Balance Sheet Ratios

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Balance Sheet Ratios

• Roger Betz, Sherrill Nott and
• Gerald Schwab
• Day 2
• 100 p.m. to 130 p.m.

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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

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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

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Balance Sheet

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

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Balance Sheet Analysis

• To remember. . .
• Basic equations
• ? Assets Debt Equity
• ? Assets minus debts equity
• ? Assets - equity debt

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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.

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Balance Sheet Ratios

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

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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

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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

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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

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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

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Current in DebtTotal Current Liabilities
(divided by)Total Current Assets(times 100 for
percentage)

• Measures amount of current farm assets relative
  to the level of current farm liabilities
• Measures the extent to which current farm assets,
  if sold, would be used to cover current farm
  debts
• January versus June? Timing!

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Intermediate in DebtTotal Intermediate
Liabilities(divided by)Total Intermediate
Assets(times 100 for percentage)

• Measures the amount of intermediate farm assets
  relative to the level of intermediate farm
  liabilities
• What items make up the majority of intermediate
  assets? e. g. machinery, breeding livestock

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

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Equity to Asset RatioTotal 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

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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

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Can you define and use some other Balance Sheet
ratios?

• What is the formula for
• Current intermediate farm in debt?
• Long-term farm in debt?
• Nonfarm in debt?

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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

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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

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• 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

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Whats Next?

• Examine the case study farm balance sheet
• Quality check and interpret your balance sheet.