WARSAW, Mo. – Handling farm finances wisely means knowing some key numbers that indicate the health of your operation.

“One of those key numbers is your farm’s financial efficiency,” said Amie Breshears, University of Missouri Extension agricultural business specialist. “Financial efficiency measures your farm’s ability to use all its valuable resources and produce income. In the words of Dave Ramsey, ‘If you don’t stay on top of numbers associated with your business, you will fail. You can’t outearn disorganization or the need to handle your finances wisely.’”

Financial efficiency measurements answer the questions, “How well is your farm using assets to generate income?” and “Where is your farm spending the income dollars it generates?”

Interest expense ratio is one of four measures of financial efficiency. Interest expense ratio measures the percentage of farm income used to pay interest owed on debt. It indicates how well the farm is generating income to pay interest expense on farm debt.

The other three measurements are operating expense ratio (how much of your farm’s income it takes to pay operating expenses, not including depreciation and interest); depreciation and amortization expense ratio (how much of your farm’s income it takes to cover your depreciation/amortization expenses); and income from operations ratio (how much of your farm’s income is left after paying operating expenses, depreciation/amortization and interest expenses).

The formula for interest expense ratio is total farm interest expense divided by gross revenues.

“Total farm interest expense includes all interest expenses from farm debt,” said Breshears. “Gross revenues include payments from the sale of agricultural products, any crop insurance proceeds or agricultural program payments such as Agricultural Risk Coverage and Price Loss Coverage payments, and other payments such as cash rent payments, payments for custom work or dividends from farm cooperatives.”

Generally, a lower interest expense ratio is better, said Breshears. An interest expense ratio less than 5% is strong. An interest expense ratio of 5%-9% is a sign that caution is needed. If the interest expense ratio is 10% or greater, that is considered “weak,” meaning the farm may not be able to generate enough income to cover its interest expense, operating expenses, depreciation/amortization and family living expenses.

Why does this matter?

The farm business should be generating enough income to pay for its interest expenses as well as cover operating expenses, depreciation/amortization expenses and family living expenses. If not, the farm is in a weak position.

What are some ways to improve the interest expense ratio? First, improve the profitability of the farm by increasing revenues, decreasing expenses, or both. Second, reduce family living expenses. Finally, work to restructure debt.

“You can make improvements and improve your farm numbers, including financial efficiency,” said Breshears. “One step at a time, day by day, small changes and better habits can add up to measurable results, including better farm finances.”

MU Extension offers farm accounting resources including Missouri Farm Business Record Books, budgets and spreadsheets at muext.us/FarmAccounting, or at your county MU Extension center.

Have a recordkeeping or budgeting question? Want to pass along your experiences with farm records? Contact Breshears at abreshears@missouri.edu or 660-619-7994, and follow MU Extension in Benton County on Facebook.

Find more resources at http://muext.us/AgBusinessPolicy.