Financial Ratios Used in Financial Management

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Financial aspects of the farm business have rapidly increased in importance in recent years. Farm business size has increased. Cash expenses have gone up. Larger amounts of credit are being used.

As the size of an operation increases and credit use is expanded, financial management becomes more critical to the success of the operation. More sophisticated accounting systems are needed to furnish farm financial management information. This calls for tools to aid in interpreting the accounting figures. This is where financial ratios come in.

Non-agriculture businesses have used financial ratios to interpret data from financial reports for many years. When investments in farm businesses were small, the need for this type of analysis was minimal. With the magnitude of today’s farm businesses, financial ratios can aid in converting the mass of data that is common in an effective farm accounting system into meaningful information.

A financial ratio is simply a comparison of two measurements of a business to each other. For example, a measurement of income may be compared to a measurement of size. The two measurements are expressed in terms of a ratio of one number to another number. The measurements can also be expressed in terms of the percent that one is to another. For example, a farm business with a net farm income of $50,000 and a value of farm production of $250,000 has a net farm income to value of farm production ratio of 1:5. Expressed in percentage terms, this same farm business has a net farm income that is 20 percent of the value of farm production.

Michael R. Langemeier
Kansas State University Agricultural Experiment Station and Cooperative Extension Service