Is a farm expansion in your future? Here’s 5 key ratios you’ll need to calculate before meeting with your banker:
- Current Ratio: This ratio is a comparison of your current assets and current liabilities, and is used by the bank to help determine if the farm is likely/able to make loan payments on time. Many banks consider a ratio of 1.7 – or $1.70 in assets per $1.00 in debt – to be favorable.
Current assets are considered anything that can be used/sold within one year, and may include cash/checking account balances, crops and feed, etc. Similarly, current liabilities should include outstanding balances on credit cards, lines of credit, and accounts payable over 30 days.
- Debt-to-Asset Ratio: A comparison of total farm debt to total farm assets. Bankers use this to measure the risk the farm has, therefore a lower ratio or percentage is better.
The debt-to-asset ratio is sometimes considered as the amount of the farm the bank owns. A business with a debt-to-asset ratio of 31% means the bank essentially owns 31% of the business.
- Term Debt Coverage: This calculation determines how well a farm can repay debts. A term debt coverage ratio of 1:1 (also written as 1.0), indicates that a farm is able to cover debt. A ratio of less than one means that the farm does not have the ability to pay off debts and must liquidate assets or borrow more money to cover outstanding debt.
- Net Farm Income: The profitability of a farm, calculated by comparing the value of goods and the cost requirements to produce said goods. Bankers look for a steady growth in profitability over time, indicating an increasing net worth.
- Rate of Return on Assets: A measurement of the average interest rate earned on your farm investments. Measured as a percentage, a higher number – indicating more interest earned – is desirable.
- Beck, Timothy and Heather Weeks. “What Your Banker Want To Know About Your Next Expansion.” Dairy Herd Management.
- Kantrovich, Adam. “Financial Ratios.” Michigan State University Extension