July 26, 2023
As facilitator of the original Farm Financial Standards Task Force, one of the goals was to create key financial ratios for benchmarking. These ratios can be invaluable to lenders conducting a financial risk management assessment and for producers for peer benchmarking. One of my favorite databases for benchmarking is the FINBIN database, published by the University of Minnesota. Aaron Brudelie, a Farm Management Instructor, annually summarizes data from the ratio benchmarks utilizing my old book, Weighing the Variables. A trend analysis is conducted on these ratios to determine how the industry stacks up.
Term debt and lease coverage ratio
One of the key ratios to assess a producer's ability to repay financial obligations is the term debt and lease coverage ratio. Over the years, a “super green” benchmark is when this ratio is over 200 percent. More than 150 percent is considered a green light, 110 to 150 percent is a yellow or caution light, and less than 110 percent is a higher risk, red light. The producers in this year's database financially knocked the ball out of the ballpark!
The top 20 percent of profitable producers had an astounding 529 percent coverage ratio. This allowed those with financial discipline to prepay expenses, pay down operating loans, and grow or expand operations. The average producer had a 372 percent coverage ratio or $3.72 of cash flow for every dollar of debt repayment obligations. The debt service coverage ratio of the bottom 20 percent of profitable producers was only 85 percent.
A debt service coverage ratio at this level is considered a high-risk, red-light area with the inability to cover debt obligations. This often leads to refinancing of losses into longer-term debt, if equity is available. When examining the last three years, this ratio has been off the charts for the average and above average producers. Of course, government payments have been very helpful, but high prices before interest rate and cost increases were also very beneficial. These ratios are performing similarly to the great commodity super cycle from 2007 to 2012.
Measured by the current ratio, there appears to be a trend of building working capital. Used by many agricultural lenders, the industry standard for the current ratio is 1.5 to 1. The top 20 percent of profitable producers had a current ratio of 3.29 to 1 and the average was 2.83 to 1.
Again, it appears that the average and above average producers were using profits and cash flow to build financial liquidity as a shock absorber, which I think bodes very well for the industry. If financial adversity were to occur, these metrics are even stronger than during the great commodity super cycle from 2007 to 2012.
Stay tuned for the next article where we will discuss some further analysis. In the meantime, your challenge is to pull out your records and see how you stack up. Monitoring these financial metrics is a key to having a high business and financial IQ.
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