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

RatiosBe 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 =

• 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

Total Current Farm Assets

Total Current Farm Liabilities

Current Ratio =

• 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

Total Current Farm Assets

Total Current Farm Liabilities

Farm Working Capital =

• Similar to Current Ratio, is dollar amount, not a percentage or ratio

• Difficult to compare to other farms

• Depends on size of business

Total Current Farm Assets -Total Current Farm Liabilities

Current % in DebtTotal 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 RatioTotal 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, don’t hit

• Should include deferred taxes if using market value versus cost basis

Equity to Asset RatioTotal Farm Equity (divided by)

Total Farm Assets

• Measures financial position of the business

• Owner’s claim against the business

• Ratios add to one:

(Equity Asset) + (Debt Asset) = 1

• % owner finance + % debt finance = total capital

Debt to Equity RatioTotal 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 34 34• Intermediate % in debt 25 16• Long-term % in debt 62 28

Balance Sheet RatiosFinpack 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 can’t meet debt service plus

everything else

What’s Next?

• Examine the case study farm balance sheet

• Quality check and interpret your balance sheet.