“What's considered enough money? Just a little bit more.” — Will Rogers
“If you owe the bank $100, that's your problem. If you owe the bank $100 million, that's the bank's problem.” — John Paul Getty
Managing a farm's finances involves keeping a close eye on key areas of financial performance and position. These areas, as outlined by the Farm Financial Standards Council, include liquidity, financial efficiency, profitability, solvency, and repayment capacity. Within these categories, sixteen essential ratios are widely regarded as benchmarks. Today, we’ll focus on six of the most critical ratios, especially relevant in today’s tight commodity markets.
Six Ratios for Farm Resilience
1. Working Capital
Working capital, a primary measure of liquidity, is calculated by subtracting current liabilities from current assets. Adequate working capital is critical for handling unforeseen challenges. Ideally, this figure should exceed 20% of your farm’s gross revenue to ensure sufficient cash flow.
2. Current Ratio
Another vital liquidity measure, the current ratio, is determined by dividing current assets by current liabilities. A ratio of 1.25 or higher is generally preferred, as it provides a cushion against adverse price changes, production setbacks, or rising input costs. Highly leveraged farms, particularly those that rely heavily on cash-rented land, should pay close attention to this metric to maintain financial resilience.
3. Asset Turnover Ratio
The asset turnover ratio evaluates financial efficiency by measuring how effectively farm assets generate revenue. Calculated as gross farm revenue divided by average total farm assets, a healthy ratio is 60% or higher. A strong asset turnover ratio indicates your resources are being utilized efficiently. For further insight, this ratio can be combined with the operating profit margin ratio to calculate your farm’s return on assets.
4. Interest Expense Ratio
This financial efficiency measure is calculated by dividing total farm interest expense by operating profit (profit before interest, taxes, and depreciation, or EBITDA). As a general guideline, it is preferable to keep the interest expense ratio below 25%. A consistently higher ratio may indicate that your current debt level is difficult to sustain and may put pressure on long-term profitability.
5. Operating Profit Ratio
Profitability reflects how well your operation generates financial gain. The operating profit ratio, a key profitability measure, is calculated as:
Net income from operation + interest expenses − family living & partner draws
______________________________________________________________________________________
Gross farm revenue − land rents
A preferred ratio is 0.35 or higher, indicating strong financial health and the ability to reinvest in the business, service debt, and provide for family living expenses.
6. Equity to Asset Ratio
Solvency measures the extent to which your business’s assets exceed its liabilities. The equity to asset ratio, calculated by dividing total equity by total assets, gauges how much of your operation is owned outright versus financed by creditors. A ratio of 0.40 or higher is generally preferred for long-term financial stability.
Why These Measures Matter
These six ratios are just a starting point among the sixteen financial measures your operation should monitor. The ranges suggested above serve as general guidelines, but factors like crop insurance and other risk management tools may influence what lenders consider adequate.
Farmers operating at the lower end of these ranges may feel financial strain first during periods of tight margins. Conversely, those with stronger ratios are better positioned to navigate economic challenges and sustain their operations over time.
How We Can Help
Understanding these financial metrics is essential, but implementing them effectively is even more critical. At UnCommon Farms, we’re here to guide you in assessing your current financial position and developing a strategy tailored to your unique needs. Contact us to learn more about how we can help you strengthen your farm’s financial foundation and achieve your goals.
