In capital-intensive industries, it’s extremely important to gauge the efficiency of asset utilization. For example, for manufacturing firms, measuring capacity utilization, or the percentage of the time that a plant is utilized, is a key financial metric. As production agriculture continues to substitute capital such as machinery and equipment for labor, measuring the efficiency of asset use becomes increasingly important.
The asset turnover ratio can be used to measure how efficiently farm assets are being used to generate value of farm production, which is a measure of gross income. Farms that use assets more efficiently would have a higher asset turnover ratio.
The asset turnover ratio is computed by dividing value of farm production by average total assets. Value of farm production can be obtained from the farm’s income statement, and average total assets can be obtained from the farm’s market value balance sheet. It’s important to note that gross revenue is sometimes used instead of value of farm production to compute the asset turnover ratio.
A long-term benchmark for the asset turnover ratio is 35%. Due to relatively low gross income in the last five years, the benchmark for the last five years has been closer to 20%. However, farms in the top quartile in terms of this metric had an average asset turnover ratio of 30% during the last five years. If a farm’s asset turnover ratio is relatively low, the farm should compare its machinery investment and cost per unit of production to similar farms.
Farm type is a factor
The dependence of the asset turnover ratio on land ownership and farm type complicates the analysis of the asset turnover ratio. Holding all else constant, a farm that owns a higher proportion of its acres will have a lower asset turnover ratio.
The benchmarks discussed here apply to nonirrigated crop farms. Irrigated crop farms would have higher asset turnover benchmarks, and beef and dairy operations would have lower asset turnover benchmarks.
More information pertaining to an accrual income statement, financial ratios such as the asset turnover ratio, and crop machinery investment and cost can be obtained on the Purdue Center for Commercial Agriculture website.
Langemeier is a Purdue University Extension agricultural economist and associate director of the Purdue Center for Commercial Agriculture.