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Transcript of Strategic Business Planning for Commercial Producers Measuring Financial Performance: How Do I...
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Strategic Business Planning for Commercial Producers
Measuring Financial Performance: How Do I Measure It?
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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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Strategic Business Planning for Commercial Producers
Measures of Financial Position and Performance
•Profitability•Liquidity•Solvency•Financial efficiency•Repayment capacity
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Strategic Business Planning for Commercial Producers
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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Strategic Business Planning for Commercial Producers
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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Strategic Business Planning for Commercial Producers
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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Strategic Business Planning for Commercial Producers
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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Strategic Business Planning for Commercial Producers
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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Strategic Business Planning for Commercial Producers
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
NFIFO + Interest expense – Unpaid labor compensation
Ending Total Assetsx 100
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Strategic Business Planning for Commercial Producers
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
x100
Equity Total Endingoncompensatilabor unpaid - NFIFO
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Strategic Business Planning for Commercial Producers
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
100Revenue Gross
oncompensatilabor Unpaid-Interest NFIFOx
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Strategic Business Planning for Commercial Producers
Net Farm Income
Gross Revenue $___________ Interest Expense - ___________Other Expense - ___________Net Farm Income $___________
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Strategic Business Planning for Commercial Producers
Return to assets
Net farm income $ ___________
Interest expense + ___________
Family living - ___________
Net return = ___________
Total assets ___________
Return to assets _________ %
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Strategic Business Planning for Commercial Producers
Return to equityNet farm income $ ___________
Family living - ___________
Equity return = ___________
Total equity ___________
Return to equity __________%
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Strategic Business Planning for Commercial Producers
Operating Profit MarginNet farm income $ ___________
Interest expense + ___________
Family living - ___________
Net income = ___________
Gross Revenue ___________
Operating profit margin
_________ %
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Strategic Business Planning for Commercial Producers
Profitability ScoresBenchmark
MeasureAverag
eHigh Profit
Our Grade
Net Farm Income
Operating profit margin 16% 32%
Return on assets 7% 14%
Return on equity 6% 18%
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Strategic Business Planning for Commercial Producers
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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Strategic Business Planning for Commercial Producers
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
Current liabilitiesCurrent assets
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Strategic Business Planning for Commercial Producers
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
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Strategic Business Planning for Commercial Producers
Debt to asset ratio
• Proportion of total assets owned by creditors
Total liabilitiesTotal assets
x 100
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Strategic Business Planning for Commercial Producers
Liquidity ScoreCurrent Ratio
Current assets = $
Current liabilities
=
$
___________
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Strategic Business Planning for Commercial Producers
Liquidity Scores
Benchmark
MeasureAverag
eHigh Profit
Our Grade
Current Ratio 3.1 3.3
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Strategic Business Planning for Commercial Producers
Solvency ScoreDebt-to-Assets Ratio:
= $
=
$
% ___________
Total liabilitiesTotal assets
x 100 x 100
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Strategic Business Planning for Commercial Producers
Solvency ScoresBenchmark
MeasureAverag
eHigh Profit
Our Grade
Debt to Asset 32% 26%
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Strategic Business Planning for Commercial Producers
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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Strategic Business Planning for Commercial Producers
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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Strategic Business Planning for Commercial Producers
Asset turnover ratio
• Reflects how efficiently farm assets generate revenue
• Indicates the volume of business generated by the asset base
Total assetsGross revenue
X 100
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Strategic Business Planning for Commercial Producers
Revenue per full-time laborer
• Reflects the productivity of labor• Indicates if revenue generated is
sufficient for full-time employment
Number of full time laborersGross revenue
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Strategic Business Planning for Commercial Producers
Operating expense ratio
• Proportion of total revenues absorbed by operating expenses
Gross revenueTotal operating expenses - depreciation
X 100
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Strategic Business Planning for Commercial Producers
Depreciation expense ratio
• Proportion of total revenues absorbed by depreciation
Gross revenueDepreciation expense
X 100
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Strategic Business Planning for Commercial Producers
Interest expense ratio
• Proportion of total revenues absorbed by interest expense
Gross revenueTotal farm interest
X 100
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Strategic Business Planning for Commercial Producers
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
Gross revenueNFIFO
X 100
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Strategic Business Planning for Commercial Producers
Account for each dollar of gross revenue
Operating expense ratioDepreciation expense ratioInterest expense ratioNet farm income ratio
Sum to 1
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Strategic Business Planning for Commercial Producers
Asset Turnover Ratio
= $
=
$
___________
Gross revenueTotal assets
x 100
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Strategic Business Planning for Commercial Producers
Financial Efficiency Scores
Benchmark
MeasureAverag
eHigh Profit
Our Grade
Asset Turnover Ratio
35% 43%
Revenue per FTE
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Strategic Business Planning for Commercial Producers
Operating Expense Ratio
Other expenses $ ___________
Depreciation - ___________
Oper. expense = ___________
Gross revenue ___________
Ratio _________ %
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Strategic Business Planning for Commercial Producers
Where does the revenue go?
Benchmark
MeasureAverag
eHigh Profit
Our Grade
Operating Expense Ratio 63% 52%
Depreciation expense ratio 8% 7%
Interest expenseratio
8% 6%
Net farm income ratio 20% 37%
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Strategic Business Planning for Commercial Producers
Summary• Key financial measures assess
– Profitability– Liquidity– Solvency– Financial efficiency
• Calculations• Interpretation
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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.