By Chris Zoller and Eric Richer
At the start of the new year, you likely updated your farm balance sheet to accurately reflect the assets, liabilities, and net worth of your farm. Let’s look at how you can assess farm financial health using your current balance sheet.
Introduction
The balance sheet is one of four financial statements critical to the management and operation of a farm business. It is probably the simplest of the four but can provide you with a tremendous amount of information about the financial health of your farm, including the ability to measure the liquidity and solvency of your business.
A balance sheet includes two columns, on the left is a listing of the assets of the business and on the right is a list of the liabilities incurred by the business. Subtracting liabilities from assets provides the calculated net worth or equity of the business. The balance sheet represents a snapshot in time of the business.
If you have questions about developing a balance sheet, speak with your lender or review the OSU Extension Fact Sheet, The Basics of a Farm Balance Sheet, available at https://ohioline.osu.edu/factsheet/anr-64.
Using your balance sheet
If you are completing this statement each year only to check a box that satisfies your lender, you are missing an opportunity to use and learn from your balance sheet. The balance sheet can be used for these purposes (not an exhaustive list):
It is a useful instrument to determine farm (LLC) valuation.
It provides fundamental financial communication between generations.
It tells us what assets a farm has and how they are financed (debt vs. equity)
It gives insight on how much risk a farm can bear, and
It is the best measure of farm financial health (growth, liquidity, solvency, ratios)
As mentioned previously, values recorded on the balance sheet can help you gauge financial performance by calculating ratios and comparing your performance to industry standards.
This article focuses on the farm financial health measures. Let’s review each of these calculations, what they mean, how they are calculated, and what you can learn as a result.
Liquidity – measures the ability of a farm business to pay short-term (less than one year) debts. Two ratios can be calculated to assess the liquidity of your business:
Current ratio is considered strong if it is greater than 1.5 and is determined by this formula: current farm assets/current farm liabilities.
Working capital will vary by business size but should be positive. It is calculated using this formula: current farm assets – current farm liabilities.
The Farm Financial Standards outlines the following suggestions for evaluating liquidity measures
A current ratio of 2.0 or greater is strong; 1.3-2.0 is stable; and less than 1.3 is weak.
Working capital should be positive and will vary by size of business. A review of FINBIN Whole Farm Summaries from 2021 provides a measure of working capital based on gross farm income:
Farms with less than $100,00 gross farm income reported working capital of $39,889
Farms with $250,000 to $500,000 gross farm income reported working capital of $214,812
Farms with $1 million to $2 milliongross farm income reported working capital of $636,000
Solvency – the ability of a farm to meet its long-term debt obligations and three ratios can be calculated to measure the solvency of the business.
Debt to asset ratio is calculated using this formula: total farm liabilities/total farm assets
Equity to asset ratio is calculated using this formula: total farm equity/total farm assets
Debt to equity ratio is calculated using this formula: total farm liabilities/total farm equity
Use these guidelines to compare your performance against industry standards:
Summary
Monitoring financial performance and measuring it against established standards is critical. These measures should be conducted annually, at a minimum, and used in making business management decisions. We encourage you to take time to review your balance sheet, complete the calculations described in this article, and compare to industry standards. Consult your lender or extension professional for more information.
(Chris Zoller is an Ohio State University Extension educator in agriculture and natural resources for Tuscarawas County. Eric Richer is a field specialist in farm management for Ohio State University.)
