Working capital is the excess of a farm’s current assets over it current liabilities.  Current assets are your short-term liquid assets such as cash, crop inventories, and receivables for crops sold.  Your current liabilities are what you owe on a short-term basis such as notes payable to banks, accounts payable, wages and taxes payable and your current portion of any long-term debt payments.  Many farmers forget to include this item when doing their current ratio calculation.

It used to be that the current ratio was very important to calculate.  This number is based upon taking your total current assets and dividing by your total current liabilities.  If this ratio was about 2 or higher, this was considered very good, between 1 to 2 was marginal to good and below 1 was bad.  However, we are now stressing that your working-capital to revenue is a much more important metric to measure and strive for.

The problem with the current ratio is that it does not indicate how much working capital is available to fund your farm operations.  For example, assume your annual farm revenues is $1 million dollars.  Assume you have total current assets of $250,000 and current liabilities of $125,000.  Your current ratio is 2 to 1 which is considered good, however, your working capital as a percentage of revenues is only 12.5%.  This means that you would need to have the ability to borrow from a bank to fund current operations until you are able to harvest your crop and convert it to cash.

Based upon information from FINBIN, the top 20% of crop producers had working capital divided by gross farm revenue ranging from 28% to 43% in the past four years.  The average producers ranged from about 20% to 33%, while the bottom 20% were in the low 20% range for these four years.

As more lenders use this metric in assessing farm operations, you need to know what yours is and what it should be.  I would suggest that you strive for it to be at least 30% for most crop farm operations.  Livestock operations would be about 5-10% lower.

As advisors, we see many business and farm financial statements through out the year.  Most of the successful farm businesses have several key financial ratios in common.  Even though each farm business is different, it is surprising how these ratios tend to be in the same range for each business.

These key ratios that we look at are as follows:

• Current Ratio – This is the ratio of current assets comprised of cash, inventories and receivables divided by current liabilities comprised of short-term notes payable, accounts payable, accrued liabilities and current portion of long-term debt.  This ratio determines how much of your assets will be available to pay off the debts owed over the next year.  It is important to include any long-term debt that will be paid off in the next year.  This ratio should exceed 2:1 and for most successful farm businesses, it is usually over 3:1.

• Net Worth to Debt – This is the ratio of your farm net worth divided by the total debt of the farm.  The higher the ratio the less your farm is leveraged.  Most successful farms will have a ratio that exceeds 2:1 and in most cases will approach 5:1.  A starting farmer’s ratio will usually be much lower than a long-term many generation farmer.  This is one of the ratios that bankers will always put the most importance on.

• EBIDTA – This is your farm earnings before interest, depreciation, taxes and amortization.  The reason this ratio is important is that it places each farm operation on the same level, i.e., you are able to compare a farm bought for cash to a farm bought with debt.  This will let you know for each farm or farm unit what income is being generated by the farm.  This income should always have an expense component for the farmer’s salary to make it comparable to other businesses.  The ratio of EBIDTA to net farm sales will vary greatly depending on the type of farm crop grown, but in general, we should see a ratio that exceeds 20% or more.

• Machinery costs to sales – This ratio seems to be one of the best ratios in determining how profitable a farm is.  The lower that a farm operation can keep this number, then this farm will usually end up in the upper farms in profitability.  Some farmers will lease new equipment each year while others will keep the same farm iron forever, the key is to keep this ratio as low as possible and still get the crop grown and harvested.

I have given you four of the key ratios that I see.  Have you computed yours and are there others that you use on an annual basis.  Let me know!