Agriculture Reference
In-Depth Information
Why use fi nancial ratio analysis?
Financial ratio analysis is often used to measure the performance of the many facets of the
business mentioned in the introduction to this chapter. When properly used (with its limita-
tions understood), this fi nancial management tool can be a very useful management aid.
Many agribusiness managers use ratio analysis extensively because it not only provides
better indicators for managerial decisions but also is useful in the following ways:
1.
Easy to calculate
: Most ratios compare two accounts that are normally provided by the
income statement or the balance sheet. Because these data are readily available, not
much time or expense is required to compute a fi nancial ratio.
2.
Easy to make comparisons
: Ratios facilitate comparison of past with present perform-
ance, as well as comparisons with fi rms of a similar nature. Ratios are of particular value
to corporate boards of directors.
3.
Easily understood
: Not all members of the management team are fi nancial sophisti-
cates, and ratios provide overview information simply and clearly for all management
personnel.
4.
Able to communicate a fi rm's fi nancial position and performance to outside interested
parties:
For example, fi nancial authorities and stockholders, cooperative patrons, or
investors may rely on ratios to determine a fi rm's credit-worthiness and success in the
use of its resources.
Agribusiness managers and analysts are likely to develop their own favorite set of fi nancial
indicators. Also, lenders may use certain ratios to evaluate a fi rm's credit-worthiness, so
those ratios would need to be monitored by management. It would not be productive to
present an exhaustive set of ratios nor pretend that we can produce a selective set of ratios
that is of use to
every
agribusiness fi rm since these fi rms vary so greatly in size and type.
We present below some of the more commonly used and popular fi nancial ratios that
cover the four criteria used for evaluation. In many instances, the ratios discussed can be
calculated either before or after taxes, interest and other adjustments. The ratios discussed
in the following sections are calculated after interest and taxes. However, a key point to
remember when comparing and evaluating ratios is to be consistent with the approach used
to calculate the comparative benchmarks.
Selecting the proper ratios
Agribusiness managers should exercise care in selecting those ratios that provide useful
information for decision-making in their own unique businesses. Professional advice from
outside the business can often be of great help. The fi rst consideration to be made in select-
ing key ratios is whether the ratios cover those areas of the business where knowledge is
critical to good business decisions.
of interest in ratios that relate to accounts receivable and inventory because its fertilizer and
grain business is so seasonal. Loss of control over either of these important accounts could
be fatal to maintaining the fi rm's liquidity. Large variations in different periods are therefore
an important criterion for determining which accounts to analyze. Another factor is the sheer
size of an account. A corn processor like National Starch would be extremely aware of
changes in costs for direct labor and raw materials, because those costs account for the major
