Financial Measures That Strike A CORD

It may be hard to imagine but there are some people that do not find financial analysis particularly appealing! Part of the problem may be that there are so many different financial measures to choose from that it is hard to know which ones to use. If you are looking for some quick 'hits' there are some key ratios, the 'A CORD', that can reveal a lot about your operation.

First let's separate financial measures into four main categories: financial efficiency, liquidity, profitability and solvency. Financial efficiency refers to how successful the business is at using its assets to generate income. Liquidity assesses your ability to pay your bills as they come due. Profitability is well known and measures how well the business is able to generate a profit. And finally, solvency determines how much you are relying on debt to finance the business.

By category, here are my top five ratio picks and how they are calculated:

Efficiency:
Asset Turnover = Gross Farm Sales divided by Total Assets

Liquidity:
C
urrent Ratio = Current Assets divided by Current Liabilities

Profitability:
O
perating Profit Margin Ratio =
(Net Farm Income + Interest Expense) divided by Gross Farm Sales

Return on Assets = (Net Farm Income + Interest Expense) divided by Total Assets

Solvency:
D
ebt to Equity Ratio = Total liabilities divided by Equity.

Table 1 presents the average 2006 results for the Ontario Beef Cow Calf Enterprise Analysis project and compares them to dairy and swine farrow-to-finish operations. The last column provides an industry target for each of the measures. These targets are good starting points but they can vary depending on your farm type. It is important not to look at individual ratios in isolation. A weakness in one area can be compensated for by strengths in others.

Table1. Financial Measures For Three Livestock Enterprises

Ratio

Beef
Cow Calf1

Dairy2

Swine
Farrow to Finish3

Target

Asset Turnover
(Efficiency)

0.11
0.14
0.26
Greater than 0.40

Current Ratio
(Liquidity)

2.71
1.10
1.50
Greater than 1.5

Operating Profit Margin
(Profitability)

2.5%
30.0%
17.0%
Greater than 15.0%

Return on Assets
(Profitability)

1/3%
4.7%
4.4%
Greater than 5.0%

Debt to Equity
(Solvency)

0.15
0.30
0.49
Less than 0.40

1 Cow Calf Enterprise Analysis Project, University of Guelph & OMAFRA
2 Ontario Farm Management Analysis Project, OMAFRA
3 Ontario Data Analysis Project, University of Guelph - Ridgetown College

In the May edition of OMAFRA Virtual Beef I talked about the cow calf enterprise analysis project being carried out by the University of Guelph and OMAFRA. Forty-five Ontario cow-calf producers contributed their time and information to the cow-calf benchmarking project.

The focus of the project is looking into the variability across the farms. What management traits make top performers different? You may look at the dairy, swine or target columns and think most are just unattainable for the cow-calf sector. Actually in all five measures there were individual herds that met or exceeded the target numbers.

Beef cow-calf herds tend to be low debt operations and Table 1 bears that out. The average farm in the group had a current ratio of 2.71 and debt to equity of 0.15. A current ratio of 2.71 means for every dollar of debt that has to be paid in the next 12 months there are $2.71 in assets that can be easily converted to cash to pay them. A debt to equity measure of 0.15 means there is a dollar of equity for every 15 cents of debt. This will give some financial buffer in rough times like the one being experienced now in the beef business. The swine herds would be at greater risk with a higher reliance on debt to finance their farms.

Unfortunately, cow calf operations also tend to be low margin. An average operating profit margin of 2.5 percent for 2006 falls short of the 15 per cent target. But 11 farms, through cost control and good marketing strategies, had operating profit margins greater than 15 per cent.

The average farm in the study had over one million dollars in farm assets. The asset turnover ratio gauges whether the business is using those assets as effectively as it could be. A low asset turnover leads to questions like 'Is custom work for idle machinery an option?' or 'Are there under productive assets that could be sold and funds invested elsewhere?' or 'If I switched to intensive rotational grazing would this reduce my pasture requirement and free up land to grow other crops?'

A low operating profit margin and asset turnover lead to low return on assets (ROA). ROA brings marketing efforts, cost control and capital investment levels together into one measure. All three of these areas should be investigated further if ROA is consistently low. Although the average ROA for the study group of cow calf farms was 1/3 of a per cent, there were nine herds with ROA's over four per cent and five topped five per cent.

It is important to keep in mind that looking at one year provides only a single snapshot of financial performance. The financial results for 2007 and 2008 will look different for livestock sectors with high feed costs and low market prices. What will remain the same is the fact that there will be variation in the results; some producers will do better than others. A look over several years would provide a clearer picture of the management traits that contribute to this difference in financial results.

The 2006 financial summaries for the cow calf, dairy and swine benchmarking studies are available at the Ontario Farm Management Analysis Project section of the OMAFRA Agricultural Business Management website.

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