Benchmark

MeasureAverag

eHigh Profit

Our Grade

Asset Turnover Ratio

35% 43%

Revenue per FTE

Strategic Business Planning for Commercial Producers

Operating Expense Ratio

Other expenses $ ___________

Depreciation - ___________

Oper. expense = ___________

Gross revenue ___________

Ratio _________ %

Strategic Business Planning for Commercial Producers

Where does the revenue go?

Benchmark

MeasureAverag

eHigh Profit

Our Grade

Operating Expense Ratio 63% 52%

Depreciation expense ratio 8% 7%

Interest expenseratio

8% 6%

Net farm income ratio 20% 37%

Strategic Business Planning for Commercial Producers

Summary• Key financial measures assess

– Profitability– Liquidity– Solvency– Financial efficiency

• Calculations• Interpretation

Strategic Business Planning for Commercial Producers

References• Boehlje, Michael, Craig Dobbins, Alan Miller, Dawn Miller, & Freddie

Barnard, Measuring and Analyzing Farm Financial Performance, Department of Agricultural Economics, Purdue University, EC-712, 1999 (pages 7-10), <www.agecon.purdue.edu/ext/finance>

• Dobbins, Craig, Michael Boehlje, Alan Miller, Freddie Barnard, “Financial Performance: Measurement and Analysis”, Purdue Agricultural Economics Report, March 2000, pages 14-18.

• Oltmans, Arnold W. Danny A. Klinefleter, and Thomas L. Frey, AFRA - Agricultural Financial Reporting and Analysis, Doane Agricultural Services Company, St. Louis, 1998.

• Miller, Alan, Michael Boehlje, Craig Dobbins, Key Financial Performance Measures for Farm General Managers, Department of Agricultural Economics, Purdue University, ID-243, June 2001.