any producers are intimidated by the thought of analysing the financial performance of their operation. I see evidence of this each year at Syngenta Grower University when I begin my session by asking the class, “How many of you are comfortable with your farm’s finances?”
The answer is always the same: not very many! Tackling the financial statements for your operation may seem overwhelming, but the fact is your efforts will literally pay off.
It may seem dull at first, but you can learn a lot about your business by crunching some of the numbers on your balance sheet and income statement. You can identify trends that can save you from financial pitfalls, and you can lead your farm business toward greater stability and long-term profitability.
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To delve deeper into the finances of your business, there are three main categories of financial measurement to consider: liquidity, efficiency and profitability. By setting aside a few hours to work through the calculations below, you will be armed with the information you need to make major business and investment decisions and approach your accountant with the information to maximize your current financial situation.
LIQUIDITY
Can I meet my short-term and long-term financial obligations?
Liquidity indicates your ability to meet your short-term and long-term obligations. Looking at short-term obligations, calculate your current ratio by comparing your current assets to your current liabilities. Current refers to anything that you’ll collect or pay within the next year.
Ideally this number should be at least 1.5:1, meaning you should have 1.5 times more current assets than current liabilities. As well, take a look at your working capital — your current assets minus your current liabilities. Ideally you should have a working capital of about 25 per cent of next year’s cash flow requirements.
To calculate your long-term liquidity (also referred to as solvency), compare the amount you owe (debt) to the amount you have invested (equity). This figure will allow you to better evaluate your ability to meet debt obligations in a sustainable manner. The higher the number is, the more debt you have and the more risk your banker holds in your farm.
EFFICIENCY
What is the return on my assets?
Efficiency is just as it sounds. How efficiently are you producing your product, when you take into consideration your input of time, money and materials?
Efficiency can be calculated using simple division. Divide your net farm operating income by your total assets to get an immediate picture of the percentage of income your business produces from its inputs. The higher the percentage, the more money your business is generating from your investment in assets.
To evaluate this result, consider what else you could be doing with your money.
Few (If Any) Farmers Enjoy Working On Financial Ratios, But All Like The Payback
Keep in mind that this calculation really only takes into account your investment in terms of dollars. It doesn’t take into account the amount of time you’ve invested in your farm.
Profitability
How well is your business able to generate profit?
Profitability is most likely an element you’ve given great consideration. How much are you making after every-thing’s paid and settled?
Profitability measures the overall financial health of your business by weighing your ability to generate earnings against expenses and other costs of doing business. It can also help to determine whether your fixed costs are too high to sustain your business. Identify your net operating profit margin and divide by gross revenue. The higher the resulting percentage, the better, but a good rule of thumb is 20 per cent.
When approaching the subject of your farm’s performance with your accountant or banker, it pays to do some research. Your financial statements are great at telling you how your farm performed last year but not nearly as effective at telling you how much your farm is worth.
Know the market value of your assets, as this information is not necessarily included on your balance sheet. Have a good idea of what your revenues and expenses are going to be next year. Be prepared to talk to your banker with a full understanding of what happened last year and, even better, your prediction of where you’ll be next year.
Getting a handle on the finances of your farm will put you in a better position to work with your accountant and ensure the long-term sustainability of your operation. Your accountant often uses set fields to determine certain elements of the financial benchmarks of your business, so do your homework and be prepared to have holes poked in your ideas. With a little preparation and the right knowledge you can better communicate and take control of your farm’s finances. CG
Mary Heisz is a lecturer in the Managerial Accounting and Control Group with the Richard Ivey School of Business at the University of Western Ontario in London, Ont. She teaches numerous financial courses as part of the Syngenta Grower University programs, designed to help Canada’s top producers run their operations with increased confidence and profitability by adopting the most effective business management skills and techniques.
