' A&Lancaster Fanning, Saturday,’ June 8, 1991 f F A R MANAGEMENT UNDERSTANDING SOLVENCY AND LIQUIDITY MEASURES Russel Powell Business Management Agent Editor’s note: This second of an eight-article series written by the five Southeastern/Central Penn State Extension Farm Management Agents, covering various farm profitability and efficiency measurement tools and ratios. In these uncertain economic times, lenders have become increasingly cautious and may require more financial information than you have provided in the past Their purpose is to carefully evalu ate your financial situation and judge your ability to meet loan obligations. Solvency and liquidi ty measures are two of the most commonly used tools to evaluate the financial health of a business. Much of the information neces sary to compute these measures is Guernsey Breeders’ Journal Hires Intern REYNOLDSBURG, Ohio— Priscilla Harvey of Vancouver, Washington, recently joined the Guernsey Breeders' Journal staff as an intern. Harvey assumed her full-time position in May. She will assist Journal staff with advertising and feature stories. She will also assist the Information Department with news releases and promotional efforts. Harvey is to be a senior this fall at Washington State University in Puliman, Washington. She is to graduate in May of 1992 with a Bachelor of Science degree in Agricultural Communications. At Washington Slate Universi ty, Harvey is a very active member of the WSU Dairy Club and served as president during her junior year. She is also an active member of Agriculture Communicators of Tommonow (ACT) and currently serves as PR Chairman. Harvey is a 2-year member of the Washington State University Dairy Judging Team and placed fourth overall in the Western Invi tational Dairy Judging Contest in Richmond, Utah, this spring. She will be competing in the national intercollegiate contest this fall. Harvey was a 10-year member of 4-H where she was involved in showing registered Guernseys, judging and giving demonstra tions. She was a Guernsey Junior Member and won several Guern sey Youth awards. Harvey was also the 1985 Clark County Dairy Princess. Harvey is the daughter of Mike found on the balance sheet This provides a “snapshot” of the finan cial situation of the business at a specific point in time. It should be developed at the end of each finan cial year by every farm manager. Comparison of successive balance sheets will then provide a general indication of business progress. Solvence Net Worth Solvency calculations begin with a comparison of total assets and liabilities. The difference is net worth. A positive net worth (assets greater than liabilities) indicates that the business is sol vent while a negative net worth (liabilities greater than assets) means that the business is insolvent. The net worth of a business reflects owner equity and is a very general indicator of the risk involved in making a loan to that business. A large net worth rela tive to total assets means that a Mhey equipment COMPANY, INC. loan would be well secured and the risk of default small. A small ilet worth could present an obstacle to securing credit because the risk of loss to the lender is greater. There are numerous ratios used in balance sheet analysis to evalu ate solvency and liquidity. Howev er, these ratios should only be used as tools for an initial evaluation and not to answer specific ques tions about problems within the business. They are only general indicators pointing to a need for further investigation. The net capital ratio is a com mon measure of solvency and is calculated by dividing total assets by total liabilities. A solvent busi ness is one with a ratio of 1:1 or higher (one dollar of assets for each dollar of liabilities). A finan cially healthy business should have a net capital ratio of at least 2.5:1, indicating that owner equity is at least 60 percent of all assets used in the business. The debt-equity ratio is a mea sure of solvency that reflects the relationship between borrowed and owned (equity) capital and is commonly used by lenders. It is calculated by dividing total debt by owner equity. A ratio of less than 1:1 indicates that the owner of the business owns a larger share of that business than the lender. One of the best uses for this ratio is a com parison from one year to another to SUDEHGA IS OH THE LEVEL! With an integrated horizontal mixing system. The new series of Sudenea Computa-Batch feed processing systems offer greater flexibility and reliability L'p to 36 ingredients, up to 8 discharge locations, over 100 feed rations, and more. All at a price that’s on the level Sudenga also manufactures premixers, pneumatic feed conveyors, bulk feed transports, and elevator legs. Call or write for information. Prewired Electrical No hidden or costly set-up expenses, simplifies trouble shooting V Sudenga SIMCt amdsSt >m« Net Capital Ratio Debt-Equity Ratio Micro Ingredients Up to 20 micro ingredients with commercial style screw feeders \ Stale Auumy Sudenga weighing system is more accurate and more reliable than compression weighing used in other systems » » t m- w n asses the changes in debt over time. As the ratio decreases, owner equity increases. A financially health business should have a debt equity ratio of 2:3 (.67) or less, but this will vary with the quality of management, the source of income and the level of profits. Liquidity A financially healthy business will have a greater amount of cur rent assets than current liabilities (“current” indicates an impact on the business within me year). Generally current assets should at least equal I.S times total current liabilities. This excess is needed to serve as a financial cushion in case of a rapid drop in the price of current assets (such as a crop). A rapid decrease in price of current assets could destroy the liquidity of a business if there are barely enough current assets to cover current liabilities. The excess of current assets also indicates good financial health because the excess is the source of working capital (the funds neces sary for covering day to day expenses). A shortage of working capital may mean borrowing additional funds or liquidating longer-term assets (i.e. machinery or land) to cover current operating expenses. Neither of these options are advis able because borrowing additional funds may take too long, and sell ing other assets may reduce future production capacity or the ability \ :Z SYCAMORE IND. PARK 255 PLANE TREE DRIVE LANCASTER, PA 17603 (717) 393-5807 to borrow. The current ratio measures cur rent liabilities relative to total lia bilities as follows: Current Debt Ratio = Current liabilities /Total liabilities The current debt ratio indicates the part of total debt that must be repaid within a year. Al:5 ratio (or .2) indicates that 20 percent of total debt must be repaid within one year. The higher the ratio, the grea ter the drain on cash reserves and the greater the risk of being unable to meet current financial obliga tions. A high ratio could indicate a need to refinance to convert part of the current debt into a longer-term obligation. However, be careful not to dig yourself into a deeper hole by converting current debt into long-term liabilities without a realistic plan for repayment. The current debt ratio must be interpreted with care and probably should be used only to put other ratios in perspective because it does not include net worth. For example, an individual with $500,000 net worth and $5,000 of debt composed of $4,000 of cur rent liabilities and sl,oooof longer term liabilities would have a cur rent debt ratio of 4:5 (.8) but is not in immediate financial danger. For more information about financial analysis, contact your county extension office for a copy of “Farm Business Analysis: Key to Pennsylvania Farm Profitabili ty” (extension circular 375). Horizontal Minor Today’s advanced feed rations require a more advanced mixer design l The Sudenga combination dual ribbon/paddle type agitator is designed to provide a more uniform mix with up to 75% less mixing time. \ "■A * Route 30 West at the Centerville Exit. Current Debt Ratio Designers of QuaCittf Systems for (Poultry, Stoine and Qrain (Handling
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