Financial Statement Analysis -- Chapter 6
Financial Criteria Liquidity Solvency Profitability Repayment Capacity Financial Efficiency
Liquidity• The ability to meet current financial
obligations• Structural liquidity relates to the
relationship between current assets and current liabilities
• Operational liquidity relates to cash flow measures
Liquidity Measures
• WORKING CAPITAL
Current Assets-Current Liabilities
• CURRENT RATIO
Current Assets/Current Liabilities
• CASH FLOW COVERAGE RATIO
The total cash available divided by the projected total cash required
Working Capital A measure of the amount of funds that
would be available to purchase inputs and inventory items after the sale of all current assets and payment of all current liabilities.
Current Ratio Current Assets Divided by Current
Liabilities.
The higher the ratio, the more liquid the business.
Solvency• Evaluates what would happen if the assets are
sold and all liabilities are paid.
• A longer-term measure of the ability of the business to meet financial obligations.
Debt to Asset Ratio EXPRESSES TOTAL LIABILITIES AS A
PROPORTION OF TOTAL ASSETS
INFLUENCED BY THE VALUE PLACED ON THE ASSETS
A REASONABLE STANDARD FOR THE RATIO WILL VARY FROM ONE TYPE OF ENTERPRISE TO ANOTHER
Debt to Equity Ratio LEVERAGE RATIO
REFLECTS THE EXTENT TO WHICH FARM DEBT CAPITAL IS BEING COMBINED WITH EQUITY CAPITAL
A RATIO OF LESS THAN 1:1 MEANS THAT CREDITORS HAVE LESS MONEY IN THE BUSINESS THAN THE OWNER.
Equity to Asset Ratio EXPRESSES THE PROPORTION OF TOTAL
ASSETS FINANCED BY THE OWNER’S EQUITY CAPITAL
THE MIRROR IMAGE OF THE DEBT-TO- ASSET RATIO
Return on Assets MEASURES THE RATE OF RETURN ON ASSETS
AND IS OFTEN USED AS AN OVERALL MEASURE OF PROFITABILITY
NET FARM INCOME FROM OPERATIONS + INTEREST EXPENSE - UNPAID OPERATOR AND FAMILY LABOR AND MANAGEMENT DIVIDED BY AVERAGE TOTAL ASSETS
Return on Equity MEASURES THE RATE OF RETURN ON
OWNER’S EQUITY EMPLOYED IN THE BUSINESS
NET FARM INCOME FROM OPERATIONS - UNPAID OPERATOR AND FAMILY LABOR AND MANAGEMENT DIVIDED BY AVERAGE TOTAL EQUITY
Operating Profit Margin Ratio MEASURES THE RETURNS TO CAPITAL PER
DOLLAR OF GROSS FARM REVENUE
NET FARM INCOME FROM OPERATIONS + INTEREST EXPENSE - UNPAID OPERATOR AND FAMILY LABOR AND MANAGEMENT DIVIDED BY GROSS FARM REVENUES
Long Run Un-profitability
• THERE ARE ONLY THREE WAYS THAT A BUSINESS CAN REMAIN UNPROFITABLE AND SURVIVE IN THE LONG-RUN:
(1) USE NON-FARM INCOME TO OFFSET FARM LOSSES,
(2) THE BORROWER IS INHERITING OR BEING GIFTED MONEY FASTER THAN THE BUSINESS IS LOSING IT,
(3) THE VALUE OF THE BUSINESS ASSETS ARE APPRECIATING FASTER THAN THE BUSINESS IS LOSING MONEY.
Repayment Capacity• TERM DEBT AND CAPITAL LEASE COVERAGE
RATIO
• CAPITAL REPLACEMENT AND TERM DEBT REPAYMENT MARGIN
• DEBT-TO-INCOME RATIO
Term Debt and Capital Lease Coverage Ratio PROVIDES A MEASURE OF THE ABILITY OF A
BORROWER TO COVER ALL REQUIRED TERM DEBT AND CAPITAL LEASE PAYMENTS
Financial Efficiency
ASSET TURNOVER RATIO
MEASURES HOW EFFICIENTLY ASSETS ARE BEING USED TO GENERATE REVENUE
THE HIGHER THE RATIO THE MORE EFFICIENT ASSETS ARE BEING UTILIZED
WHEN THE ASSET TURNOVER RATIO IS MULTIPLIED BY THE OPERATING PROFIT MARGIN THE RESULT IS THE RATE OF RETURN ON ASSETS
A BUSINESS HAS TWO WAYS TO INCREASE TOTAL BUSINESS PROFITS:
INCREASE PROFITS PER UNIT PRODUCED
OR
INCREASE THE VOLUME OF PRODUCTION WHILE MAINTAINING THE PROFIT PER UNIT
ONE OF THE PROBLEMS IN AGRICULTURE IS THAT THE INDUSTRY AS A WHOLE HAS A LOW ASSET TURNOVER RATIO AND LOW OPERATING PROFIT MARGIN, RESULTING IN A LOW RETURN ON ASSETS
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