The Farm Financial Standards Council (FFSC) recently held its annual meeting where several updates were approved for the Financial Guidelines for Agriculture. These updates will be officially released in the 2022 version of the Guidelines. Here are some highlight the changes related to FFSC recommended ratios.
Financial Ratio Updates
An ongoing sub-committee has been reviewing the financial criteria and measures (aka the ratios) recommended by FFSC. This has been a thorough review, over the past two years, and initially included a feedback survey of farmers and other farm financial professionals. As a result of this work, the Farm Financial Standards Council has adopted the following 13 financial criteria and measures as their recommended ratios.
13 Recommended Ratios
- Current Ratio
- Working Capital as % of Gross Revenues
- Debt to Asset Ratio
- Rate of Return on Assets
- Rate of Return on Equity
- Operating Profit Margin Ratio
- Asset Turnover Ratio
Repayment and Replacement Capacity
- Debt Coverage Ratio
- Replacement Coverage Ratio
- Operating Expense Ratio
- Depreciation/Amortization Expense Ratio
- Interest Expense Ratio
- Income from Operations Ratio
So, what changed?
Previously there were 21 recommended financial criteria and measures. Many of these were numbers, coming directly from a financial statement, are calculated in a related schedule, or defined in the glossary. It was determined to only recommend financial ratios going forward, realizing the other numbers are found elsewhere. (These previously recommended “numbers” include net farm income, EBITDA, capital debt repayment capacity, capital debt repayment margin, and replacement margin.)
New Addition – Debt Coverage Ratio
As you see on the above list, there is one new ratio being adopted, Debt Coverage Ratio. Debt coverage ratio includes all interest expense in the calculation, not just interest on term debt. Feedback from many indicated it can be difficult to separate current interest expense from term interest expense. Hence, the additional ratio.
As you can see above, Term Debt and Finance Lease Coverage Ratio is no longer on the list of recommended ratios. This has not been completely removed by FFSC, but instead has been moved to be included as an alternative ratio.
Alternative Financial Ratios
In addition to Term Debt and Finance Lease Coverage Ratio, there are several other alternative financial ratios offered. These alternatives are considered acceptable ratios for financial analysis use and provide users flexibility. The alternative financial ratios include:
- Working Capital as % of Operating Expense
- Equity to Asset Ratio
- Debt to Equity Ratio
Repayment and Replacement Capacity
- Term Debt and Finance Lease Coverage Ratio
The alternative measures include ratios previously utilized in the Guidelines. It was determined with this update to recommend only one solvency ratio and include the other two as alternatives since they are redundant versions. And, working capital as a % of operating expenses is also an acceptable alternate liquidity measure.
FINPACK Credit Analysis Updates
These changes came too late for inclusion in our Fall 2021 release of FINPACK. While we expect to add Debt Coverage Ratio to FINPACK’s agricultural credit analysis tools with the Fall 2022 release, our plan is to continue to include Term Debt Coverage Ratio for those who rely on it for risk rating and other credit analysis purposes. Additionally, we envision the comprehensive list of financial ratios and measures you’ve come to expect and rely on will remain in FINPACK output. We understand and appreciate the fact our users look to different financial ratios and measures for their credit analysis and underwriting purposes.
The FINPACK Team has been involved with the Farm Financial Standards Council since its inception. Dale Nordquist was a founding member of the organization and had a long tenure of involvement. Today, Pauline Van Nurden represents FINPACK and CFFM on the Farm Financial Standards Council. She is a Technical Committee member and also an Elected Director of the organization. In addition, several FINPACK Team members served on the recent ratios sub-committee. All interested individuals are welcome and encouraged to join FFSC. Learn more at https://ffsc.org/join-the-ffsc/.