Balance Sheet Ratios Roger Betz, Sherrill Nott and Gerald Schwab Day 2

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
Ratios
Be 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 =
Total Current Farm Assets
Total Current Farm Liabilities
• 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
Current Ratio =
Total Current Farm Assets
Total Current Farm Liabilities
• 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
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
Current % in Debt
Total 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 Ratio
•
•
•
•
Total 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 Ratio
Total 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 Ratio
Total 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
• Current % in debt
• Intermediate % in debt
• Long-term % in debt
34
25
62
Market
34
16
28
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
• 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.