# Documentation for the Farm Sector Financial Ratios

The Economic Research Service’s Farm Sector Financial Ratios report includes a series of financial ratios designed to measure the financial standing of the agricultural sector. Consistent with the Farm Income and Wealth Statistics data product, ratios are calculated using aggregated sector level data. (We use aggregate sector-level data rather than reporting summary statistics for farm-level data. For a discussion of the differences, see Ahrendsen and Katchova, 2012.) The ratios can be used to conduct financial analysis of the agricultural sector in order to examine the sector’s present financial position and the sector’s financial performance over time. Financial *position* refers to the sector’s financial standing at a given point in time and compares asset, debt, and equity values. In contrast, financial *performance* refers to how well the sector utilized its assets during a given time period. Financial performance measures include data from the income statement and balance sheet. Since solvency ratios only include data from the balance sheet, they are measures of the sector’s financial position at a point in time. The efficiency, liquidity, and profitability ratios are used to analyze the sector’s financial performance for a calendar year.

In order to report financial ratio statistics consistent with those commonly used in the financial profession, ERS' Selected Financial Ratios report uses Farm Financial Standards Council (FFSC) financial ratio definitions unless otherwise noted. The FFSC report includes recommendations on "Universal Financial Criteria and Measures," which covers the estimation and use of financial ratios for agribusiness. The FFSC standards outline definitions, formulas, interpretations, and limitations of many widely used financial measures. By following industry standards, the sector financial ratio calculations can be used for both historical analyses at the sector level, and as a benchmark for comparing farm businesses to the sector, where applicable.

The financial ratios reported by ERS are calculated using data from the balance sheet of the agricultural sector and the farm sector’s income statement. For further information on the sources and methodology used to create these data, please see the Farm Income and Wealth Statistics general documentation and documentation for the farm sector balance sheet.

This documentation below includes the estimation methodology used and background information on the financial ratios calculated as part of the Financial Ratios report. There are four main sections corresponding to the primary groups of financial ratios recommended by the FFSC and reported by the Farm Financial Ratios report—Efficiency Ratios, Liquidity Ratios, Profitability Ratios, and Solvency Ratios. Each section provides a brief overview of the aspect of farm sector financial position and/or performance being measured, the specific methodology and data used, and any limitations in interpreting the resulting financial ratios.

### Table of Contents

- Efficiency Ratios
- Asset Turnover Ratio
- Operating Expense Ratio
- Net Farm Income Ratio
- Interest Expense Ratio
- Capital Consumption Ratio
- Liquidity Ratios
- Current Ratio
- Working Capital
- Working Capital To Gross Revenues Ratio
- Debt Service Ratio
- Times Interest Earned
- Profitability Ratios
- Net farm Income
- Earnings Before Interest, Taxes, and Capital Consumption (EBITC)
- Operating Profit Margin Ratio
- Total Rate of Return on Farm Equity
- Rate of Return on Farm Equity from Income
- Rate of Return on Farm Equity from Capital Gains
- Total Rate of Return on Farm Assets
- Rate of Return on Farm Assets from Income
- Rate of Return on Farm Assets from Capital Gains
- Solvency Ratios

### Efficiency Ratios

Farm sector efficiency ratios provide information on how efficiently the sector uses its assets to create revenue. As a result, the ratios can be used to gauge the performance of sector production, marketing, and financing activities.

The sector’s gross revenues are either used to cover expenses or realized as net income. Therefore, the operating expense ratio, net farm income ratio, interest expense ratio, and capital consumption ratio sum to one. As a result, the four ratios provide a complementary picture of the sector’s efficiency: increases in one ratio are mirrored by decreases in the others.

Data used to calculate the efficiency ratios are reported as part of ERS’s Farm Income and Wealth Statistics data product, see each ratio for the particular variables used in calculations. For further information on the sources and methodology used to estimate the Farm Income and Wealth Statistics data, please see the general documentation.

#### Asset Turnover Ratio

The asset turnover ratio measures the efficiency with which farm assets are used to generate production. According to the FFSC guidelines, numerator is gross revenues. However, their definition of gross revenues matches the value of production calculation in the farm income and wealth statistics data product. Because asset values reported on the balance sheet are estimated as of December 31^{st} each year, the average of the total assets from the start and end of the year are used to represent the average value of assets available to support production during the year in this ratio. This is represented by the denominator (Assets_{t} + Assets_{t-1}/2). Higher ratios signify the sector’s assets are being used to generate production more efficiently.

The operating profit margin ratio, asset turnover ratio and rate of return on farm assets from income provide complimentary information on farm sector efficiency and profitability. The farm sector can increase its profits in two primary ways: increasing its production or increasing its per unit profit margin. As a result, the following formula holds: *Asset turnover ratio _{t} * Operating profit margin ratio_{t} = Rate of return on assets from income_{t}*.

##### Asset Turnover Ratio Formula

##### Data Sources

Each data series used in the calculation is available as part of ERS’s Farm Income and Wealth Statistics data product. Value of production data are reported in the value added by U.S. agriculture report. Farm sector asset levels are reported as part of the farm sector balance sheet report.

#### Operating Expense Ratio

The operating expense ratio measures the amount of cash the farm sector spends to generate a dollar of production. According to the FFSC guidelines, the denominator is gross revenues. However, its definition of gross revenues matches the value of production calculation in the farm income and wealth statistics data product. Therefore, the ratio can be thought of as the proportion of production required to cover operating expenses. Higher values indicate a greater proportion of production is required to cover operating expenses, signifying less efficiency in converting production to profits. Values less than one indicate production exceeds cash expenses.

##### Operating Expense Ratio Formula

##### Data Sources

Each data series used in the calculation is available as part of ERS’s Farm Income and Wealth Statistics data product. Total production expenses (excluding operator dwelling), interest expense, and capital consumption are reported as part of production expenses by category. Value of production data are reported in the value added by U.S. agriculture report. Farm sector asset levels are reported as part of the farm sector balance sheet report.

#### Net Farm Income Ratio

The net farm income ratio measures the amount of net farm income generated per dollar of production in the farm sector. Alternatively, it shows the proportion of production remaining after accounting for expenses. A value of one would signify all production was realized as net income or equivalently, no expenses were incurred. Larger values signify increased sector efficiency in converting production to net farm income.

##### Net Farm Income Ratio Formula

##### Data Sources

Each data series used in the calculation is available as part of ERS’s Farm Income and Wealth Statistics data product. Net farm income and value of production are reported as part of the value added by U.S. agriculture report.

#### Interest Expense Ratio

The interest expense ratio measures the proportion of production used to make interest payments on debt. Higher levels of the ratio suggest a higher interest payment burden relative to production.

##### Interest Expense Ratio Formula

##### Data Sources

Each data series used in the calculation is available as part of ERS’s Farm Income and Wealth Statistics data product. Both interest expenses and value of production data are reported as part of the value added by U.S. agriculture report.

#### Capital Consumption Ratio

Farm income and wealth statistics reports capital consumption instead of depreciation allowed in the tax code. For this reason, capital consumption is used rather than depreciation as is recommended in the FFSC guidelines. Capital consumption represents the amount of farm sector capital used up in the production process or damaged in a given year. Capital consumption is estimated separately for automobiles, trucks, tractors, farm machinery, farm service buildings, and operator dwellings. These components are aggregated to sector capital consumption. Therefore, the capital consumption ratio measures the proportion of production needed to cover the sector’s capital consumption.

##### Capital Consumption Ratio Formula

##### Data Sources

Each data series used in the calculation is available as part of ERS’s Farm Income and Wealth Statistics data product. Capital consumption and value of production data are reported as part of the value added by U.S. agriculture report.

### Liquidity Ratios

In finance, the term liquidity has two related meanings. Liquidity is often used to refer to the ease with which an asset can be converted into cash. Liquidity is also used to refer to the amount of capital readily available as cash. Each of the reported liquidity ratios provides a way to assess the farm sector’s ability to make scheduled financial payments as they come due.

Each data series used in the liquidity ratios, excluding debt principal payments, is reported as part of ERS's Farm Income and Wealth Statistics data product. Where debt principal payments are used, a description is provided. For further information on the sources and methodology used to estimate the Farm Income and Wealth Statistics data please see the general documentation.

#### Current Ratio

The current ratio measures the ability of current assets, if sold and converted to cash, to cover current debt obligations. A higher current ratio indicates greater liquidity.

##### Current Ratio Formula

##### Data Sources

Each data series used in the calculation is available as part of ERS's Farm Income and Wealth Statistics data product. Current assets and current debt (excluding operator dwellings) are reported as part of the current and noncurrent farm sector balance sheet report.

#### Working Capital

Working capital measures the amount cash that would be available to fund operating expenses after paying off current debt. Working capital is similar to the current ratio in that it measures the capacity for current assets to fund current liabilities.

##### Working Capital Formula

##### Data Sources

Each data series used in the calculation is available as part of ERS's Farm Income and Wealth Statistics data product. Value of production and interest expenses are reported as part of the value added by U.S. agriculture report. Farm sector asset levels are reported as part of the farm sector balance sheet report.

#### Working Capital To Gross Revenues Ratio

The working capital to gross revenues ratio measures the working capital relative to the size of the farm sector.

##### Working Capital To Gross Revenues Ratio Formula

##### Data Sources

Each data series used in the calculation is available as part of ERS’s Farm Income and Wealth Statistics data product. Value of production data are reported in the value added by U.S. agriculture report. Farm sector asset levels are reported as part of the farm sector balance sheet report.

#### Debt Service Ratio

Debt servicing ratio describes the share of production used for debt payments. Higher debt servicing ratios implies a greater share of production is needed to make debt payments, implying less liquidity.

##### Debt Service Ratio Formula

##### Data Sources

Each data series used in the calculation is available as part of ERS's Farm Income and Wealth Statistics data product. Value of production and interest expenses are reported as part of the value added by U.S. agriculture report. Real and nonreal estate debt figures used in the principal payments calculations are reported as part of the farm sector balance sheet report. Principal payments data are not publicly reported, but are calculated as follows:

##### Principal payments calculation:

The present value of an annuity calculation is used to calculate principal payments.

All loans are assumed to be halfway through the term. Payments are assumed to be made monthly at the end of the month. Average loan assumptions for real estate (RE) is 30 years, 5 years for nonreal estate (NR).

#### Times Interest Earned

Times interest earned is another measure of ability to cover debt payments, specifically interest payments. A value less than 1 implies there is not enough cash from operations to meet interest payments. Therefore, borrowing or drawing down assets must occur to make interest payments. Higher times interest earned indicates greater ease in making debt payments.

##### Times Interest Earned Formula

##### Data Sources

Each data series used in the calculation is available as part of ERS's Farm Income and Wealth Statistics data product. Net farm income and interest expense data are part of the value added by U.S. agriculture report

### Profitability Ratios

Profitability refers to the sector’s ability to generate returns from production inputs. Accordingly, profitability ratios measure the farm sector’s return relative to resources used. Returns to farming are realized through operations (income) or growth in the value of total farm assets (capital gains) for the sector.

Data used to calculate the profitability ratios are reported as part of ERS’s Farm Income and Wealth Statistics data product. For further information on the sources and methodology used to estimate the Farm Income and Wealth Statistics data please see the general documentation.

Net farm income is one of the most commonly used measures of profitability. It is the residual income left over after all the factors of production are paid. It represents the returns for operator labor, managements and equity, as well as any other unpaid resources used for farm production instead of elsewhere.

Net farm income is calculated in the Farm Income and Wealth Statistics data product. For further information on the sources and methodology used to estimate the Farm Income and Wealth Statistics data please see the general documentation.

##### Net Farm Income Formula

##### Data Sources

Each data series used in the calculation is available as part of ERS's Farm Income and Wealth Statistics data product and are available from the value added by U.S. agricultural sector report.

#### Earnings Before Interest, Taxes, and Capital Consumption (EBITC)

Earnings before interest, taxes, depreciation, and amortization (EBITDA) is widely used as a profitability measure and is also recommended by the FFSC guidelines because for comparisons across industries because accounting and financing effects are ignored. Due to data limitations, it is not possible to calculate EBITDA at the sector level. Farm income and wealth statistics report capital consumption instead of depreciation allowed in the tax code. For this reason, capital consumption is used rather than depreciation as is recommended in the FFSC guidelines. Capital consumption represents the amount of farm sector capital used up in the production process or damaged in a given year. Capital consumption is estimated separately for automobiles, trucks, tractors, farm machinery, farm service buildings, and operator dwellings. These components are aggregated to sector capital consumption. Data on amortization -the depreciation of intangible assets- is not available and therefore excluded from the calculation.

##### EBITC Formula

##### Data Sources

Each data series used in the calculation is available as part of ERS's Farm Income and Wealth Statistics data product. Net farm income and interest expense data are available from the value added by U.S. agricultural sector report.

#### Operating Profit Margin Ratio

The operating profit margin ratio measures profitability as a proportion of total production. This ratio increases as expenses decrease relative to value of production. Higher values mean the sector is efficiently converting production into returns (net farm income, interest, and returns to unpaid labor and management).

The operating profit margin ratio, asset turnover ratio and rate of return on farm assets from income provide complimentary information on farm sector efficiency and profitability. The farm sector can increase its returns by increasing production or increasing the per unit profit margin. As a result, the following formula holds: *Asset turnover ratio _{t} * Operating profit margin ratio_{t} = Rate of return on assets from income_{t}*.

##### Operating Profit Margin Ratio Formula

##### Data Sources

Each data series used in the calculation is available as part of ERS's Farm Income and Wealth Statistics data product. Net farm income and interest expense data are available from the value added by U.S. agricultural sector report. Many farms enterprises use unpaid operator or family member labor and management. From an economic perspective, it is necessary to subtract the opportunity cost of using this time as a production input. The estimate of the returns to unpaid labor and management is taken from the Agricultural Resource Management Survey (ARMS).

#### Total Rate of Return on Farm Equity

The rate of return on farm equity can be broken down into the returns from farm operations and capital gains. The rate of return from income provides a measure of farm operation profitability. Changes in the value of farm sector assets are used to measure the returns from capital gains. By including the return from farm operations and capital gains, the total rate of return on farm equity provides a measure of farm sector profitability more comparable to the return on other forms of investment such as stocks or bonds.

##### Total Rate of Return on Farm Equity Formula

##### Data Sources

For additional information on the calculation of each component please see the documentation for the rate of return on farm equity from income and rate of return on farm equity from capital gains.

#### Rate of Return on Farm Equity from Income

The rate of return on farm equity from income measures the returns to farm sector equity from current farm operations. Unlike the rate of return on farm assets from income, this ratio does not add sector interest expenses back to farm income, because interest expense represents a return to creditors’ claims on farm assets. Many farms enterprises use unpaid operator or family member labor and management. From an economic perspective, it is necessary to subtract the opportunity cost of using this time as a production input. Typically a higher rate of return on farm equity from income signals increased profitability, while lower values suggest lower profits. However, the ratio is also sensitive to the sector’s reliance on debt. Increases in farm sector debt-financed assets would reduce equity for a given level of assets, increasing the return on farm equity from current income.

##### Rate of Return on Farm Equity from Income Formula

##### Data Sources

Each data series used in the calculation is available as part of ERS's Farm Income and Wealth Statistics data product. Equity is reported on the farm sector balance sheet report. The estimate of the returns to unpaid labor and management is taken from the Agricultural Resource Management Survey (ARMS).

#### Rate of Return on Farm Equity from Capital Gains

The rate of return on farm equity from capital gains measures the returns to the sector’s equity position from an increase in the value of sector assets.

##### Rate of Return on Farm Equity from Capital Gains Formula

##### Data Sources

Each data series used in the calculation is available as part of ERS's Farm Income and Wealth Statistics data product. Equity and assets are part of the farm sector balance sheet report.

#### Total Rate of Return on Farm Assets

The rate of return on farm assets can be broken down into the returns from farm operations and capital gains. The rate of return from income provides a measure of farm operation profitability. Changes in the value of farm sector assets are used to measure the returns from capital gains. The total rate of return on farm assets differs from total rate of return on farm equity because the former includes the returns to all stakeholders.

##### Total Rate of Return on Farm Assets Formula

##### Data Sources

For additional information on the calculation of each component please see the documentation for the rate of return on farm assets from income and rate of return on farm assets from capital gains.

#### Rate of Return on Farm Assets from Income

The rate of return on farm assets from income measures the returns to farm sector assets from current farm operations. Unlike the case with the rate of return on farm equity from income, interest expenses are considered a return to assets and added back into net farm income. This is done because interest expense represents a return to creditors’ claims on assets. Many farms enterprises use unpaid operator or family member labor and management. From an economic perspective, it is necessary to subtract the opportunity cost of using this time as a production input. A higher rate of return on farm assets from income signals increased profitability.

The rate of return on farm assets from income, operating profit margin ratio and asset turnover ratio provide complementary information on farm sector efficiency and profitability. The farm sector can increase its returns by increasing production or increasing the per unit profit margin. As a result, the following formula holds: *Asset turnover ratio _{t} * Operating profit margin ratio_{t} = Rate of return on assets from income_{t}*.

##### Rate of Return on Farm Assets from Income Formula

##### Data Sources

Each data series used in the calculation is available as part of ERS's Farm Income and Wealth Statistics data product. Assets are reported as part of the farm sector balance sheet report. The estimate of the returns to unpaid labor and management is taken from the Agricultural Resource Management Survey (ARMS).

#### Rate of Return on Farm Assets from Capital Gains

The rate of return on farm assets from capital gains measures the returns to the assets from an increase in the assets’ value, apart from their income generating potential.

##### Rate of Return on Farm Assets from Capital Gains Formula

##### Data Sources

Each data series used in the calculation is available as part of ERS's Farm Income and Wealth Statistics data product. Assets are reported as part of the farm sector balance sheet report.

### Solvency Ratios

Solvency ratios compare the amount of debt relative to equity invested in the farm sector. The ratios are often referred to as measuring “leverage,” which is the amount of debt used to finance assets. As a result, the ratios provide a measure of the sector’s ability to repay financial liabilities via the sale of assets. By providing a picture of the sector’s current financial position, the ratios also measure the farm sector’s risk exposure and ability to overcome adverse financial events.

Each of the three solvency ratios reported (debt-to-asset, equity-to-asset, debt-to-equity) are inherently linked because all assets must either be claimed by the farm owner or owed to a creditor. Therefore, the equity-to-asset ratio and debt-to-asset ratio necessarily sum to one. The debt-to-equity ratio represents the proportion of assets owed to creditors relative to those financed by owner equity. As a result, it is the ratio of the debt-to-asset and equity-to-asset proportions. As a result, all three measures should provide similar conclusions on sector solvency.

Each data series used to calculate the solvency ratios is reported as part of the U.S. and State Farm Income and Wealth Statistics. Comprehensive information on the calculation of farm sector asset, debt and equity levels can be found in the farm sector balance sheet documentation. The balance sheet values assets and debt at market value. Accordingly, two important considerations need to be made when interpreting the solvency ratios. The use of market as opposed to historical cost valuation makes it is more useful to compare sector solvency benchmarks to individual operations or classes of businesses; however, typical solvency ratios will vary substantially for farms engaged in different types of production. Additionally, when valuing assets at market, the deferred taxes on the potential sale of the assets should ideally be included as an expected debt liability in the balance sheet. Due to data limitations this is not currently possible. This may lead the resulting financial ratios to overstate the sector’s solvency.

#### Debt-to-Asset Ratio

The debt to asset ratio measures the proportion of assets owed to creditors to cover outstanding debt obligations. Higher debt-to-asset ratios indicate more assets are financed by debt as opposed to owner capital (equity). A value of 1 would indicate all assets are financed by debt.

##### Debt-to-Asset Ratio Formula

##### Data Sources

Each data series used in the calculation is available as part of ERS's Farm Income and Wealth Statistics data product. Debt and asset data are both reported as part of the farm sector balance sheet report.

#### Debt-to-Equity Ratio

The debt-to-equity ratio measures the proportion of aggregate farm capital in the form of debt relative to owner provided capital (equity). A higher debt-to-equity ratio indicates more of the sector’s assets are financed by credit relative to owner capital (equity). A value of 1 indicates an equal amount of debt and equity capital was used to finance farm sector assets.

##### Debt-to-Equity Ratio Formula

##### Data Sources

Each data series used in the calculation is available as part of ERS's Farm Income and Wealth Statistics data product. Debt and equity data are both reported as part of the farm sector balance sheet report.

#### Equity-to-Asset Ratio

The equity-to-asset ratio measures the proportion of farm assets that were financed by the owner’s capital (equity). Alternatively, the ratio can be thought of as the percentage of farm sector assets claimed by farm owners. Higher equity-to-asset ratios indicate more assets are financed by owner capital (equity) as opposed credit. A value of 1 would indicate all assets are financed by owner equity.

##### Equity-to-Asset Ratio Formula

##### Data Sources

Each data series used in the calculation is available as part of ERS's Farm Income and Wealth Statistics data product. Equity and asset data are both reported as part of the farm sector balance sheet report.