FINANCIAL RATIOS
The information contained by the income and balance statements of the bookkeeping farms is condensed to a few key figures describing the result, profitability, solidity and liquidity of the farms.
The traditional key figures of the agriculture, key figures recommended by Committee for Corporate Analysis and the key figures of the FADN system of the EU are calculated.
Key figures describing the RESULT, PROFITABILITY and SOLIDITY of the enterprise
1. THE RESULT OF THE ENTERPRISES
Farm Family Income: Family Farm Income (FFI) is one of the basic income indicators. Family farm income is left as compensation to fixed factors of production of the family (labour and capital) and remuneration to the entrepreneur's risks (loss/profit) in the accounting year.
Family Farm Income = Net Result + wages claim
Family Farm Income = Gross Return - costs without wages claim
Net result: The net result is the interest to the own capital (equity) invested in the enterprise. If the net result will be negative for many years, the consequence is the reduction of the own capital and the weakening of the solidity. When examining the net result, it is to be noted that the taxes have not been subtracted.
2. PROFITABILITY
Profitability refers to the enterprise's long-term capability to show profit.
Entrepreneurial Profit: Entrepreneurial profit indicates the profitability of agricultural production, and it makes up the compensation to the risks of entrepreneurship. Entrepreneurial profit is calculated by subtracting opportunity costs of the family labour and the net worth (own capital) from Family Farm Income (FFI).
The opportunity cost of family labour, wage claim, is calculated by multiplying the number of hours worked by the farm family with the average hourly salary paid to external labour force. The opportunity cost of net worth, interest claim, is calculated by multiplying the average net worth of the accounting year with the interest rate paid for loans.
Profitability ratio: The profitability ratio is calculated by dividing Family Farm Income (FFI) by the sum of costs for family factors, i.e. the wage claim and the interest claim of agriculture (opportunity costs of family labour and equity).
When the profitability ratio is 1.0 all production costs including costs of family factors (opportunity costs) have been covered and the entrepreneur's profit is zero. As a relative concept profitability ratio is well suited for comparisons between different years as well as farms representing different size classes and production sectors.
The Family Farm Income (FFI) can be divided proportionately into the returns to the family factors, i.e. own labour and capital by the profitability ratio. When the hourly wage claim and the interest claim (%) are multiplied by the profitability ratio, we get the actually earned returns on the factors measured per working hour and interest rate. In this method labour and capital are considered to be equal as production factors.
PROFITABILITY RATIO =Family farm income / (wages claim + interest claim)
RETURN ON HOUR OF FAMILY WORK (€/h) = profitability ratio * wages claim per hour
RETURN ON EQUITY (%) = profitability ratio * interest claim per cent
Earnings: Labour earnings represent the income earned by the farm entrepreneur family for their agricultural work. When calculating labour earnings, the required return on the entrepreneur's own capital is deducted from entrepreneurial income; thus, capital is given priority as a factor of production over labour input.
Earnings = Family Farm Income - interest claim
Hourly earnings: The income concept annual earnings of the farm family are arrived by subtracting the interest claim for the net worth from Family Farm Income (FFI). When this annual earnings is divided by the hours of family labour, we arrive at the hourly earnings of the farm family. These indicators can be used in comparisons of farmers' incomes to the incomes of other wage earners.
Hourly Earnings = Earnings / farm family working hours
Return on equity: Return on equity is the compensation earned by the farm entrepreneur family for its own capital. When calculating return on equity, the entrepreneurial income is reduced by the wage claim of the entrepreneur family; thus, labour is given priority as a factor of production over own capital.
Return on Equity (net result) = Family Farm Income - wage claim
Return on Equity %: When the wage claim of family labour is subtracted from the Family Farm Income (FFI), we get the net profit, which is left as remuneration for the use of own capital. As a percentage to the equity, it indicates the return on own capital. This return can be compared with interests received from market investments with equal level of risks.
Return on Equity % = 100 * Return on equity / Equity
Return on total assets: The return on total assets indicates how much interest the company generates on the total assets invested in the operations.
Return on total assets = Net result + interests paid
Return on total assets %: Return on total assets is calculated by subtracting the wage claim of family labour from the Family Farm Income (FFI) and adding interests paid to the Family Farm Income (FFI). When this return is divided by the average total assets, we arrive at Return on Total Assets, %. As a percentage ratio to the total assets, it indicates the return on total capital. This yield can be compared to the interests paid for liabilities.
Return on total assets % = 100 * (Net result + interests paid) / total capital
3. SOLIDITY
The equity ratio: The equity ratio is calculated by relating the company's year-end equity, as reported in the balance sheet, to its total assets (balance sheet value). The higher the equity ratio, the more solvent the business is and the lower its financial risk.
Equity ratio = 100 * Equity / total capital
If the net profit remaining as compensation for own capital is negative, the farm's equity and wealth decrease. In such cases, additional capital must be injected from external sources, for example through investments, if production is to continue. This additional capital may take the form of debt capital, but it is often also equity-financed (e.g. forestry income, wage income, etc.), in which case the farm does not become more indebted, and its equity ratio improves.
Relative indebtedness: Relative indebtedness is a measure of solvency. It describes the relationship between a company's liabilities and the scale of its operations. It provides a rough indication of the operating margin requirements that the servicing costs of debt capital impose on the business.
Relative indebtedness = 100 * liabilities / turnover
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