Agriculture Reference
In-Depth Information
Solvency ratio
:
owner's equity divided by total net assets
. This solvency ratio (Equation 10)
shows the relationship between what the owners are contributing toward supporting the
fi rm and the total net assets of the fi rm.
Owner s Equity
'
/
Total Net Assets
=
Solvency
(10)
$,
1
From Balance Sheet qq h gg q and kk
3 665
,
000
/$,
3 655
,
000
=
.
00
(
)
,
,
,
,
,
Note that in the equation above, Total Net Assets = Net Working Capital + Net Fixed
Assets: that is, Total Net Assets = (h - gg) + (q - kk). Net working capital is calculated
by subtracting current liabilities from current assets, and net fi xed assets are calculated
by subtracting long-term liabilities from fi xed assets.
There is no exact standard for every business, but usually if owners contribute less than
50 percent of the total net assets of a fi rm, one is more likely to fi nd solvency problems
developing and to experience diffi culty in securing more long- and short-term credit. So
this ratio typically needs to be greater than 0.5.
Debt-to-asset ratio
:
total liabilities divided by total assets
. The third solvency ratio is used
to determine the proportion that lenders are contributing to the total capital of the fi rm:
(11)
Total Liabilities
/
Total Assets
=
Debt-to-Asset Ratio
$,
6 677 45
From Balance Sheet ll and s
312
0 00
,
/$ ,
,
000
=
0
.
(
)
,
Note that the debt-to-asset ratio (Equation 11) conveys the same information as the
debt-to-equity ratio (Equation 9). Both ratios are used to report the solvency position of
a fi rm.
Changes in this ratio can signal danger if the lenders' portion becomes excessively
high. By the same token, a low percentage invested by lenders could signal the oppor-
tunity for expansion or additional borrowing potential. It would appear from this ratio
that BF&G could expand its use of debt or liabilities. Expansion plans and current inter-
est rates would be important factors to consider in making this decision. The upper limit
lenders assign to this ratio is usually 0.50 or less, which corresponds to a 1:1 upper limit
to the debt-to-equity ratio. At 50 percent both outsiders and insiders have equal invest-
ments in the fi rm.
Effi ciency ratios
The fi nal area to be discussed in relation to the use of fi nancial ratios is in the area of fi rm
effi ciency. This area, in particular, offers the greatest opportunity for BF&G's management
to develop unique, meaningful ratios that will be of greatest value to its business in the effi -
ciency or operations area. Here, ratios tend to be highly tailored to fi t the specifi c type of
business being evaluated, and the effi ciency ratios needed to monitor a retail farm equipment
dealership are very different than those used by a soybean processor.
