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 Assets x 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

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

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 equity Net farm income$ ___________ Family living- ___________ Equity return= ___________ Total equity  ___________ Return to equity __________%

Strategic Business Planning for Commercial Producers Operating Profit Margin Net farm income$ ___________ Interest expense + ___________ Family living- ___________ Net income= ___________ Gross Revenue  ___________ Operating profit margin _________ %

Strategic Business Planning for Commercial Producers Profitability Scores Benchmark MeasureAverageHigh ProfitOur Grade Net Farm Income Operating profit margin16%32% Return on assets7%14% Return on equity6%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 liabilities Current 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 liabilities Total assets x 100

Strategic Business Planning for Commercial Producers Liquidity Score Current Ratio Current assets=$ Current liabilities = $ ___________

Strategic Business Planning for Commercial Producers Liquidity Scores Benchmark MeasureAverageHigh ProfitOur Grade Current Ratio3.13.3

Strategic Business Planning for Commercial Producers Solvency Score Debt-to-Assets Ratio: =$ = $ % ___________ Total liabilities Total assets x 100

Strategic Business Planning for Commercial Producers Solvency Scores Benchmark MeasureAverageHigh ProfitOur Grade Debt to Asset32%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 assets Gross 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 laborers Gross revenue

Strategic Business Planning for Commercial Producers Operating expense ratio Proportion of total revenues absorbed by operating expenses Gross revenue Total operating expenses - depreciation X 100

Strategic Business Planning for Commercial Producers Depreciation expense ratio Proportion of total revenues absorbed by depreciation Gross revenue Depreciation expense X 100

Strategic Business Planning for Commercial Producers Interest expense ratio Proportion of total revenues absorbed by interest expense Gross revenue Total 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 revenue NFIFO X 100

Strategic Business Planning for Commercial Producers Account for each dollar of gross revenue Operating expense ratio Depreciation expense ratio Interest expense ratio Net farm income ratio Sum to 1

Strategic Business Planning for Commercial Producers Asset Turnover Ratio =$ = $ ___________ Gross revenue Total assets x 100

Strategic Business Planning for Commercial Producers Financial Efficiency Scores Benchmark MeasureAverageHigh ProfitOur 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 MeasureAverageHigh ProfitOur Grade Operating Expense Ratio 63%52% Depreciation expense ratio 8%7% Interest expense ratio 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), Dobbins, Craig, Michael Boehlje, Alan Miller, Freddie Barnard, “Financial Performance: Measurement and Analysis”, Purdue Agricultural Economics Report, March 2000, pages Oltmans, Arnold W. Danny A. Klinefleter, and Thomas L. Frey, AFRA - Agricultural Financial Reporting and Analysis, Doane Agricultural Services Company, St. Louis, Miller, Alan, Michael Boehlje, Craig Dobbins, Key Financial Performance Measures for Farm General Managers, Department of Agricultural Economics, Purdue University, ID-243, June 2001.