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Balance Sheet Ratios

Roger Betz, Sherrill Nott and

Gerald Schwab

Day 2

1:00 p.m. to 1:30 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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Ratios

Be Selective• Now is the time to become familiar 

with f inancial   ratios

• Select ratios that help focus attentionon 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 FINPACKprints out (must be important!)

 Your balance sheet may or may nothave a number for all the ratiosdiscussed.

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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 tocover current liabilities?

 – Current portion of term debts included

• Current portion of income taxesoften forgotten

• Static in nature, no timing of cashflows

• Ignores lines of credit available

Total Current Farm Assets

Total Current Farm Liabilities 

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Current Ratio =

• 12 month planning horizon

• Value of current assets may changewhen sold

• Desired level varies by type of farm

 – Dairy versus fruit or cash crop

• Value can vary during production

cycle

Total Current Farm Assets

Total Current Farm Liabilities 

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Farm Working Capital =

• Similar to Current Ratio, is dollar 

amount, not a percentage or ratio• Difficult to compare to other farms

• Depends on size of business

Total Current Farm Assets -Total Current Farm Liabilities

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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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Debt to Asset RatioTotal Farm Liabilities (divided by)

Total Farm Assets

• What % of my business assets do I owe tocreditors

•

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 usingmarket 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

• Owner’s 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 debtincreases

• Also called Financial Leverage Ratio

• Lenders tend to use it

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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., matchmaturities

 – 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 can’t meet debt service plus

everything else

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What’s Next? 

• Examine the case study farm balance

sheet

• Quality check and interpret your balance sheet.