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

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Measures of Financial Position and Performance

Profitability Liquidity Solvency Financial efficiency Repayment capacity

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Four Questions
Are the returns adequate? How liquid is the business? How is the business financed? How efficient is the business?

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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

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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

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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)

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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

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Rate of return on assets

NFIFO + Interest expense Unpaid labor compensation Ending Total Assets x 100

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

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Rate of return on equity NFIFO - unpaid labor compensation x100 Ending Total 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

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Operating Profit Margin

NFIFO  Interest - Unpaid labor compensation x100 Gross Revenue

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

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Net Farm Income

Gross Revenue Interest Expense Other Expense Net Farm Income $___________ - ___________ - ___________ $___________

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Return to assets
Net farm income Interest expense Family living Net return Total assets Return to assets + = $ ___________ ___________ ___________ ___________ ___________ _________ %

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

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Operating Profit Margin

Net farm income Interest expense Family living Net income Gross Revenue Operating profit margin $ ___________

+
=

___________ ___________ ___________ ___________ _________ %

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Profitability Scores
Benchmark
Measure Net Farm Income Operating profit margin Return on assets Return on equity Average High Profit Our Grade

16% 7% 6%

32% 14% 18%

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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

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Current ratio
Current assets Current liabilities
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

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Solvency
Gauges the farms 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

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Debt to asset ratio

Total liabilities Total assets

x 100

Proportion of total assets owned by creditors

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Liquidity Score
Current Ratio

Current assets Current liabilities

= $ $ = ___________

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Liquidity Scores
Benchmark
Measure Current Ratio Average 3.1 High Profit 3.3 Our Grade

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Solvency Score
Debt-to-Assets Ratio:

Total liabilities x 100 = Total assets =

$ $ % ___________

x 100

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Solvency Scores
Benchmark
Measure Debt to Asset Average 32% High Profit 26% Our Grade

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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

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Financial Efficiency Measures

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

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Asset turnover ratio

Gross revenue Total assets X 100

Reflects how efficiently farm assets generate revenue Indicates the volume of business generated by the asset base

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Revenue per full-time laborer

Gross revenue Number of full time laborers
Reflects the productivity of labor Indicates if revenue generated is sufficient for full-time employment

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Operating expense ratio

Total operating expenses - depreciation X 100 Gross revenue
Proportion of total revenues absorbed by operating expenses

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Depreciation expense ratio

Depreciation expense Gross revenue X 100

Proportion of total revenues absorbed by depreciation

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Interest expense ratio

Total farm interest Gross revenue X 100

Proportion of total revenues absorbed by interest expense

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Net farm income ratio

NFIFO Gross revenue X 100

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

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Account for each dollar of gross revenue

Operating expense ratio Depreciation expense ratio Interest expense ratio Net farm income ratio

Sum to 1

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Asset Turnover Ratio

Gross revenue x 100 Total assets = $ $ ___________

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Financial Efficiency Scores

Benchmark
Measure Asset Turnover Ratio Average 35% High Profit 43% Our Grade

Revenue per FTE

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Operating Expense Ratio

Other expenses Depreciation Oper. expense Gross revenue Ratio = $ ___________ ___________ ___________ ___________ _________ %

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Where does the revenue go?

Benchmark
Measure
Operating Expense Ratio Depreciation expense ratio Interest expense ratio Net farm income ratio

Average 63% 8% 8% 20%

High Profit 52% 7% 6% 37%

Our Grade

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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.