Balance Sheet Ratios

Roger Betz, Sherrill Nott and Gerald Schwab

Day 2 1:00 p.m. to 1:30 p.m.

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

Ratios
Be 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

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

Balance Sheet Analysis

To remember. . .
Basic equations
Assets = Debt + Equity Assets minus debts = equity Assets - equity = debt

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.

Balance Sheet Ratios

Schedule W from Finpack 99 Note both Cost and Market value columns

Current Ratio =
Total Current Farm Assets Total Current Farm Liabilities

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

Current Ratio =
Total Current Farm Assets Total Current Farm Liabilities

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

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

Current % in Debt
Total 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

Debt to Asset Ratio

Total 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, dont hit

Should include deferred taxes if using market value versus cost basis

Equity to Asset Ratio

Total Farm Equity (divided by) Total Farm Assets

Measures financial position of the business Owners claim against the business Ratios add to one: (Equity Asset) + (Debt Asset) = 1 % owner finance + % debt finance = total capital

Debt to Equity Ratio

Total Farm Liabilities (divided by) Total Farm Equity

Measures financial position of the business Ratio gets high rapidly as debt increases Also called Financial Leverage Ratio Lenders tend to use it

Balance Sheet Ratio Analysis

How to interpret? (for Mich. Dairy Farm) Dec. 31, 1999
Cost Market

Current % in debt Intermediate % in debt Long-term % in debt

34 25 62

34 16 28

Balance Sheet Ratios

Finpack Balance Sheet Sch. W: be selective!

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

 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 cant meet debt service plus everything else

Whats Next?
Examine the case study farm balance sheet Quality check and interpret your balance sheet.