Financial Statement Analysis

1
Financial Statement Analysis

• Chapter 6

2
Financial Statement Analysis -- Chapter 6

• Financial Criteria
• Liquidity
• Solvency
• Profitability
• Repayment Capacity
• Financial Efficiency

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Liquidity

• The ability to meet current financial obligations
• Structural liquidity relates to the relationship
  between current assets and current liabilities
• Operational liquidity relates to cash flow
  measures

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Liquidity Measures

• WORKING CAPITAL
• Current Assets-Current Liabilities
• CURRENT RATIO
• Current Assets/Current Liabilities
• CASH FLOW COVERAGE RATIO
• The total cash available divided by the
  projected total cash required

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Working Capital

• A measure of the amount of funds that would be
  available to purchase inputs and inventory items
  after the sale of all current assets and payment
  of all current liabilities.

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Current Ratio

• Current Assets Divided by Current Liabilities.
• The higher the ratio, the more liquid the
  business.

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Cash Flow Coverage Ratio

• The total cash available divided by the projected
  total cash required.

8
Solvency

• Evaluates what would happen if the assets are
  sold and all liabilities are paid.
• A longer-term measure of the ability of the
  business to meet financial obligations.

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Solvency Measures

• DEBT-TO- ASSET RATIO
• DEBT-TO- EQUITY RATIO
• EQUITY-TO- ASSET RATIO

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Debt to Asset Ratio

• EXPRESSES TOTAL LIABILITIES AS A PROPORTION OF
  TOTAL ASSETS
• INFLUENCED BY THE VALUE PLACED ON THE ASSETS
• A REASONABLE STANDARD FOR THE RATIO WILL VARY
  FROM ONE TYPE OF ENTERPRISE TO ANOTHER

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Debt to Equity Ratio

• LEVERAGE RATIO
• REFLECTS THE EXTENT TO WHICH FARM DEBT CAPITAL IS
  BEING COMBINED WITH EQUITY CAPITAL
• A RATIO OF LESS THAN 11 MEANS THAT CREDITORS
  HAVE LESS MONEY IN THE BUSINESS THAN THE OWNER.

12
Equity to Asset Ratio

• EXPRESSES THE PROPORTION OF TOTAL ASSETS FINANCED
  BY THE OWNERS EQUITY CAPITAL
• THE MIRROR IMAGE OF THE DEBT-TO- ASSET RATIO

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Profitability

• RETURN ON ASSETS
• RETURN ON EQUITY
• OPERATING PROFIT MARGIN RATIO

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Return on Assets

• MEASURES THE RATE OF RETURN ON ASSETS AND IS
  OFTEN USED AS AN OVERALL MEASURE OF PROFITABILITY
• NET FARM INCOME FROM OPERATIONS INTEREST
  EXPENSE - UNPAID OPERATOR AND FAMILY LABOR AND
  MANAGEMENT DIVIDED BY AVERAGE TOTAL ASSETS

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Return on Equity

• MEASURES THE RATE OF RETURN ON OWNERS EQUITY
  EMPLOYED IN THE BUSINESS
• NET FARM INCOME FROM OPERATIONS - UNPAID OPERATOR
  AND FAMILY LABOR AND MANAGEMENT DIVIDED BY
  AVERAGE TOTAL EQUITY

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Operating Profit Margin Ratio

• MEASURES THE RETURNS TO CAPITAL PER DOLLAR OF
  GROSS FARM REVENUE
• NET FARM INCOME FROM OPERATIONS INTEREST
  EXPENSE - UNPAID OPERATOR AND FAMILY LABOR AND
  MANAGEMENT DIVIDED BY GROSS FARM REVENUES

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Long Run Un-profitability

• THERE ARE ONLY THREE WAYS THAT A BUSINESS CAN
  REMAIN UNPROFITABLE AND SURVIVE IN THE LONG-RUN
• (1) USE NON-FARM INCOME TO OFFSET FARM LOSSES,
• (2) THE BORROWER IS INHERITING OR BEING GIFTED
  MONEY FASTER THAN THE BUSINESS IS LOSING IT,
• (3) THE VALUE OF THE BUSINESS ASSETS ARE
  APPRECIATING FASTER THAN THE BUSINESS IS LOSING
  MONEY.

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Repayment Capacity

• TERM DEBT AND CAPITAL LEASE COVERAGE RATIO
• CAPITAL REPLACEMENT AND TERM DEBT REPAYMENT
  MARGIN
• DEBT-TO-INCOME RATIO

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Term Debt and Capital Lease Coverage Ratio

• PROVIDES A MEASURE OF THE ABILITY OF A BORROWER
  TO COVER ALL REQUIRED TERM DEBT AND CAPITAL LEASE
  PAYMENTS

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Financial Efficiency

• ASSET TURNOVER RATIO
• MEASURES HOW EFFICIENTLY ASSETS ARE BEING USED
  TO GENERATE REVENUE
• THE HIGHER THE RATIO THE MORE EFFICIENT ASSETS
  ARE BEING UTILIZED
• WHEN THE ASSET TURNOVER RATIO IS MULTIPLIED BY
  THE OPERATING PROFIT MARGIN THE RESULT IS THE
  RATE OF RETURN ON ASSETS

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• A BUSINESS HAS TWO WAYS TO INCREASE TOTAL
  BUSINESS PROFITS
• INCREASE PROFITS PER UNIT PRODUCED
• OR
• INCREASE THE VOLUME OF PRODUCTION WHILE
  MAINTAINING THE PROFIT PER UNIT

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• ONE OF THE PROBLEMS IN AGRICULTURE IS THAT THE
  INDUSTRY AS A WHOLE HAS A LOW ASSET TURNOVER
  RATIO AND LOW OPERATING PROFIT MARGIN, RESULTING
  IN A LOW RETURN ON ASSETS

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• OPERATING EXPENSE RATIO
• MEASURES THE PROPORTION OF GROSS FARM REVENUES
  BEING SPENT FOR OPERATING EXPENSES
• OTHER EXPENSE RATIOS ARE
• DEPRECIATION EXPENSE RATIO
• INTEREST EXPENSE RATIO