Managing In Tough Times

“Bits & Tips”

Using Financial Records to Measure Farm Profitability

Farm Financial Records• Many benefits of maintaining accurate

farm financial records. • Profitability is key to sustaining the

business into the future.–Net Farm Income–Rate of Return on Farm Assets–Rate of Return on Farm Equity

Net Farm Income• Net Farm income is

the difference between income and expenses.

• Net farm income will provide a snapshot of the short-term profitability of the farming operation.

Return on Farm Assets (ROA)• A way to evaluate the rate of return on all farm

assets, including land, livestock, equipment, facilities, etc.

• To calculate Return on Assets:– Add net farm income and farm interest expense– Estimate and subtract the value of operator and

unpaid family labor– This figure is then divided by the average total farm

assets for the year. (Farm assets can be valued at cost or at current market value)

Rate of Return on Farm Assets• 8%--strong measure• 4% or below--reason to reassess your current

enterprise selection• A higher ROA signifies a more profitable

farm.• You want your rate of return on assets to

exceed your current average interest rate on borrowed capital.

Return on Farm Equity (ROE)• ROE measures your return on the equity in

your farm business, compared to ROA, measures the return on your total farm assets.

• ROE provides 2 useful pieces of information:– Helps identify if and by how much your farm net

worth is increasing.– It allows you to compare the interest rate you are

earning based on your investment in the farm to other rates of return.

Calculating Rate of Return on Farm Equity

• Subtract the estimated value of operator and unpaid family labor from net farm income.

• Divide this total by farm net worth. • In general, you have a healthy farm

operation if your rate of return on farm equity is higher than the interest rates being charged by lenders.

Evaluating Rate of Return on Farm Equity

• The interpretation can be misleading.• A high rate of return is normally associated

with a more profitable farm business but it can also signify that the business is highly-leveraged or carrying a large debt load.

• High levels of debt increasing the owner’s risk.