Extension and Ag Research News


Measure Your Farm Financial Efficiency

An explanation of why it was a good or bad year usually can be encapsulated by weather, markets and costs.

The most important number to summarize the year's financial success or bust is net farm income.

""An explanation of why it was a good or bad year usually can be encapsulated by weather, markets and costs,"" says Andrew Swenson, North Dakota State University Extension Service farm management specialist. ""However, you can go backward or upstream from the income statement bottom line to help explain financial performance.""

The first step back is to look at the total amount of gross revenue the farm was able to generate and compare it with what is left (net farm income) after all expenses are removed. This is called “net farm income as a percent of gross revenue” and indicates how efficient the operation was at converting gross revenue to net revenue.

The second step back is to compare the gross revenue with total farm assets. This is a measure of how effective the farm operator was at using assets to generate gross revenue. It is called the asset-turnover ratio.

In any one year, both of these measures will be greatly affected by weather, markets and costs, but they help gauge how successful the producer has been in the difficult task of managing these variables with insurance, crop rotations and production practices, marketing and procurement.

""A more logical route for understanding the relationship among total farm assets, gross revenue and net farm income may be to start at the top and work down,"" Swenson says. ""The starting point is the value of all the farm assets, (machinery, livestock, land, etc.). Again, the asset-turnover ratio is a measure of the how well the farm employed its assets to create gross revenue.""

The formula simply is gross revenue divided by total farm assets. The typical asset turnover ratio during the past five years for farms in North Dakota’s Business Management Education program was .39. For example, a farm with $900,000 of assets would generate about $350,000 of gross revenue. Asset turnover ratio is correlated with farm type, cropland tenure and farmer age.

The average asset-turnover ratio of crop farms (.47) is greater than for livestock farms (.27) in North Dakota because most livestock farms are beef cow-calf operations. This indicates that the investment in beef cows, facilities and equipment, and pasture doesn’t generate the gross revenue of a similar investment in machinery and cropland.

Ownership of cropland will lower the asset-turnover ratio, compared with renting land. The reason is that ownership increases the level of assets. The typical asset-turnover of farms that rent all cropland is more than .50, compared with less than .30 for farms that own more than 40 percent of their cropland.

However, owning land, depending on the debt level, will tend to lower operating costs and improve the portion of gross revenue that is converted to net income. Younger farmers tend to have a better asset-turnover ratio than older farmers because the younger farmers are more likely to rent a greater portion of their land and machinery.

After determining gross revenue, the next question is how much of it goes for interest, depreciation and operating expenses. The portion left is net farm income. In North Dakota, net farm income as a portion of gross revenue can vary greatly from year to year, but averages about 17 percent, or $17,000, of net farm income for every $100,000 of gross revenue.

For example, a farm with $350,000 gross revenue would net about $59,500. The highest median net farm income as a percent of gross revenue in the past 10 years was 22.4 in 1999 and the lowest was 8.1 in 1997, according to data from all farms in the North Dakota Farm Business Management Education program. Livestock farms have gone through extremes during the past two years, going from 28.2 percent in 2005 to only 6 percent in 2006.

Farms with relatively high levels of debt struggle. During the past five years, the median net income of farms with more than 70 percent debt was only $8,000 for every $100,000 of gross revenue, compared with $25,000 per $100,000 of gross revenue for farms with debt of less than 40 percent.

Asset-turnover, net farm income as a percent of gross revenues and also the expenses of interest, depreciation and operating as a percent of gross revenues are the measures of farm financial efficiency recommended by the Farm Financial Standards Task Force.

""They can be useful in helping to evaluate how a farm is performing against its peers and, maybe more importantly, for tracking its performance during a period of time to determine trends,"" Swenson says. ""I recommend using a financial management package, such as Finpack, or enrolling in the North Dakota Farm Business Management Education Program, (701) 328-3162, to track a farms financial performance."

NDSU Agriculture Communication

Source:Andrew Swenson, (701) 231-7379, andrew.swenson@ndsu.edu
Editor:Rich Mattern, (701) 231-6136, richard.mattern@ndsu.edu
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