Farm Management
Chapter 18
Farm Business Analysis
Chapter Outline
• Types of Analysis
• Standards of Comparison
• Diagnosing a Farm Business Problem
• Measures of Profitability
• Measures of Size
• Efficiency Measures
• Financial Measures
• Enterprise Analysis
• Farm Business Analysis and Accounting
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Chapter Objectives
1. To show how farm business analysis contributes to
the control function of management
2. To suggest standards of comparison to use
3. To outline a procedure for locating economic or
financial problem areas
4. To review measures that can be used to analyze
solvency, liquidity, and profitability
5. To identify measures of business size
6. To illustrate the concept of economic efficiency
7. To demonstrate the use of enterprise analysis
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Table 18-1
Returns to Management per Farm
by Level of Gross Sales
Returns to Management per Farm ($)
Gross sales ($) Low Third Middle Third High Third
40,000 to 100,000 -$35,478 -$10,537 $1,938
100,000 to 250,000 -50,194 -9,766 23,702
Over 250,000 -37,944 23,988 127,628
Source: Iowa Farm Business Association
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Types of Analysis
1. Profitability
2. Farm Size
3. Efficiency
4. Financial
5. Enterprise
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Standards of Comparison
Once a measure has been calculated,
the problem becomes one of evaluating
the result. Is the value good, bad, or
average? Compared with what? Can
it be improved?
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Three Basic Standards
• Budgets: measures are compared against
budgeted goals or objectives identified
during planning
• Comparative farms: measures are
compared against actual results from
similar farms
• Historical trends: the manager looks for
improvement over time
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Diagnosing a
Farm Business Problem
A complete whole-farm business
analysis can be carried out using
a systematic procedure to identify
the source of the problem.
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Figure 18-1
Procedures for diagnosing
a farm business problem
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Measures of Profitability
• Net farm income
• Return to labor and management
• Return to management
• Rate of return on farm assets
• Rate of return on farm equity
• Operating profit margin ratio
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Table 18-2
Measures of Farm Profitability
Average of
comparison
Item group Our farm Comments
1. Net farm income $83,822 $39,857 much lower
2. Return to labor and management $39,144 $6,643 much lower
3. Return to management $3,144 -$23,357 much lower
4. Rate of return on farm assets (ROA) 5.2% 2.8% lower
5. Rate of return on farm equity (ROE) 5.3% 0.6% much lower
6. Operating profit margin ratio 20.8% 11.6% much lower
Comparison group based on Illinois Farm Business
Farm Management Association data for dairy farms
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Figure 18-2
How is the total revenue pie divided?
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General Comments
Two cautions regarding returns to labor,
management, assets and equity:
1)The estimation of opportunity costs
used in calculating returns is somewhat
arbitrary.
2) The returns are average returns to
factors, not the marginal returns.
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Measures of Size
• Quantity of sales
• Total or gross revenue
• Value of farm production
• Total farm assets
• Total acres farmed
• Livestock numbers
• Total labor used
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Table 18-3
Measures of Farm Size
Average of
comparison
Item group Our farm Comments
1. Gross revenue $306,030 $302,507 about the same
2. Pounds of milk produced 1,927,930 1,830,556 lower
3. Total farm assets $1,224,277 $1,269,300 about the same
4. Total crop acres farmed 307 299 about the same
5. Number of cows milked 95 94 about the same
6. Total labor 1.8 persons 2 persons higher
Comparison group based on Illinois Farm Business
Farm Management Association data for dairy farms
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Value of Farm Production
• Total (gross) revenue
• minus livestock purchases
• minus feed purchases
• equals value of farm production
Value of farm production is a convenient
way to compare the size of different
types of farms.
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Efficiency Measures
production
Efficiency =
resources used
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Economic Efficiency
• Asset turnover ratio:
gross revenue÷market value of total farm assets
• Operating expense ratio:
total operating expenses÷gross revenue
• Depreciation expense ratio:
total depreciation expense÷gross revenue
• Interest expense ratio:
total farm interest expense÷gross revenue
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Economic Efficiency (continued)
• Net farm income from operations ratio:
net farm income÷gross revenue
• Livestock production per $100 feed fed
• Feed cost per 100 pounds of gain
• Crop value per acre
• Gross revenue per person
• Machinery cost per crop acre
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Table 18-4
Measures of Economic Efficiency
Average of
comparison
Item group Our farm Comments
Capital Efficiency:
1. Asset turnover ratio 0.25 0.24 about the same
2. Operating expense ratio 0.65 0.68 about the same
3. Depreciation ratio 0.05 0.09 higher
4. Interest expense ratio 0.05 0.10 higher
5. Net farm income from 0.25 0.13 lower
operations ratio
Livestock Efficiency:
6. Production per $100 of feed $245 $244 about the same
7. Feed cost per 100 lb milk $6.51 $6.78 higher
Labor Efficiency:
8. Gross revenue per person $170,017 $151,254 lower
Marketing:
9. Price received per cwt of milk $15.25 $15.59 higher
Comparison group based on Illinois Farm Business
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Farm Management Association data for dairy farms
Physical Efficiency
Poor economic efficiency can result
from poor physical efficiency. Physical
efficiency measures bushels harvested
per acre, pigs weaned per sow, and
pounds of milk sold per cow.
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Table 18-5
Measures of physical efficiency
Average of
comparison
Item group Our farm Comments
1. Milk production per cow per year (lb) 20,294 19,474 lower
2. Cows milked per person 53 47 lower
3. Pounds of feed per cwt. milk 190 198 higher
4. Calves born per cow 0.95 0.92 lower
Comparison group based on Illinois Farm Business
Farm Management Association data for dairy farms
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Financial Measures
• Solvency: debt/asset ratio, change in
equity
• Liquidity: current ratio, working capital
• Measures of repayment capacity: term
debt and capital lease coverage ratio,
capital replacement and term debt
repayment margin
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Term Debt and
Capital Lease Coverage Ratio
This ratio is computed by dividing the
cash available for term debt payments
for the last year by the total term debt
payments due next year. The ratio should
be greater than 1.
“Term debt” refers to liabilities with
scheduled, amortized payments.
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Capital Replacement and
Term Debt Repayment Margin
This measure is calculated by taking
the difference between cash available
and total term debt payments due.
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Cash Available
• net farm income from operations
• plus total nonfarm income
• plus depreciation expense
• plus interest paid on term debt and capital
leases
• minus withdrawals for family living and
personal income taxes
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Table 18-6
Measuring the Financial Condition
of the Business
Average of
comparison
Item group Our farm Comments
1. Net Worth $893,555 $837,147 lower
2. Debt/asset ratio 0.27 0.34 higher
3. Current ratio 1.75 1.5 lower
4. Working capital $36,933 $35,620 about the same
Comparison group based on Illinois Farm Business
Farm Management Association data for dairy farms
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Farm Business Analysis Case Study
• Example farm in tables 18-2 to 18-6 had net farm
income considerably lower than comparison group
• The resource levels of the sample farm are about
the same, with a little more labor than average
• Our sample farm has more debt, pays higher
average interest rates, and has considerably more
depreciation expense
• To improve profitability, the farm may need to
reduce debt load, reduce the size of the machinery
complement, and increase production efficiency
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Enterprise Analysis
• Crop enterprise analysis
• Livestock enterprise analysis
• Internal transactions
• Verifying inventories
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Table 18-7
Example of an Enterprise Analysis for Peanuts
Percent to
Farm total peanuts Peanuts total Per acre
Peanut production (125 acres) 387,650 lb. 3,101 lb.
Income:
Sales of peanuts $119,643 100% $119,643 $957.14
USDA payments $2,500 100% 2,500 20.00
Total income $122,143 $977.14
Variable costs:
Seed $9,782 100% $9,782 $78.26
Fertilizer 2,418 100% 2,418 19.34
Lime 4,800 40% 1,920 15.36
Pesticides 23,654 100% 23,654 189.23
Fuel, lubrication 9,680 35% 3,388 27.10
Machinery repairs 13,264 35% 4,642 37.14
Hauling and drying 8,170 100% 8,170 65.36
Insurance, miscellaneous 7,806 35% 2,732 21.86
Labor 20,000 35% 7,000 56.00
Interest on variable costs 5,471 35% 1,915 15.32
Fixed costs:
Machinery ownership $49,100 35% $17,185 $137.48
Land rent 15,000 40% 6,000 48.00
Farm overhead 11,560 35% 4,046 32.37
Total costs $92,852 $742.82
Profit $29,291 $234.32
Average income per pound $0.32
Average cost per pound $0.24
Average profit per pound $0.08
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Table 18-8
Income Statement Example with Enterprise Accounting
Whole farm Crops Cattle Machinery Overhead
Income
Cash crop sales $42,644 $42,644
Cash livestock sales 72,271 72,271
Government payments 2,100 2,100
Miscellaneous income 3,369 3,369
Home consumption 427 427
Livestock inventory change (2,870) (2,870)
Crop inventory change 13,835 13,835
Total revenue 131,776 58,579 69,828 0 3,369
Expenses
Crop inputs 16,971 16,971
Machine hire 4,693 4,693
Fuel, lubrication 4,356 4,356
Machinery repairs 3,780 3,780
Building repairs 3,224 1,156 2,068
Purchased feed 6,031 6,031
Insurance, property taxes 3,462 3,462
Utilities 2,056 456 1,600
Interest paid 19,433 15,000 3,000 1,433
Livestock health, supplies 1,228 1,228
Miscellaneous 4,021 4,021
Depreciation 19,058 1,688 3,351 12,944 1,075
Total Expenses $88,313 $35,271 $17,278 $25,773 $9,991
Net farm income $43,463 $23,308 $52,550 ($25,773) ($6,622)
Internal transactions
Raised crops fed 0 39,500 (39,500)
Manure credit 0 (4,500) 4,500
Machine work (allocated by hours) 0 (23,773) (2,000) 25,773
Allocation of net overhead
(proportional to gross revenue) 0 (2,357) (4,265) 6,622
farm management Net farm income by enterprise $43,463 $32,178 $11,285 $0 $0
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Table 18-9
Verifying Crop Inventories
Sources Quantity Value per cwt. Value ($)
Beginning (cwt.)
3,100 $2.85 $8,835
inventory
Purchased None
Produced 11,200 $34,813 *
Total 14,300 $43,648
Uses Quantity Value per cwt. Value ($)
Ending inventory (cwt.)
5,300 $3.10 $16,430
Sold 1,470 $3.25 $4,778
Used for seed none
Used for feed 7,480 $3.00 $22,440
Spoilage, other 50 $0.00
losses
Total 14,300 $43,648
*Equal to total value of crop increase ($43,648 - $8,835)
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Table 18-10
Verifying Livestock Inventories (cattle)
Sources Head Weight (cwt.) Value per cwt. Value ($)
Beginning inventory 315 1,890 $80 $151,200
Purchased 265 1,908 $75 $143,100
Produced 175 2,843 * $194,398 **
Reclassified in 0 0 0
Total 755 6,641 $488,698
Uses Head Weight Value per cwt. Value ($)
Ending inventory 296 1,702 $84 $142,968
Sold 415 4,648 $70 $325,360
Death loss 11 xxx xxx
Reclassified out 30 255 $70 $17,850
Home used 3 36 $70 $2,520
Total 755 6,641 $488,698
*Equal to total hundredweight of gain produced (6,641 – 1,890 – 1,908)
**Equal to total value of livestock increase ($488,698 - $151,200 - $143,100)
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Farm Business Analysis and Accounting
Most farm accounting programs calculate
many of the measures and ratios used
for farm business analysis. Most also
have the ability to perform basic enterprise
analysis.
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Summary
A whole-farm business analysis is
like a complete medical examination.
It should be conducted periodically
to check for symptoms that indicate
the business is not functioning as it
should.
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