rategic Business Planning for Commercial Producers Measuring Financial Performance: How Do I Measure It?
Dec 14, 2015
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.