Analyzing a Net Worth Statement*

Revised November 2004

William EdwardsWilliam Edwards                                                           
Iowa State Extension Economist
478C Heady
515.294.6161

wedwards@iastate.edu


Once you have completed your net worth statement, take time to look it over and understand what it can tell you. To begin, look at each major liability listed and see if a corresponding item can be found under the asset side. The corresponding item will usually be listed under the same section (current or fixed). If a corresponding asset cannot be found, you may have forgotten to list something. Or the asset originally acquired with borrowed money may have already been sold or used up before paying the corresponding liability. This is a danger sign. It means that you must generate funds to pay this debt elsewhere in the farm business.

Another danger sign is a liability that appears closer to the top of the statement than its corresponding asset. An example is a machinery item bought on a one-year note. It is usually difficult to pay for an asset over a period of time considerably shorter than its useful life.

Sometimes the value of a particular liability is greater than the value of its corresponding asset. This may mean that the debt is not adequately secured, or it may occur simply because rapid depreciation methods have been used.

Financial ratios

Several ratios can be computed from the net worth statement, and used to help analyze the financial security of your business. More information on these ratios, including benchmark values, can be found in Information File Interpreting Financial Performance Measures.

Debt-to-asset ratio (or percent debt) is equal to total liabilities divided by the market value of total assets. It indicates the portion of total capital supplied by creditors. A successful farm business will have a decreasing ratio over time, except in years when major assets such as land are purchased with borrowed capital. A low debt-to-asset ratio usually leads to less year-to-year variability in net farm income.

A personal debt-to-asset ratio can also be calculated, using total farm and personal asset and liability values.

A current ratio can be calculated by dividing total current assets by total current liabilities. This is a measure of liquidity, or the ability to pay bills and debts as they come due.

A farm business with good overall risk-bearing ability can still have liquidity problems. This may be caused by a low income year resulting in carry-over operating debt, or too rapid investment of cash into intermediate and long-term assets, such as machinery or land.

Many lenders consider a current ratio of 2.0 or greater to show good short-term risk-bearing ability, while a ratio close to 1.0 or lower indicates potential cash flow problems. However, this is affected by the type of farm, volume of production, and financial structure. For example, farms with regular livestock sales, such as dairy, often require lower current ratios than crop farms that have production only late in the year.

Some lenders prefer to look at the difference between current assets and current liabilities rather than their ratio. This difference is called working capital, and indicates the potential cash available for meeting daily operating costs, consumption expenditures, and other items not listed under current liabilities.

In many cases current liabilities will be paid from income generated from sales of farm products that have not yet been produced and do not appear as current assets. A more accurate analysis of repayment capacity can be made by developing a cash flow budget, as explained in Information File Twelve Steps to Cash Flow Budgeting.

Year-to-Year Comparisons

The financial progress of the farm business can be measured by comparing a current net worth statement with earlier ones.

The change in cost value net worth from one year to the next shows the growth (or loss) due to net income earned from the farm business, and consumption. The following formula summarizes the relation among cost value net worth, income, and consumption expenditures:

net farm income (accrual)

+ non-farm income, gifts, or inheritances invested in the farm business

- farm income used for living expenses, income tax payments, and other consumption

= change in cost value farm net worth

Example of financial statement analysis

The change in market value net worth is found by subtracting the market net worth shown on last year's financial statement from that shown on this year's. It measures the change in the market value of your equity share of the farm business. It also depends on net income and consumption, but includes changes in the market value of land or machinery, as well.

A decrease in net worth from one year to the next may result from low net farm income or high consumption expenditures. It may also result from large changes in inventory prices of current and fixed assets. For this reason, it is useful to compare similar items on the balance sheet from one year to the next. Changes in their values may be due to changes in volume, changes in unit prices, or both.

Many different forms and formats exist for developing a net worth statement. However, all of them contain the same basic information. Completing an annual net worth statement is one of the simplest means available for analyzing the risk-bearing ability and financial progress of your farm business.


* Adapted from Ag Decision Maker, Iowa State University Extension “Analyzing a Net Worth Statement”,   www.extension.iastate.edu/agdm