Managing For Profit In Commerical Agriculture
5. FOURTEEN SIGNALS OF FINANCIAL HEALTH
A broad variety of financial ratios and indices have been applied successfully for decades to measure business performance in virtually every major industry except agriculture. In fact, correct application of financial ratio and index procedures has been so effective generally that most business analysts would feel severely handicapped without them.
Professors John B. Penson, Jr., Danny A. Klinefelter, and David A. Lins observed in their 1982 book on agricultural finance, “Because there is no nationally recognized publication of financial ratios for farmers and ranchers, the use of ratio analysis in agriculture is limited.”1 They commented further, "The successful use of ratio analysis requires well-established standards or norms for comparison purposes and a general feeling about acceptable deviations from these norms"2 Finally the three economists noted that, “Monitoring trends for a business is extremely important, as it helps determine the direction the business is heading.”3
Several factors have contributed to why such a valuable analytical tool was virtually ignored throughout U.S. and Canadian agriculture until the Ferguson System Of Financial Analysis was introduced. Numerous departures from GAAP in constructingBalance Sheets and Operating Statements were certainly at the forefront, and agriculture's misconceived “doctrine of inherent uniqueness” played a strong role. Concentrating on Asset ownership instead of Profit generation was another factor. Many in agriculture appeared to surrender completely to an inflationary psychology that assumed an uninterrupted ascension of land values voided a serious need for more than minimal financial understanding. Tunnel vision on production technology accompanied by widespread disdain for number crunching continue as key elements even today.
Proper application of financial ratio and index analysis procedures achieves two elementary business objectives that are crucial strategically. First, management is able to identify and quantify critically important financial interrelationships involving Assets,Liabilities, Sales, and Expenses. Secondly, corresponding financial performance measurements can be forecast, monitored, and tracked, thus substituting control for crisis management.
Users should remember, however, that even though calculation and application are dual requirements, they are not necessarily synonymous. Both must be done correctly. Penson, Klinefelter, and Lins were completely accurate in their observation that well-established standards accompanied by acceptable deviations are essential prerequisites. Simply preparing a long series of ratio and index values without benchmarks to gauge their practical relevance to individual businesses accomplishes very little. That is the fundamental reason why establishing useful guidelines for key commodity sectors was stressed from the beginning in the development of the Ferguson System Of Financial Analysis for commercial agriculture.
The following performance measurements represent fourteen, basic performance indicators for determining a commercial agricultural business' internal structural balance. These are especially indicative of a firm's inherent financial health and prospectiveProfitability when aligned in a four-to-six-year format that reveals trend paths.
Performance guidelines for each individual enterprise are essential prerequisites of financial ratio and index analyses.
Weighted average adjustments of ratio or index guidelines must be calculated to reflect each individual, diversified farm or ranch's [a] percentage of Assets owned versus rented, [b] precise Interest Expense % Of Total Revenue in effect, and (c) percentage division of dollar Sales for each enterprise.
ROI @ FMV application.
ROE @ BV application.
S/FA @ BV application.
S/I&BS @ FMV application.
IE %TR application.
PE @ FMV application.