Financial Standards for Iowa Agribusiness Firms

Transcription

1 Elevator Financial Ratios, FY97 FY00 Published Fall, 2001 Financial Standards for Iowa Agribusiness Firms Prepared by Dr. Roger G. Ginder & Georgeanne M. Artz The U.S. Department of Agriculture (USDA) prohibits discrimination in all its programs and activities on the basis of race, color, national origin, gender, religion, age, disability, political beliefs, sexual orientation, and marital or family status. (Not all prohibited bases apply to all programs.) Many materials can be made available in alternative formats for ADA clients. To file a complaint of discrimination, write USDA, Office of Civil Rights, Room 326-W, Whitten Building, 14th and Independence Avenue, SW, Washington, DC or call Issued in furtherance of Cooperative Extension work, Acts of May 8 and June 30, 1914, in cooperation with the U.S. Department of Agriculture. Stanley R. Johnson, director, Cooperative Extension Service, Iowa State University of Science and Technology, Ames, Iowa.

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3 Financial Standards for Iowa Agribusiness Firms Financial ratios are useful in understanding and analyzing financial statements. Ratios help to show key relationships between different parts of the statements that might otherwise be difficult to observe. Ratios may be used in two ways: 1. Comparisons can be made between an individual firm's ratio and the industry average. In other words, an average ratio for a number of similar firms may be used as a "standard" or expected level of performance. This allows a manager or owner to see how his company compares to other similar companies. 2. A second kind of evaluation can be made by comparing the most recent year's ratio to the ratios in the same firm from previous years. This kind of comparison shows whether or not the position of the business is improving or getting worse over time. It gives management advance warning so that corrective action can be taken to prevent more serious problems. The statistics in this publication are intended to provide financial information suitable for common usage. This revised edition is abridged in that much of the narrative has been excluded the focus instead being the ratios themselves. Some of the ratios have been recalculated to more accurately reflect financial circumstances and may differ from previous editions. The Sample A sample of 86 Iowa firms was used to calculate these statistics. Firms were selected on the basis of type of ownership and product line. Variation in accounting practices and data availability made some observations unusable or unavailable for some ratios, and the composition of the sample may vary slightly year to year as a result. To maintain consistency in reporting, the years in this bulletin refer to fiscal years. The fiscal period used here runs from March1 to February 28. For example, fiscal year 2000 includes financial information reported between March 1, 2000 and February 28, This period was selected to take advantage of natural breaks in the sequence of statement dates and to roughly follow crop years. Adjustments to Data in Calculating the Standards In calculating averages of financial ratios, observations that are extremely large (or extremely small) may have a disproportionate impact on the mean value. For example, a firm with a current ratio of 30 to 1 in a population of 25 firms with current ratios of less than 2 to 1 can raise the mean beyond 2 to 1. This is true despite the fact that 96 percent of the firms (24 of the 25) have a current ratio less than 2 to 1. Although the true average current ratio might be a useful figure for some purposes, its use as a standard may be questionable. The primary purpose of a standard is to reflect the level of performance that might be expected by a typical firm. Using such an average as a standard might 1

4 be misleading. For this report, extreme values (greater than two standard deviations from the mean) were excluded to calculate the adjusted average ratios. This technique results in excluding only the most extreme values, while at the same time limiting extreme distortions. Unadjusted Quartile Ranges It is sometimes useful to know the actual range of values for ratios in the sample before any adjustments have been made. The observations for each ratio were divided into four parts or "quartile ranges." For ratios where high values are desirable the highest ratios were placed in the top 25%. Similarly where low values were desirable, lower ratios are placed in the top 25%. These ranges cover all ratios in the sample including the extreme values that were dropped in calculating the standards. Adjustments for Regional Cooperative Equity and Dividend Income In the federated cooperative system local cooperatives frequently receive a portion of their patronage refunds from regional cooperatives in the form of equity certificates. These certificates are periodically redeemed by a decision of the regional cooperative board. They are carried on the balance sheet of the local cooperative as an asset (usually called investments ). These firms may also receive cash and/or non-cash patronage dividends that contribute to net savings (profit). For ratios involving asset, equity, and income accounts for which this situation may confound analysis, adjusted ratios have been calculated. These measures exclude the value of investments in other organizations and/or any patronage dividend income. These adjustments were made to facilitate accurate comparisons between cooperative performance on a local level and proprietary firms. The adjusted ratios are designated as coops locally in the tables. Firm Activity Type Classification as either grain or supply firm is based on the percentage of grain sales to total revenue. Firms with grain sales greater than or equal to 66 percent of total sales and other income were classified as grain firms. All others were classified as supply firms. Firms were reclassified for each fiscal year, so an individual firm may switch classification from one year to the next. This may cause some of the fluctuation in averages between years for these cross-tabulations. In addition, information for separating total sales into grain and supply components was not available for some firms. The ratios for these firms are included in the all firms category (where appropriate) but cannot be used for the grain or supply firm sub-classification. As such, apparent inconsistencies may exist between averages for the entire sample and the grain/supply subgroups. Report Organization The report is organized as follows: Highlights, page 3 Solvency Ratios, page 4 Profitability Ratios, page 7 Productivity Ratios, page 12 Liquidity Ratios, page 15 Cash Flow Ratios, page 19 Insolvency Forecasting Model Ratios, page 23 2

5 Highlights Figure 1 The sample-wide debt-to-asset ratio was relatively stable over the four-year period of review, as depicted in Figure 1. This ratio rises approximately 30% when only local assets are included Debt To Asset Ratio With Regional Assets With Local Assets Figure 2 Profitability, as measured by the local return on local investment ratio is shown in Figure 2. Sample wide ROI (after interest and before taxes) fell from 7.3% to 4.1% over the period. This ratio measures the return before patronage income from regionals on the equity remaining after investment in regional cooperative equities has been excluded. 8.0% 6.0% 4.0% 2.0% 0.0% Local Return on Local Investment 7.3% 5.9% 3.5% 4.1% Figure 3 Local return on fixed assets provides a measure of net margins earned in relation to the fixed assets employed in the business post interest. Values for this ratio in 1999 and 2000 were 40% to 50% lower than in 1997 and Local assets increased by about 10% during this period but much of the decline can be traced to a reduction in local earnings of approximately 25%. Local return on fixed assets is shown before and after interest in Figure Local Return on Fixed Assets After Interest Before Interest 3

6 Other Highlights Figure 4 Figure Debt To Equity Ratio $9.0 $8.0 $7.0 $6.0 $5.0 $4.0 $3.0 $2.0 $1.0 $0.0 $6.3 $3.7 Average Equity (in millions ) $7.2 $7.5 $7.8 $4.1 $4.1 $4.1 With Regional Equity With Local Equity Total Equity With Local Equity Figure 5 Figure 7 $8.0 $7.0 Average Debt (in millions) $6.5 $6.3 $6.3 $7.0 $40.0 Average Sales and Service Income (in millions) $36.54 $6.0 $5.0 $4.0 $3.0 $2.0 $1.4 $1.7 $1.8 $1.9 $35.0 $30.0 $25.0 $33.32 $27.97 $30.21 $1.0 $0.0 $20.0 Long Term Debt Total Debt 4

7 Solvency Ratios Solvency ratios give an indication of balance sheet strength and the relative claims of the owners and debtors on the assets owned by the company. Term Debt to Equity: Long Term Liabilities Owner Equity The term debt to equity ratio shows the amount of long term debt capital the company has in relation to the amount of owner s money in the company. For example, a term debt to equity ratio of.21 would indicate that there is 21 cents of long term debt for each dollar of owner s equity in the company. Trend: Term debt to local equity has trended up sharply over the past four years. Local losses have contributed to this trend along with increased borrowing. With regional equity Local equity only Grain Supply (Local Equity) Quartile Top 25% Second 25% Third 25% Fourth 25%

8 Term Debt to Fixed Assets: Long Term Liabilities Fixed Assets The term debt to fixed assets ratio shows how many dollars of debt have been used to finance each dollar of fixed assets. For example, a term debt to fixed asset ratio of.34 indicates that the company has 34 cents of long-term debt for each dollar of fixed assets. This ratio is one of several factors that are likely to be considered by lenders in determining whether or not additional fixed assets may be financed with long term debt. In general, lower ratios are desirable. Ratios of 1.0 or more indicate that the value of fixed assets is inadequate to liquidate the long-term debt of the company. This may or may not be a serious problem depending on the amount of working capital the company has. Trend: Term debt to fixed assets has risen approximately 25% over the past four years. However, on average, cooperatives still have only about 34 of debt for each dollar of fixed assets. Local operations Grain Supply Quartile Top 25% Second 25% Third 25% Fourth 25%

9 Owner Equity to Fixed Assets: Owner Equity Fixed Assets Fixed Assets refer to balance sheet accounts such as plant, property, and equipment. Such assets may be financed by either debt capital or owner's capital. The owner equity to fixed assets ratio shows the number of dollars the owners have invested in the company for each dollar of fixed assets. For example, an owners equity/fixed asset ratio of 1.93 would indicate that the owners invested $1.93 for each dollar of fixed assets the company owns. It is possible to have a high equity to fixed assets ratio and still have a high long-term debt to fixed asset ratio if a large portion of current assets are financed with owner's money. Nevertheless, this ratio may be useful as an indication of the ability of the company to borrow for the purchase of additional fixed assets. But firms with highly depreciated fixed assets may have higher ratios and still have difficulty in getting credit. It may temper a high long-term debt to fixed asset ratio. In general, higher ratios are more desirable that smaller ones. Trend: Local equity to fixed assets has declined by approximately 10% over the past four years. However firm equity levels were on average still equal to fixed asset levels. With regional Local equity only Grain Supply (Local Equity) Quartile Top 25% Second 25% Third 25% Fourth 25%

10 Profitability Ratios Return on Assets (Before Interest): (Net Profit + Interest) Total Assets The assets used in a business may be financed with either equity (owner) capital or debt capital. In either case, the assets must be used effectively if the business is to succeed in the long run. Return on assets before interest is a useful way to measure how well assets are being used. Return on assets (before interest) measures the profit before the effects of leverage are considered. ROA may be interpreted as the net margin generated by each dollar of assets before those providing debt capital are paid. Firms with a high rate of return on assets are generally in a better position to assume higher debt loads and withstand increases in interest rates on the debt they have. Trend: Pre-interest return on assets fell slightly over this period. With regional Local earnings & assets only Grain Supply (Local Return on Local Assets) Quartile Top 25% Second 25% Third 25% Fourth 25%

11 Return on Total Assets: Net Profit (After Interest) Total Assets Return on total assets after interest measures how well the total assets are used by the business to generate net profits after all expenses. It may be interpreted as the number of dollars of profit earned for each dollar of assets that is employed by the business with the effects of borrowing included. For example, a return on total assets of.03 indicates that three cents of profit is earned for each dollar (either borrowed or furnished by owners) that is used by the business. Return on total assets after interest is a more complete measure of profit performance than ROA because the interest and finance charges have been taken into account. The quality and condition of fixed assets is also an important consideration. Firms with depreciated fixed assets can be expected to show higher return on total asset ratios than firms with relatively new fixed assets with large undepreciated values. Trend: Return on total assets after interest remained very low during the entire four year period. With regional Local return on local assets Grain Supply Quartile Top 25% Second 25% Third 25% Fourth 25%

12 Return on Fixed Assets (After Interest): Net Profit (After Interest) Fixed Assets The return on fixed assets ratio provides an indication of how well the fixed assets in the business are being used to generate profit. In business ventures that require a high fixed capital investment (such as grain elevators), it is important to monitor the return generated by the fixed assets employed. The return on fixed assets ratio may be interpreted as the number of dollars of profit that a dollar of net fixed assets generates. (Note: The profit figure is calculated after interest obligations have been met.) For example, a return on fixed assets ratio of.10 shows that each dollar of fixed assets generated ten cents of profit. Return on fixed assets will vary somewhat depending upon whether or not rapid depreciation methods have been used. Generally, a high return on fixed assets is desirable. As the pool of fixed assets becomes depreciated, the ratio might be expected to increase. Depreciation expense will be lower and thus profit will generally be higher under these circumstances. Hence, the ratio is boosted from the effects of both the higher net profits and the lower level of net fixed assets. Trend: After interest, local return on fixed assets fell to 50% of 1997 levels in 1999 then recovered slightly in With regional Local earnings only Grain Supply Quartile Top 25% Second 25% Third 25% Fourth 25%

13 Return on Fixed Assets (Before Interest): Net Profit (Before Interest) Fixed Assets The return on fixed assets ratio provides an indication of how well the fixed assets in the business are being used to generate profit. In business ventures that require a high fixed capital investment (such as grain elevators), it is important to monitor the return generated by the fixed assets employed. The return on fixed assets ratio may be interpreted as the number of dollars of profit that a dollar of net fixed assets generates. (Note: The profit figure is calculated after interest obligations have been met.) For example, a return on fixed assets ratio of.18 shows that each dollar of fixed assets generated ten cents of profit. Return on fixed assets will vary somewhat depending upon whether or not rapid depreciation methods have been used. Generally, a high return on fixed assets is desirable. As the pool of fixed assets becomes depreciated, the ratio might be expected to increase. Depreciation expense will be lower and thus profit will generally be higher under these circumstances. Hence, the ratio is boosted from the effects of both the higher net profits and the lower level of net fixed assets. Trend: Pre-interest return on fixed assets fluctuated over the period between 11% and 15%. With regional Local earnings only Grain Supply Quartile Top 25% Second 25% Third 25% Fourth 25%

14 Return on Investment: Net Profit (After Interest) Owner Equity One important measure of profitability is the rate of return on owner equity. Return on investment may be interpreted as the amount of profit that is earned for each dollar the owners or stockholders have invested in the company. For example, a return on investment ratio of.053 would indicate that owners earned 5.3 cents of profit for each dollar they have tied up in the business. The return on investment (after interest) ratio is sensitive to the amount of debt capital in the business. Two firms with equal assets and equal profits might have greatly different return on investment ratios. If one of these firms finances its assets with heavy borrowing, its equity will be lower and its return on investment ratio will be higher. Therefore, it is best to use the return on investment ratio in conjunction with other measures of return; such as return on total assets employed. High values for return on investment are generally desirable but are more desirable (and more difficult to obtain) when the level of debt is relatively low. When the level of debt is large, high return on investment is often associated with higher levels of financial risk. Trend: Return on investment fell by more than 50% between 1997 and 1999 then recovered slightly. Low ROI indicates that returns in the industry are under pressure. With regional Local margins & equity Grain Supply Quartile Top 25% Second 25% Third 25% Fourth 25%

15 Net Profit to Total Expenses: Net Profit Total Expenses The net profit to total expenses ratio indicates how many dollars of profit a dollar of expenses has generated. For example, a net profit to total expense ratio of.10 indicates that ten cents of profit is generated for each dollar of expense. This ratio provides some indication as to whether expense control may be a problem. This ratio is very sensitive to increases in expenses since an increase in expenses will simultaneously reduce the numerator and increase the denominator (assuming gross margins are constant). It should be remembered, however, that inadequate gross margins can impact the value of this ratio as well as expense control. Since a decline in the net profit can be caused by a decline in gross margins, managers should check both expenses and gross margins when the net profit to total expenses ratio falls. Trend: Overall there has been a downward trend over the four year period, although there was some recovery in Profits were under pressure throughout the period. With regional Local earnings Grain Supply Quartile Top 25% Second 25% Third 25% Fourth 25%

16 Productivity Ratios Productivity ratios measure efficiency by relating expenses and/or assets to sales. It is important to monitor expenses carefully to ensure the productive use of the resources that are needed to generate sales. Firm Productivity: Total Expenses Total Sales & Other Income This ratio allows management to track the number of dollars of expenses required to generate a dollar of sales. This statistic is also useful in determining the gross margins necessary for a profitable operation. Subtracting this ratio from gross margins as a percent of sales will yield the net profit margin before income tax. Thus, if management has a good idea of operating expenses, gross margins, and service income as a percent of sales, net profit margins may be targeted by adjusting margins upward or expenses downward. Trend: Firm productivity displayed an upward trend, indicating higher expense per dollar of sales. Lower commodity and fertilizer prices have exaggerated this in the past two years by reducing the dollar sales for a given level of physical volume of sales. Local operations Grain Supply Quartile Top 25% Second 25% Third 25% Fourth 25%

17 Labor Productivity: Labor Expenses Total Sales & Other Income Labor expense is often considered to be the major expense item agribusiness managers control. Even so, it may not be easy (or even wise) to make a rapid adjustment to labor expense. The labor expense to sales ratio shows the number of dollars of labor expense that was required to generate a dollar of sales. It is a particularly useful indicator to management of supply firms where the price of products sold (therefore, the level of sales) is usually more stable. In grain firms the wide variability in grain prices can affect the value of the ratio. The dollar sales may increase or decrease markedly for a given bushel volume of grain. Because the labor to handle that bushel volume will not change much, the ratio may give misleading signals if large price differences are not considered. Trend: The labor expense to sales ratio increased somewhat over the four year period. Reduction in dollar sales along with trends toward hiring more technical employees contributed to the increase. Local operations Grain Supply Quartile Top 25% Second 25% Third 25% Fourth 25%

18 Asset Turnover: Total Sales & Other Income Total Assets Asset turnover measures the number of times that total value of assets are generated in sales and other income. An asset turnover ratio of 2.26, for example, indicates that $2.26 of sales were generated by each dollar of assets used by the business. High asset turnover ratios are generally more desirable than lower ones. In firms that are capital intensive (i.e., depend heavily upon land, plant and equipment) the asset turnover ratio is more important than in service businesses where labor is a bigger factor. In two firms with similar assets, an asset turnover ratio that is low generally indicates that higher net profit margins might be required to maintain return on assets. Firms with relatively new fixed assets with high undepreciated values on the balance sheet will have lower asset turnover ratios than firms with assets that have been more fully depreciated. For this reason, year to year comparisons of the asset turnover ratio in a given firm is perhaps more meaningful than comparisons between firms. Trend: Asset turnover declined over the period. Much of the decline can be attributed to lower dollar sales resulting from lower grain and fertilizer prices. With regional Local assets only Grain Supply (Local Assets Only) Quartile Top 25% Second 25% Third 25% Fourth 25%

19 Liquidity Ratios Working capital is necessary to purchase inventory, finance accounts receivable and, in general, meet the day-to-day demands for cash. To calculate working capital, current liabilities are subtracted from current assets. Current Ratio: Current Assets Current Liabilities The current ratio may be read as the number of dollars of current assets that are available for each dollar of current liabilities the firm must meet. The current ratio in Iowa takes on added significance for firms with State Grain Dealer and Warehouse licenses. Current law requires firms to maintain a 1.0 to 1.0 current ratio as a prerequisite for licensing. Interpretation of the current ratio must be tempered with knowledge of the "quality" of current assets. For example, two firms with equal ratios may not be in an equivalent liquidity position if the current assets of one are mostly inventory and accounts receivable and the current assets of the other are mostly cash and marketable securities. Trend: The average current ratio trended upward from 1997 through 1999, but fell in Reduced grain and fertilizer prices reduced inventory values and resulted in lower current asset values in Local operations Grain Supply Quartile Top 25% Second 25% Third 25% Fourth 25%

20 Quick Assets: (Current Assets-Inventory) Current Liabilities An alternative measure of the ability of a company to meet its current debts and obligations is the quick assets (or acid test) ratio. In this ratio, the dollar value of inventories is removed from the total dollars of current assets because it might be difficult to convert them to cash within a short period of time. The remaining current assets are then divided by current liabilities just as they were in the current ratio. The ratio may be interpreted as the number of dollars of cash that could be raised quickly to meet current liabilities. For example, a quick assets ratio of 0.68 means that the firm could turn $0.68 of current assets into cash (on short notice) to meet each dollar of current liabilities. In general, higher quick assets ratios are an indication that the firm will have little difficulty meeting current obligations. However, extremely high quick assets ratios may indicate that the company is not utilizing cash as well as it could. Trend: Quick assets (without the effects of inventory values) were much more stable over the period. Local operations Grain Supply Quartile Top 25% Second 25% Third 25% Fourth 25%

21 Average Number of Days Sales in Receivables: (Accounts Receivable 360) Non-Grain Sales The average number of days sales in accounts receivables is a useful measure of the accounts receivable position of the firm. This ratio provides an indication as to the extent accounts receivable tie up potential cash flow from sales. If the firm plans to expand sales, the additional operating capital necessary for accounts receivable can be derived from the average number of days sales in receivables ratio. The ratio may also be compared to the credit policy to roughly determine whether or not the policy is being met. Average number of days sales in receivables does not provide a good indication as to the age of the accounts. Hence this measure is not a substitute for a regular aging analysis. This ratio is also sensitive to the time that the balance sheet was drawn up in some businesses. A balance sheet drawn up during peak sales periods is likely to yield a higher measure than one drawn up at a later time. However, most firms attempt to close their books at times when inventories and accounts are low. Trend: Days sales in receivables increased over the period. The increase reflects the impact of both lower fertilizer prices and higher levels of receivables. Local operations Grain Supply Quartile Top 25% Second 25% Third 25% Fourth 25%

22 Working Capital to Sales: Working Capital Total Sales & Other Income Working capital needs increase as sales increase. A greater number of dollars of working capital are required to finance accounts receivables and inventories when more products are sold. Likewise, inflation means that the value of inventories of the same number of physical units will be higher and thereby tie up more working capital. The working capital to sales ratio gives an indication of the amount of working capital available to support a dollar of sales. For example, a working capital sales ratio of.046 indicates that 4.6 cents of working capital are available for each dollar of sales. In general, higher working capital to sales ratios are desirable in companies where inventories and accounts receivables are large and turnover is slow. Supply firms fall into this category. Trend: Working capital to sales increased over the period. Changes mostly reflect lower sales and service income later in the period. Local operations Grain Supply Quartile Top 25% Second 25% Third 25% Fourth 25%

23 Cash Flow Ratios Cash flow is an important factor to the survival of a firm in both the short-term and the long-term. Although cash flow will not guarantee survival (profits are necessary in the long run), all agribusiness managers should monitor cash flow on a regular basis. Interest Coverage: (Net Profit + Interest Expense) Interest Expense The interest coverage ratio shows the number of times interest could be paid from net profit before interest expense. A ratio of 1.0 indicates that the firm can just pay its interest bill and has zero profit. An interest coverage ratio of less than 1.0 indicates that interest must be paid with cash flow from depreciation or taken from working capital. An interest coverage ratio of 3.9, for example, indicates that the firm could pay its interest bill nearly four times from cash flow available from earnings or net savings before interest. A ratio of 2.5 would be considered fair and indicates fairly good repayment capacity from current operations. Trend: Interest coverage increased midway then fell at the end of the period. Levels at the end of the period were below desired 2.0 to 2.5 levels. With regional Local earnings Grain Supply Quartile Top 25% Second 25% Third 25% Fourth 25%

24 Term Debt to Depreciation: Long Term Liabilities Depreciation Expense The term debt to depreciation ratio measures the number of years that would be required to repay long-term debt from the cash flow generated from depreciation. For example, a term debt to depreciation ratio of 2.3 indicates that the cash flow from depreciation (if it were devoted entirely to debt repayment) would pay off all the term debt the company now has in a little more than two years. Generally, lower ratios indicate stronger cash flow positions from depreciation. Trend: Term debt to depreciation trended down steadily over the period. Relatively stable average cash flows from depreciation coupled with increases in debt resulted in weaker ratios. Local operations Grain Supply Quartile Top 25% Second 25% Third 25% Fourth 25%

25 Long Term Claims: (Net Profit + Depreciation) (Term Debt + Owner Equity) Capital used by a company to finance fixed assets comes from lenders who have loaned money to the company for a certain number of years or from owners who have put equity capital into the firm. The long-term claims ratio measures the ability of the cash flow generated from earnings (profits) and depreciation to service these claims. Servicing debt includes repayment of principal and interest. Servicing equity is generally done through payment of dividends or drawing out cash through equity retirement.. The ratio may be read as the number of dollars of cash flow available to service long-term debt and equity claims on the firm. For example, a long-term claims ratio of.143 would indicate that 14.3 cents of cash flow would be available to service each dollar of long-term debt and equity in the company. Ratios that are higher generally indicate that the company can better provide cash to meet demands of creditors and stockholders. A low ratio may mean difficulty in servicing debt if a large debt load exists since the two major sources of cash flow are embodied in this measure. Extremely low or negative ratios mean that funds to service debt or equity must come from working capital, asset liquidation, or a source outside the firm. Trend: The average local long term claims ratio exhibited a slight decline in 1998 but remained stable during the latter part of the period. With regional Local earnings & equity only Grain Supply Quartile Top 25% Second 25% Third 25% Fourth 25%

26 Debt-Service Ratio: (Net Profit + Depreciation) Long Term Liabilities This ratio measures the ability of a firm to generate cash to cover long term debt obligations. Lenders are generally interested in the ability of the firm to repay loans. In cases where abnormally rapid depreciation is used, this ratio provides a more accurate picture of the repayment capacity of the firm than earnings alone. In situations where lenders are more interested in repayment ability than the collateral value of assets, this debt-service measure can provide an alternative to fixed asset or debt to equity ratios as a guide. High debt-service ratios are more desirable and usually occur where a relatively high equity level exists. The measure may be somewhat variable in industries where wide fluctuations in earnings occur. A debt-service ratio of 2.0, for example, indicates that about two dollars of cash is generated by the business for each dollar of long-term debt. Trend: Average local debt service ratios declined precipitously in 1998 then remained stable. The decline reflects declining profits, relatively stable depreciation and increased long term debt. With regional Local earnings only Grain Supply Quartile Top 25% Second 25% Third 25% Fourth 25%

27 Insolvency Forecasting Model Ratios Research has identified three financial ratios that may be useful in providing early warning of insolvency: debt to asset ratio, adjusted cash flow to debt ratio, and adjusted working capital to sales ratio. The three ratios must be interpreted simultaneously through a statistical equation to predict the probability of failure or bankruptcy. However, they can provide some insight about the strengths and weaknesses in the firm when evaluated alone. Debt-to-Asset Ratio: Total Liabilities Total Assets The debt-to-asset ratio provides a measure of the level of total debt as a percentage of total assets. Lenders typically become concerned before a firm reaches the point of technical insolvency (i.e. has a debt-to-asset ratio of 1.0). Warehouse authorities may also become concerned by low levels of net worth as the debt-to-asset ratio approaches 1.0. Therefore, firms with high debt to asset ratios are in greater danger of intervention by either lenders or warehouse and grain dealer licensing authorities. Trend: Average debt to local assets was stable with a small upturn in With regional Local assets only Grain Supply Quartile Top 25% Second 25% Third 25% Fourth 25%

28 Adjusted Cash Flow to Debt: (Net Cash Flow Interest Expense) Total Debt Net cash flow is used by elevators to repay debt, replace fixed assets, service equity and in some cases finance new assets. At minimum, it is necessary for an elevator to have sufficient cash flow to promptly service its debt with principal payments. The raw data for many of the firms in the sample did not contain sufficient detail to determine the precise amount of cash flow required for annual debt repayment. As an alternative, one year's interest expense was used as a rough proxy for the required payments. Use of interest expense as a proxy had the advantage of incorporating the effect of different debt levels in different firms. In general, it is a very conservative estimate of what a firm would need to repay on its term debt. The adjusted net cash flow to debt ratio may be interpreted as the amount of cash flow from net profit and depreciation available after interest and a modest principal payment has been made. For example, an adjusted cash flow to debt ratio of.14 would imply that the firm had 14 cents of cash flow for each dollar of debt after a modest principal payment (equal to its interest expense) has been made. Trend: Adjusted cash flow to debt declined in 1999 and 2000 reflecting reductions in cash flow due to lower earnings. With regional Local earnings only Grain Supply Quartile Top 25% Second 25% Third 25% Fourth 25%

29 Adjusted Working Capital to Sales: Adjusted Working Capital Total Sales & Other Income Adjusted Working Capital = Actual Working Capital Target Working Capital Actual Working Capital = Current Assets Current Liabilities Target Working Capital = (Grain Sales.015) + (Supply Sales.09) The adjusted working capital to sales ratio provides a measure of liquidity. It differs from other liquidity measures in that each firm's working capital is measured against a "target" level deemed appropriate for the unique product mix of each firm. An adjusted working capital to sales ratio of.009 would mean that the firm had about one cent more working capital per dollar of sales than it needs to conduct business (given its current sales mix between grain and farm supplies). Ratios less than zero imply that the firm may be somewhat short on working capital and could experience liquidity problems. As the sales mix changes the adjusted working capital to sales ratio will also change to reflect the differences. Trend: Average working capital to sales was above zero throughout the period indicating that there was adequate working capital to support business activity. Local Operations Grain Supply Quartile Top 25% Second 25% Third 25% Fourth 25%