[BLOG] 5 Powerful Tools for Accurately Measuring Your (Farm) Business’ Health
Sometimes you need to get a loan from a bank; win over equity investors or attract strategic partners. If you’re a big thinker, you could even have a vision to sell your farm business’ shares in the capital market. Or you might want to expand by buying another farm(s). And sometimes you may just want to ascertain that all is well with your farm. The requirements to be met for each of the foregoing will differ.
But one thing is certain: To do any of the above, you need accurate production records to generate reliable financial performance indicators! As long as you keep good production records, don’t be in a hurry to hire a potentially expensive expert.
This article discusses five powerful financial performance indication tools YOU can quickly and easily compute to determine your farm’s financial state of health. And what you learn can aid you in assessing a hired expert, if/when you decide to engage one. Note also, that these tools can be used to evaluate any business type.
Click here to download a spreadsheet containing easy to understand computation formats for the different financial tools discussed below. Figures used in the example calculations were obtained from it. You may therefore find it useful to study the different computation formats as you read through the explanations, for better comprehension.
The 5 Key Financial Performance Indication Tools
Group One: Aggregate Measures
This group comprises two financial statements that provide an overview of a farm business’ performance in monetary terms (I.e. income earned vs. expenses incurred), as it relates to the business’ bottom line.
(a) Income (or Profit and Loss) Statement: is often used in combination with the Net worth statement (see b. below). It is a summary of expenditure and income, which can be prepared for a farm unit or for individual enterprises e.g. on a mixed farm, comprising livestock and crop ventures. The key value reported is known as Net Income.
Net Income = Sum of Income minus Sum of Expenditure
Most people know this value needs to stay positive, for the business to make a profit.
(b) Net worth Statement (or Balance Sheet): is used to determine the overall performance of a farm within a period of time. It is computed as follows:
Net worth = Assets minus Liabilities
This shows the value of assets that would remain if the business were to fold up and all outside claims were paid off. Incidentally, the net worth statement is the source for all the values used to compute the three remaining financial ratios to be discussed.
Group Two: Performance Ratios
This group comprises three performance measures which - unlike the financial aggregates - do not have units. And this makes them very useful for comparing performances of different farm sizes.
These ratios go deeper than the aggregate measures do, to uncover areas of possibly "poor health" in your (farm) business (or indeed in ANOTHER [farm] business that you wish to purchase or invest in) which the income statement or net worth may not reveal.
For instance, the ratios indicate the degree of a (farm) business' "financial safety" by comparing the load of assets and liabilities carried by it at a point in time.
As a business owner, THAT information alerts you to areas in the business that you may need to take decisive action to fortify in order to avert potential disaster etc. As a prospective buyer or investor, this ratio’s reported value can help you assess how "safe" or "risky' it would be to purchase - or invest in - another person’s farm. That will guide you to negotiate smarter, with the owner – IF you decide to go ahead.
Computing the Ratios
For the purpose of the example calculations done for these ratios, dummy values from the net worth statement format for a fictitious XYZ farms were used. Download the MS Excel resource workbook mentioned earlier, to study the different computation formats.
In our workbook dummy example, total assets were 75,900 and liabilities were 45,500 giving a net worth of 30,400. The farm’s inventory, accounts receivable and cash in hand constituted the assets. So the figure 30,400 indicates that the total assets exceeded total liabilities, and this can be useful; when comparing farms over a period of time.
Let’s now see how each of our three performance ratios is computed(Remember you need to download the workbook to see the dummy net worth statement source):
a. Current Capital Ratio (CCR) - This is computed as follows:
Sum of Current Assets divided by Sum of current liabilities
I.e. 9,200/2,500 = 3.68 (using our dummy data from the net worth statement)
The CCR measures the degree of immediate safety or solvency of the farm i.e. its ability of the farm to meet its current obligations. The value obtained in our example indicates that the farm can meet its immediate current liabilities three times over.
b. Working Capital Ratio (WCR) - This is computed as follows:
Sum of Working and Current Assets divided by Sum of Medium Term and Current Liabilities.
I.e. 24,900/16,500 = 1.51 (using our dummy data from the net worth statement)
The WCR measures the degree of financial safety in the medium term. The value obtained in our example indicates the farm is not very safe, in the medium term.
c. Net Capital Ratio (NCR) - This is computed as follows:
Sum of Assets divided by Sum of Debts
i.e.75,900/45,500 = 1.67 (using our dummy data from the net worth statement)
The NCR value indicates the farm’s degree of financial safety. This ratio is computed annually. The value obtained above indicates the farm has assets that amount to about one and a half times its liabilities.
It goes without saying that in evaluating your farm and/or one you wish to invest in, the reported values for each of the above ratios will guide your decision making better.
Final Words: Minimize Errors by Using Spreadsheets (and Automation)
Calculating these performance measures manually can be cumbersome and risky. Use of spreadsheets would greatly help. You may need to do some learning. But if you’d rather not, you could have a nifty little VBA driven workbook built to automate it for you.
Download my MS Excel resource workbook (see link below) which contains the different computation formats (complete with formulas) used for this write-up. Adapt it for your use. Nothing stops you from requesting RAW production data and posting them into this tested workbook, to see if the values turned out agree with what you’ve been given – say by your farm manager…or the owner of a farm you’re interested in.
Reference/Further Reading: Essentials of Agricultural Economics by A.J. Adegeye and J.S. Dittoh, Impact Publishers Limited (1985)
Tayo Solagbade works as a Performance Improvement Specialist/multipreneur, with a bias for Farm Research & Extension Advisory Services provision. He is the author of the Practical Livestock Feed Formulation Handbook, and developer of its accompanying MS Excel-VB driven Feed Formulation spreadsheet software.
Visit Tayo’s Self-Development Nuggets™ blog to download your copy of his FREE MS Excel resource workbook which contains the different computation formats (complete with formulas) used for this write-up. When he’s not amazing clients with his superhuman skills (wink), Tayo works as the creative force behind his Cost-Saving Farm Business Ideas website, and the Public Speaking IDEAS newsletter (which he publishes to promote Burt Dubin's Public Speaking Mentoring service to experts working across the African continent.