There are key financial measures to remember (Credit Corner)
(Editor’s note: Austin Benner is a loan officer with MidAtlantic Farm Credit.)
As a young or beginning farmer, you’ll find there are many ways to prepare for the financial aspects of owning a farm.
Working with an agricultural lender like Farm Credit from the very start is my first recommendation to be sure that your business is understood and the cyclical nature of the industry is taken into consideration.
The below five key financial measures are used by most lenders in the loan approval process.
These indicators should be used regularly by farm and business owners to measure the success of their business.
• Equity: This measures the financial position and the overall leverage of the borrower.
An equity ratio will tell you what you would walk away with if you sold everything you have today and paid off all obligations.
A “100 percent” means you do not owe anyone and can keep all of the proceeds from the sale of your assets.
• Liquidity: measures a farm’s ability to meet financial obligations in an ordinary course of business (a growing year) without a major disruption to normal operations of the business.
Current assets are cash or other farm assets that will be sold in a year. Example: corn, steers, hay, produce, etc.
Assets that are more “liquid” are easier to sell.
An example of a current liability would be loan payments due over the next 12 months and the balance on your line of credit.
The higher liquidity would indicate an operation’s ability to pay their bills due over the next 12 months.
• Profitability: This is the amount earned after both cost of goods sold and operating expenses are subtracted.
This indicates a business’ ability to produce profit from normal operations prior to financing costs and owner draws/living expenses.
• Efficiency: This, ultimately, the use of assets to generate gross revenues.
We look at this in two ways:
a) Business efficiency: Such as cost control — what percent of income goes toward expenses? Are costs in line with the specific industry?, and
Asset Turnover Ratio: measures the efficiency assets generate revenue for the business. The higher the number the better, as this indicates how efficiently the assets or money you’ve invested is generating revenue. This is a problem if land values continue to rise, but income on the farm remains stagnant or even declines.
b) Operational efficiency: yield and production figures/measures.