This article is one of a series of financial management articles that examine financial statements and financial analysis.  In this article, repayment capacity measures are illustrated for a case farm and discussed.

This article is one of a series of articles that examine financial statements and financial analysis.  In this article, a case farm in west central Indiana is used to illustrate financial performance benchmarks for profitability and financial efficiency ratios.

It takes a lot of family and hired labor to run modern farms.  Labor is an important and costly input and farm managers need to ask if they are getting the efficiency and productivity needed from that labor to be competitive.  One way to evaluate this question is to use benchmarks created using data from similar farms.  Labor benchmarks should include family and operator labor as well as hired labor. 

For a farm to grow, it is essential that the replacement margin be large enough to repay term debt, replace assets, and purchase new assets, and that the replacement coverage ratio be greater than one.  This article defines and illustrates the use of key repayment capacity measures.

The Du Pont financial analysis model is a useful method of illustrating the relationship between the asset turnover ratio, the operating profit margin ratio, return on assets, and return on equity. In this article, a case farm is used to examine the relationships between profitability and financial efficiency ratios, and to examine the impact of a change in revenue, variable costs, or owning rather than leasing 150 acres on financial performance.

A farm’s ability to operate on the production frontier depends on its ability to produce crop and livestock enterprises efficiently, while a farm’s ability to produce on the cost frontier pertains to its ability to produce on the production frontier, manage costs, and market crop and livestock commodities.  The asset turnover ratio, on the other hand, measures how efficiently farm assets are being used to generate value of farm production (a gross income measure).

The rates of return on assets and equity are extremely useful when comparing farm investments with other investments.  However, these two measures are sensitive to how farm assets are valued on the balance sheet.  For this reason, the operating profit margin is more conducive for benchmarking profitability among farms.

It is widely accepted that accrual accounting provides a more accurate estimate of annual farm profitability than cash accounting or Schedule F net farm profit. This article compares cash and accrual net farm income for a case farm in west central Indiana given alternative scenarios pertaining to prepaid expenses and crop inventories.