Measuring Financial Performance: How Do I Measure It?

1. Measuring Financial Performance: How Do I Measure It?

2. Objectives • Introduce the measures of financial performance: Liquidity, Solvency, Profitability and Financial Efficiency • Describe the calculations used • Interpret the measures using benchmarks

3. Measures of Financial Position and Performance Profitability Liquidity Solvency Financial efficiency Repayment capacity

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

5. 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

6. 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

7. 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)

8. 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

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

10. 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

11. 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

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

13. Return to assets

14. Return to equity

15. Operating Profit Margin

16. Profitability Scores

17. 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

18. Current assets Current liabilities 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

19. 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

20. Total liabilities Total assets x 100 Debt to asset ratio • Proportion of total assets owned by creditors

21. Liquidity Score

22. Liquidity Scores

23. Total liabilities Total assets x 100 Solvency Score x 100

24. Solvency Scores

25. 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

26. Financial Efficiency Measures • Measured by • Asset turnover ratio • Operating expense ratio • Depreciation expense ratio • Interest expense ratio • Net farm income ratio

27. Gross revenue X 100 Total assets Asset turnover ratio • Reflects how efficiently farm assets generate revenue • Indicates the volume of business generated by the asset base

28. Gross revenue Number of full time laborers Revenue per full-time laborer • Reflects the productivity of labor • Indicates if revenue generated is sufficient for full-time employment

29. Total operating expenses - depreciation X 100 Gross revenue Operating expense ratio • Proportion of total revenues absorbed by operating expenses

30. Depreciation expense X 100 Gross revenue Depreciation expense ratio • Proportion of total revenues absorbed by depreciation

31. Total farm interest X 100 Gross revenue Interest expense ratio • Proportion of total revenues absorbed by interest expense

32. NFIFO X 100 Gross revenue 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

33. Sum to 1 Account for each dollar of gross revenue Operating expense ratio Depreciation expense ratio Interest expense ratio Net farm income ratio

34. Gross revenue Total assets x 100 Asset Turnover Ratio

35. Financial Efficiency Scores

36. Operating Expense Ratio

37. Where does the revenue go?

38. Summary • Key financial measures assess • Profitability • Liquidity • Solvency • Financial efficiency • Calculations • Interpretation

39. 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.