By Don Nitchie, U of M Extension Educator, Agricultural Business Management
Most recommended farm financial benchmarks measure financial or profitability relationships. Income as it relates to expenses for instance or assets as related to liabilities. The average of a group of farms is very good at showing a trend of that group of farms in general over time. However, comparing your benchmarks relative to other producers at your stage of career and size or type of operation, maybe even more important. Although financial standards might indicate that a certain benchmark should ideally be a certain number, you may need to stretch the acceptable range for that benchmark depending on if you are earlier in your farming career or later, or possibly by the type of your operation. Below, we look at the Current Ratio measuring Liquidity from the Balance Sheet and the Net Farm Income Ratio measuring Financial Efficiency-as two examples.
Liquidity as measured by your Current Ratio. Liquidity is the ability of your farm business to meet financial obligations as they come due over the current year. The Current Ratio is the ratio of your current farm assets/current farm liabilities. Farm Financial standards suggest this number should not be below 1.1 and anything above 1.7 is a strong position.
In the Southwest Minnesota Farm Business Management Association (SWMFBMA), as an example, the average current ratio has been trending higher until 2012, reaching a high of about 3.25 in 2011. While the average remains at an extremely strong 2.7 at the end of 2013, the trend may have reversed.
SWMFBMA Current Ratio by Size; Gross Farm Income
The table above shows the Liquidity on average of all SWMFBMA farms was strong in 2003 and was even more so in 2013. It should be noted that larger farms, (over $1 million gross income), had a lower ratio in 2003 of 1.63. In the larger group in 2013, there were 8 farms with gross incomes over $2 million who had an average current ratio of 1.95. While still very strong this was substantially less than the association average of 2.72. The category of $250,000 or less includes part-time and beginning farmers who often have off-farm income and in some cases are trading labor for machinery use or are sharing machinery. Some financial experts do advise, that over the long term, you can have excess working capital and liquidity. Keeping your capital working for you and earning profits from business operations, if production returns are good, maybe the best use of that capital. While maintaining a strong current ratio does provide a safety net for income shocks or reserves for productive asset purchases or expansion. Monitoring ratio benchmarks is all about measuring and managing a balance over time by using them to set goals and adjust.
SWMFBMA Current Ratio by Age of Operator
The above table demonstrates what is commonly true when looking at current ratios by the age of operator. When you are early in your career and trying to become established, maybe expanding your business and maybe growing a family, you may need to run a current ratio somewhat "leaner" and keep cash working as much as possible. This leaves less room for a financial or market price shock but, if some conservative inventory valuations are used on current assets, improved selling prices and sound margin management can compensate to a point. Early in a career there are many future years yet to produce and improve or correct.
Financial Efficiency as measured by your Net Farm Income Ratio. This group of benchmarks shows how effectively your business uses assets to generate income. They show what the total effects of your production, purchasing, pricing, financing and marketing decisions are on whole farm profitability. One of these, the Net Farm Income ratio, equals Net Farm Income (profit)/Gross Farm income. It shows how much is left after all farm expenses, except unpaid labor and management, are paid. Farm financial standards suggest if only 10% or less of your Gross Income ends up as Net Farm income, you may be vulnerable. If 20% or more of your Gross income remains as Net Farm income you are financially very strong and profitable. Except for 2009, most SWMFBMA farms, in recent years, have been at or above 20% until 2013. Both selling prices and costs impact this measure as it measures whole farm profitability.
SWMFBMA Net Farm Income Ratio by Size; Gross Farm Income
In the above table showing the net Farm Income ratio by select Gross Income categories, one can make a couple of observations. It does appear at the smaller Gross Income levels, where there are more part-time and beginning farmers; they are able to produce substantial Net Farm Income from a given amount of Gross. They may accomplish this by trading some labor for machine or other asset use, sharing machinery with others and possibly utilizing share-rent options. At the average and larger farm sizes margin management year over year probably becomes more important as significant investments are at risk. This also reduces some opportunities for windfall profits.
SWMFBMA Net Farm Income Ratio by Age of Operator
In the above table of Net Farm Income Ratio by age of Operator, it is not so clear that there is any identifiable trend other than it was lower in 2013 for everyone. It is encouraging that in the two years selected it is fairly consistent across ages/experience of operators. Hopefully, if true across more years, there seems to be an opportunities to be profitable at all levels.
Sources; SWMFBMA 2003 and 2013 Annual Reports. Farm Financial Scorecard, 2009, University of Vermont Extension & Center for Farm Financial Management @ University of Minnesota.