University of Wisconsin Center for Wisconsin
Rural Cooperatives, November/December 1998, pp. 18-22.
Published by the Rural Business and Cooperative Development Service
Proactive Approach to Financial Health Pays off for Nation's Major Ag Co-ops
David S. Chesnick
USDA/RBS Cooperative Services
Editor's Note: This third and final segment of Chesnick's report on the 1997 financial performance of the nation's largest ag cooperatives shows that their capital structure, ability to meet fixed obligations and operating performances has improved.
Part II can be found on page 12.
Despite falling revenues, the nation's 100 largest agricultural cooperatives strengthened their financial position in 1997. However, this doesn't really show how productive or efficient these cooperatives were. So the question remains— were the cooperatives in a better position in 1997 than in 1996? Are they better prepared to meet future challenges? For the most part, these questions are difficult to answer in a combined format. However, using certain performance measurements, we can get a good idea of how these large cooperatives are performing Table 1 lists the ratios by commodity type for 1997.
The tools developed to analyze the cooperative's financial information include four types of performance measurements:
The most common liquidity ratios used today are the current and quick ratios. Both evaluate the cooperative's short-term liquidity by measuring the degree to which it can meet its short-term obligations. Liquidity implies the ability to convert assets into cash in the current period. Liquid assets include cash, marketable securities, accounts receivable, inventories and other debt that is to be paid to the cooperative within the current fiscal year. Figure 1 illustrates both current and quick ratios from 1993 to 1997.
The current ratio is calculated by dividing total current assets by total current liabilities. The higher the ratio, the more liquid the cooperative is. However, a note of caution is warranted here. Interpreting these ratios beyond the conclusion that it represents current resources over current obligations at a given point in time requires a more in-depth look at the trends of the individual parts that make up the ratio. For example, during a business contraction, current liabilities may be paid off while there may be a concurrent involuntary accumulation of inventories and uncollected receivables causing the ratio to rise.Figure 1-Liquidity Ratios
The average current ratio for all the largest 100 agricultural cooperatives reversed the declining trend of the past few years. The current ratio improved from 1.36 to 1.39 in 1997. While both current assets and liabilities declined, current liabilities fell by a higher percentage, causing the value of the ratio to increase. The decline in inventories and account receivables is more a reaction to lower sales. The increase in the cooperatives" cash position helped strengthened their liquidity.
However, the biggest influence was the lower amount of current debt. Cooperatives moved their debt stance from short term to long term. Therefore, the results seem to support that cooperatives are strengthening their current position as a result of the downturn in sales.
Poultry/livestock were the most improved sector, moving from a position of averaging more current liabilities than cur rent assets (.97 ratio) in 1996 to a more liquid position (1.23 ratio). Other commodity groups that improved their current position include cotton, fruit/vegetable and grain. Even though the diversified and farm supply cooperatives had a decline in their current position, they still maintained a higher liquid position then the overall average. Dairy, rice and sugar cooperatives did not follow the general trend of lowering the amount of short-term debt, resulting in a relatively less liquid position.
The quick ratio is calculated the same way as the current ratio, but inventories are excluded from current assets. The theory behind this suggests that inventories cannot be converted to cash as quickly as the other current assets during liquidation. Also, if the inventory needs to be liquidated, the cash value will, in all likelihood, be much less than the book value. Therefore, it can be argued that the quick ratio is a better measure of liquidity.
The average quick ratio for all cooperatives followed that of the current ratio and improved from .77 to .80 in 1997. Cotton, diversified, and poultry/livestock cooperatives had strong liquid position, with each of the commodity groups having an averaging quick ratio above one. Although the average ratio declined for cooperatives, they still held a strong liquid position with a quick ratio of over 1.Figures 2 and 3
Grain and farm supply cooperatives improved their quick ratio. Sugar and rice cooperatives, on the other hand, had a relatively larger build-up of inventories to match an increase in short-term debt, thus dropping their average quick ratios from .65 to .44, and .51 to .42, respectively Dairy and fruit/vegetable both had slightly lower liquidity with a drop in their quick ratio of .01.
Leverage relates to the capital structure of a business. Equity is the basic risk capital put up by members of the cooperative. There must be some equity within the capital structure to bear the risk associated with the cooperative's business. Debt is the use of external funds at a fixed cost. Thus, if the fixed cost of the debt is lower than the returns those funds generate, the excess returns will accrue to the members. However, if the revenues are less than the fixed cost of the debt, member equity would have to make up the difference. This is the concept of leverage.
The first leverage ratio, debt-to-asset, is calculated by dividing total liabilities by total assets. This represents the claims by outside interests on the cooperative's assets. Figure 2 shows how this ratio has been moving during the past five years. After creeping up each year since 1994, the average debt-to-asset ratio inched downward in 1997. The debt-to-asset ratio fell from .62 in 1996 to .61 in 1997.
The driving force behind this decline came from the grain commodity group. This sector had several cooperatives that saw significant shifts in their capital structure. The overall average ratio for the grain cooperatives fell from .63 to .57. All other commodity groups either had a slight increase or had no change in their average debt-to-asset ratio.
The second leverage ratio is long-term debt-to-equity Since both equity and long term debt take a long-run view of financing, it should be a natural comparison between the two. Unlike the total debt-to-equity ratio discussed earlier, the long-term debt-to-equity ratio illustrated a dramatic change in cooperative capital structure. The average long-term debt-to-equity ratio jumped from .46 to .57 in 1997 (Figure 3).
The largest changes occurred in the poultry/Livestock and grain cooperatives. The poultry/livestock cooperatives on average are heavily leveraged. In 1997, they more than doubled the amount of long-term debt in relation to equity as illustrated by the increase in their average ratio from .97 to 2.18. Grain cooperatives, while carrying less overall debt, transferred their short-term debt to long term, resulting in an increase in their average ratio from .28 to .42.
The last leverage ratio is the times interest earned (TIE). This mainly looks at how well net revenue covers interest expense. It is calculated by dividing earnings before interest and taxes by interest payments. A note of caution is needed here. This ratio looks at the minimum expenditures needed to cover debt payments. It does not include other fixed payments such as principle and lease payments.
The average TIE ratio for the largest cooperatives fell from 6.7 to 5.0 in 1997 (Figure 4). While interest expense increased slightly (2 percent), the drop in net income before interest and taxes (5 percent) was the larger influence in pushing down the TIE ratio. With the exception of the grain commodity group, all groups experienced a lower TIE ratio. Even though the average cooperative had five times the earnings to cover interest expense, a few commodity groups—rice, sugar and fruit/vegetable—had average TIE ratios between 1 and 2.
However, this does not necessarily mean further stress on these sectors would be a grave cause for concern for these cooperatives. Many of these cooperatives operate on a pooling basis and after all expenses, the final payment to members leaves little margin left to be distributed. Thus, these cooperatives generally have low TIE ratios.
Where the first two types of ratios examined the cooperative's capital structure and its ability to meet its fixed obligations, the next two look at the operating performances. Activity ratios reveal how much revenue is generated by each dollar invested in the cooperative's assets. Higher ratios here generally mean higher efficiencies within the cooperative.
The first activity ratio, local asset turnover, is calculated by taking the total revenues divided by local assets. Local assets are total assets less investments in other cooperatives. Investment in other cooperatives is generally not considered a revenue-producing asset. Therefore, it makes sense to leave it out of the calculation when looking at the local asset turnover ratio.
The average local asset turnover ratio again improved over the prior year, setting a new record (Figure 5). The average ratio improved from 3.7 to 3.8, despite the combined lower sales and higher local assets of all top 100 cooperatives in 1997. As mentioned in Part II of this report, most of the decline in sales was attributed to a few of the largest cooperatives. However, most of the other cooperatives had higher sales. This points out the influence that some of the largest cooperatives can have on the combined statements of the 100 largest agricultural cooperatives.Figure 4
Cotton, dairy, grain and poultry/livestock cooperatives needed less assets to generate income than the other cooperatives. These commodity groups had an average ratio of over 4. Cotton and dairy cooperatives' ratio remained fairly constant from the prior year. However, grain cooperatives improved their ratio with a smaller decline in revenues verses the decrease in local assets.
Poultry/livestock cooperatives, on the other hand, saw an increase in local assets with a corresponding decrease in revenues pushing down their ratio. Most of the other groups’ local asset turnover ratio averaged between 2 and 3, with the exception of sugar cooperatives. These cooperatives generally had proportional increases in both local assets and revenues, so there was little movement in their average ratio. Sugar cooperatives are capital intensive and require a higher amount of assets to generate a given level of sales. Their local asset turnover ratio was 1.2, down slightly due to a larger increase in local assets compared to the increase in revenue.
The second activity ratio, fixed asset turnover, looks at how efficiently the cooperative uses its fixed assets. This ratio is calculated by dividing total operating revenues by net fixed assets. It must be noted that this ratio could be misleading. A cooperative with fully depreciated assets could have a high ratio due to the low value of its fixed assets. On the other hand, a cooperative that is expanding its operations could have a temporarily depressed ratio because the new capacity is not fully used at this time. Therefore, other information, such as the average age left on the fixed assets and how much new equipment is purchased, will be needed to help interpret the fixed asset turnover ratio.
The average top 100 agricultural cooperatives purchased $17.4 million in fixed assets in 1997, nearly $2 million more than in 1996. Total net fixed assets hit a record amount of $8.1 billion. The average age of fixed assets, estimated by dividing net fixed assets by depreciation expense, was similar between 1996 and 1997, at 9.2 years. These figures together would suggest that, while cooperatives are expanding their fixed asset base, the industry as a whole didn't build excess capacity—although a few cooperatives had substantial investments and appeared to have built excess capacity for future growth.
Figure 6 illustrates the cooperatives' increased efficiency in their use of fixed assets. The average fixed asset turnover ratio increased from 17.0 to 17.7 in 1997, the highest in the 5-year period. This again points out that, while the combined revenues for all top 100 cooperatives were down, most of them showed increasing efficiency with the fixed assets they employ. Grain, diversified and sugar cooperatives had a drop in their average fixed asset turnover. Lower sales were the main cause for the decline in the grain and diversified cooperatives, while building excess capacity in a heavily capitalized industry caused the sugar cooperatives' ratio to fall.Figures 5-7
Profitability ratios measure the power of the cooperative's earnings. With poor earnings, the cooperative may soon find that it cannot meet its obligations and be forced out of business. However, cooperatives can have other objectives than to accumulate high returns. The nature of a cooperative is to fill a market need of its members. Therefore, profitability ratios
can and usually are lower than investor-owned firms. However, comparisons of the same cooperative or group of cooperatives, over time, can be very informative. The four profitability ratios used in this report include gross margin percent, net operating margins, return on total assets, and return on member equity.
Gross margins are the excess of revenues above the cost of goods sold. All operating and nonoperating expenses plus payment of patronage refunds, dividends and income taxes must be covered by the gross margins. Gross margins also indicate the pricing policy of the cooperative. In other words, is the cooperative charging enough for the products sold or paying too much for member products to cover its expenses?
Figure 7 depicts the 5-year trend for the average gross margin percentage for the top 100 agricultural cooperatives. Following a gradual decline since 1994, gross profit margins leveled off to 12.9 percent in 1997.
Although cotton, farm supplies and rice cooperatives had higher revenues, they also had higher costs for those revenues, resulting in lower gross margins. Cotton cooperatives had declining margins every year during the 5-year period, from a high of 18.4 percent in 1993 to 11.6 percent in 1997. Gross margins for farm supply cooperatives fell from 13.4 percent in 1996 to 12.5 percent in 1997. Rice cooperatives dropped from 30.2 percent to 27.5 percent during the same period. Sugar cooperatives had higher sales and gross margins but as a percent of total revenues, gross margins fell from 22.8 percent to 22.3 percent.Figure 8
The increases in the gross margin percentage of the dairy, grain, poultry/livestock, and fruit/vegetable cooperatives helped keep the overall average percentage from dropping. Grain had the highest average increase, moving from 7.5 percent in 1996 to 8.5 percent in 1997. The other three commodity groups had small increases.
Net operating margin looks at the amount of margins generated by operations, expressed as a percent of total revenue. It is calculated by taking the gross margin, less operating expenses, and dividing that by total revenue. Indirect expense items (patronage refunds, interest income/expense, gains/losses on the sale of assets, and any other extraordinary revenues or expenses not directly related to operations) are not included in the calculation. Figure 8 shows net operating margins for the past 5 years.
Despite overall lower revenues and higher expenses in 1997, cooperatives were able to keep their average net operating margins at 2.1 percent of total revenues, the same as in 1996. With the exception of rice and sugar cooperatives, the movement in the net operating margins pretty much followed the same path as that of gross margins. This would indicate that, on average, cooperatives were able to keep their costs in line with their revenues. Rice and sugar cooperatives, on the other hand, were able to lower their costs while increasing their revenues.
Return on total assets is calculated by taking net income before taxes and interest, divided by total assets. This ratio looks at the return on total investment in the cooperative. After a brief drop in 1996, the average return on total assets inched up from 7.2 percent to 7.3 percent in 1997. What is interesting about this ratio is that most of the increase in assets during 1997 occurred in investments. These included joint ventures with cooperatives and noncooperatives alike. It would seem the alliances that the largest cooperatives are involved with are increasing the returns to the cooperatives.
Pushing the increase were the dairy, grain, fruit/vegetable, poultry/livestock and sugar cooperatives. Grain cooperatives, coupled with a smaller asset base and higher margins, pushed their average ratio from 6.4 to 7.8 in 1997, the highest increase of any commodity group. Dairy and sugar cooperatives showed a larger increase in revenues compared to assets for most of those cooperatives involved, thus pushing up their ratio.
Diversified cooperatives had the largest decline, dropping from 8.5 to 6.8 in 1997. This commodity group had a tremendous increase in its asset base. Unfortunately, it was met with decreased margins. Cotton cooperatives also had a substantial decline in their average return on total assets. However, their decline was due mostly to lower margins. The drop in farm supply cooperatives' average ratio was due to a larger increase in their asset base than their revenues.Figure 9
The last ratio compared in this report is the return on member equity. It is calculated by dividing the net margins after interest and taxes by total member equity Interest is a return to creditors and taxes are a return to government, so interest and taxes should be excluded to arrive at the true return on equity. What is interesting about this ratio is that, despite the wide fluctuations between the different years for each cooperative, the average return on member equity for all top 100 cooperatives has remained steady at between 11 percent and 12 percent (Figure 9).
Cotton, diversified and farm supply cooperatives had substantial declines in their average return on member equity ratios. Much of this decline is attributed to higher leverage coupled with declining margins. Sugar cooperatives ended the year with a net loss, due mostly to higher interest payments. Fruit/vegetable, grain and poultry/livestock cooperatives al1 averaged a higher return on member equity. Fruit/vegetable and grain cooperatives had tremendous increases in their net revenue along with lower debt and interest payments that pushed up their returns on member equity.
Poultry/livestock cooperatives, on the other hand, show where leverage pays off. Despite the higher amount of debt, the cooperatives were able to get a higher return from their operations, compared to the cost of the added debt. Dairy and rice cooperatives had relatively small declines in their return on member equity ratio.
Last year, the big question facing the largest cooperatives was whether they were leveraging their future. Higher amounts of debt coupled with expansion could prove to be disastrous during a downturn in the agricultural economy. However, 1997 proved that cooperatives are proactive. While there was a drop in overall business, cooperatives moved to strengthen their position through mergers, acquisitions and strategic alliances. Several cooperatives underwent a capital restructuring that increased their liquidity. However, cooperatives are still carrying substantial amounts of debt. This can prove to be dangerous and is stil1 a point of concern, especially given the state of the agricultural economy in 1998.