Balance Sheet Ratios

1. Balance Sheet Ratios Roger Betz, Sherrill Nott and Gerald Schwab Day 2 1:00 p.m. to 1:30 p.m.

2. Ratios Defined: • One number divided by another to express a relationship • You already know ratios like • Tons hay per acre • Bu. corn per acre • Pigs per litter • Milk sold per cow, etc. • The above illustrates production ratios

3. RatiosBe Selective • Now is the time to become familiar with financial ratios • Select ratios that help focus attention on the most critical areas. • Ratio analysis can be done on • Historical • Current • Projected information

4. Balance Sheet Discussion questions Judgments are made based on balance sheets. • What is a “good” balance sheet? • What is a “good” financial situation?

5. Balance Sheet Analysis To remember. . . • Basic equations  Assets = Debt + Equity  Assets minus debts = equity  Assets - equity = debt

6. Balance Sheet Ratio Analysis FINPACK Balance Sheet (Schedule W) Will now define the ratios FINPACK prints out (must be important!) Your balance sheet may or may not have a number for all the ratios discussed.

7. Balance Sheet Ratios • Schedule W from Finpack 99 • Note both Cost and Market value columns

8. Total Current Farm Assets Total Current Farm Liabilities Current Ratio = • Do I have enough current assets to cover current liabilities? • Current portion of term debts included • Current portion of income taxes often forgotten • Static in nature, no timing of cash flows • Ignores lines of credit available

9. 12 month planning horizon Value of current assets may change when sold Desired level varies by type of farm Dairy versus fruit or cash crop Value can vary during production cycle Total Current Farm Assets Total Current Farm Liabilities Current Ratio =

10. Farm Working Capital = Total Current Farm Assets -Total Current Farm Liabilities • Similar to Current Ratio, is dollar amount, not a percentage or ratio • Difficult to compare to other farms • Depends on size of business

11. Current % in DebtTotal Current Liabilities (divided by)Total Current Assets(times 100 for percentage) • Shows current farm assets relative to current farm liabilities • Similar % ratios: • Intermediate % in debt • Current & intermediate farm % in debt • Long term farm % in debt • Nonfarm % in debt

12. Debt to Asset RatioTotal Farm Liabilities (divided by)Total Farm Assets • What % of my business assets do I owe to creditors • Measures financial position or solvency of the business • Creditors claim against the business • Measure risk exposure - “ability to take hits” • a higher ratio indicates higher risk, don’t hit • Should include deferred taxes if using market value versus cost basis

13. Measures financial position of the business Owner’s claim against the business Ratios add to one: (Equity  Asset) + (Debt  Asset) = 1 % owner finance + % debt finance = total capital Equity to Asset RatioTotal Farm Equity (divided by)Total Farm Assets

14. Measures financial position of the business Ratio gets high rapidly as debt increases Also called Financial Leverage Ratio Lenders tend to use it Debt to Equity RatioTotal Farm Liabilities (divided by)Total Farm Equity

15. Balance Sheet Ratio Analysis How to interpret? (for Mich. Dairy Farm) Dec. 31, 1999 Cost Market • Current % in debt 34 34 • Intermediate % in debt 25 16 • Long-term % in debt 62 28

16. Current Ratio Lenders love it! Understand how it can vary by month 2.0 or higher is nice % in debt: current, intermediate, long, terms Borrow long-term to buy long-term-- i.e., match maturities Look at trend over time Balance Sheet Ratios Finpack Balance Sheet Sch. W: be selective!

17. Debt to Asset Ratio Lots of folks talk about it At 0.5, you own half, lenders “own” half 0.70 and higher --- danger You own 30 % Earnings can’t meet debt service plus everything else

18. What’s Next? • Examine the case study farm balance sheet • Quality check and interpret your balance sheet.