On Solid Ground

Dave Chesnick
Economist, USDA/PBS Cooperative Services 

Ratio analysis can be an important tool for management to use when formulating a  cooperative's business plan. For example,  if ratio analysis indicates that average  inventory levels are declining for farm supply cooperatives nationally but your  cooperative's inventory levels are increasing, there is cause for concern.  Management will need to look closer at inventory control. The increase in  inventory may simply reflect greater demand for certain products, which means  inventory levels will have to increase to satisfy demand. On the other hand,  inventory levels could be increasing  because sales did not meet expectations.  In this case, management may need to re-examine marketing policy.

    Financial ratios are computed from an organization's income statement and  balance sheet. Financial ratios are  meaningful only when compared to  cooperative industry averages over a set  time period. Computing financial ratios is  similar to taking a snapshot because the  ratios reflect the fiscal status of a  cooperative at just one point in time.  Comparing ratios to industry averages is  essential for uncovering positive and  negative trends affecting your  cooperative business. Trend analysis is  an excellent way to identify a  cooperative's strengths and weaknesses.

    This report examines some key  financial ratios, based on a 1994 survey  conducted by USDA Cooperative  Services of 603 agricultural cooperatives.  It provides a broader look at many of the  same ratios examined for the TOP 100  cooperatives in the November issue of  "Farmer Cooperatives," with the emphasis  on smaller cooperatives (see table 2 for a  breakdown, by size, of the cooperatives  included in this analysis). The objective is  to provide local cooperatives with a basis  to compare their operations to industry  averages. The ratios examined below include growth, liquidity,  leverage, activity and profitability.

    Overall, this analysis shows that  cooperatives appear to be positioning  themselves quite well for the future. The  tough times in the late 1980s forced many  cooperatives to either go out of business or  merge with other cooperatives.  Cooperatives that survived are in better  financial condition today to serve their  members. However, this is no time to  relax. Competition will force cooperatives  to manage their assets and liabilities better and to continue to streamline their operations for a more efficient cooperative.

    Table 1 briefly describes what each ratio is and how it is calculated. Local cooperatives should consider plotting their own values against these industry averages for insight into the fiscal strength of their own organization.

    To further help managers and board members compare key ratios with similar ratios, cooperatives are grouped into different sizes and types. The four sizes are based on sales volume. Financial data are actual; no attempt was made to deflate values. Table 2 lists the classification for size. To account for differences in operations and orientation based on product mix, cooperatives are also grouped into one of four descriptive categories for cooperative type. Table 3 presents the various categories for cooperative type. These descriptions are chosen to represent business operations of these cooperatives as closely as possible. Tables 4 through 7 present ratios for each type by size for 1994.

Growth Ratios

    · Sales—Farm supply sales in 1994 were the highest in 10 years, on average, for cooperatives within this study. Average supply sales topped $5 million for the first time, an increase of over 5 percent from the prior year. Marketing sales, on the other hand, were down nearly 15 percent from 1993. Service income was also off 20 percent from the prior year. The cumulative effect of these changes are illustrated in figure 1. The average total sales and services for cooperatives were down nearly $750,000 from 1993, an annual percentage decline of 6.4 percent.

    · Net Income—The drop in sales, however, was not all bad news. Net income average also reached a 10-year high. Interest income, patronage refunds and other income all showed an increase over prior years. Cooperatives also trimmed 1.4 percent off of their expenses. All these changes resulted in a 1 percent increase in net income to $231,446.

    · Assets: Figure 2 shows the tremendous increases in assets in the early 1990s. With inventories nearly doubling and fixed assets increasing by over two-thirds, the average amount of total assets increased by just under 75 percent from 1990 to 1994. However, in 1994 total assets declined by about 4.25 percent. This decline was attributed almost entirely to a decline in inventories, especially grain inventories. While farm supplies remained unchanged from the prior year, grain inventories dropped 27 percent.

Liquidity Ratios

    · Current ratio—Since 1990, the current ratio has been trending downward. In 1994, this trend reversed itself (figure 3). Despite the decrease in current assets, the current ratio increased slightly from 1993 to 1994. Current liabilities had a higher percentage decrease then the current assets. The drop in current assets was due to lower grain inventories. This decline in grain inventory also pushed down the grain accounts payable. However, this was not the only current liability to decrease. Cooperatives also transferred some of their debt from short-term to long-term, thereby causing a higher decrease in current liabilities vs. current assets. All other current assets and liabilities remained relatively stable. Cooperatives need to  strive  to maintain current ratio above  1.

    · Quick ratio—Although not as   apparent, figure 3 also shows that the   quick ratio increased faster than the   current ratio. All other current assets   included in this ratio remained  relatively  stable. Declining short-term  debt and  accounts payable for grain  cooperatives  caused current liabilities  to decline 13  percent. Therefore, the  quick ratio showed  a relatively  substantial increase between  1993  and 1994. While this ratio is low (i.e.,   less than 1), there is no real rule of  thumb  to follow. However, some  inventories,  such as grain, can be  more liquid than  some accounts  receivable. Therefore,  cooperatives  should strive to manage  their current  position so that they and  their  creditors feel comfortable.

Table 4 - Financial ratios for marketing by cooperative size, 1994

Item	Small	Medium	Large	Super
	Ratios
Current	2.13	1.40	1.25	1.16
Quick	1.33	0.62	0.55	0.52
Debt-to-assets	0.18	0.18	0.26	0.24
Debt-to-equity	0.03	0.11	0.12	0.20
Times-interest-earned	8.76	3.59	2.88	2.95
Total asset turnover	2.78	2.61	2.67	2.76
Fixed asset turnover	13.94	12.02	10.98	10.83
	Percent
Gross profit margin	6.68	5.28	5.42	6.37
Return on total assets before interest and taxes	7.04	4.07	5.14	5.51
Return on allocated equity	10.99	7.19	9.48	11.11
	Million dollars
Average sales volume	3.38	7.76	14.38	40.45
Average total assets	1.22	2.98	5.39	14.64

Table 5 - Financial ratios for mixed marketing by cooperative size, 1994

Item	Small	Medium	Large	Super
	Ratios
Current	1.80	1.59	1.32	1.24
Quick	0.73	0.72	0.56	0.56
Debt-to-assets	0.19	0.23	0.29	0.27
Debt-to-equity	0.07	0.09	0.15	0.18
Times-interest-earned	3.96	3.79	2.87	3.21
Total asset turnover	2.24	2.48	2.44	2.49
Fixed asset turnover	10.82	9.82	8.66	9.60
	Percent
Gross profit margin	8.95	7.57	7.93	8.14
Return on total assets before interest and taxes	4.85	6.05	5.89	6.54
Return on allocated equity	8.18	10.20	10.34	12.37
	Million dollars
Average sales volume	3.24	7.24	14.47	34.32
Average total assets	1.45	2.92	5.93	13.78

Table 6 - Financial ratios for mixed farm supply by cooperative size, 1994

Item	Small	Medium	Large	Super
	Ratios
Current	2.11	1.73	1.53	1.47
Quick	1.12	1.00	0.79	0.74
Debt-to-assets	0.18	0.24	0.24	0.21
Debt-to-equity	0.09	0.15	0.15	0.11
Times-interest-earned	3.35	4.69	4.24	4.78
Total asset turnover	2.21	2.06	2.27	2.36
Fixed asset turnover	9.82	7.45	8.06	7.80
	Percent
Gross profit margin	12.99	14.33	15.03	14.59
Return on total assets before interest and taxes	4.60	7.58	7.38	8.82
Return on allocated equity	6.57	11.64	11.54	14.45
	Million dollars
Average sales volume	2.78	7.36	13.27	27.13
Average total assets	1.26	3.58	5.85	11.51

Table 7 - Financial ratios for farm supply by cooperative size, 1994

Item	Small	Medium	Large	Super
	Ratios
Current	2.26	1.97	1.70
Quick	1.29	1.07	0.86
Debt-to-assets	0.19	0.21	0.20
Debt-to-equity	0.11	0.14	0.12
Times-interest-earned	7.88	7.29	7.69
Total asset turnover	1.76	1.82	2.08
Fixed asset turnover	8.12	7.23	7.99
	Percent
Gross profit margin	17.28	17.92	18.55
Return on total assets before interest and taxes	9.01	10.08	10.78
Return on allocated equity	13.32	14.89	18.24
	Million dollars
Average sales volume	2.39	6.92	13.19
Average total assets	1.36	3.81	6.33

Debt Ratios

    · Total debt-to-assets ratio—The   average amount of total debt  outstanding  for cooperatives fell  slightly from 1993 to  1994. However,  average total assets  declined at a faster rate throughout the  same  period. As mentioned earlier, lower grain inventories were the main cause for the drop in assets. The result is a small decline in the total-debt to  total-asset ratio. Cooperatives should strive to  maintain a ratio similar to the  average illustrated in figure 4 (between  .2 and .4).  A high ratio will indicate  high amounts of debt and a bad year could mean trouble for the cooperative if it  fails to meet its interest obligations. A low  ratio is safe, but the members are financing most of the cooperative's operations and may be able to improve their return with a little  more debt. Nevertheless, each cooperative must access their own needs and situation and  determine where they want to be.

    · Long-term debt-to-equity ratio—  Throughout the 1980s, cooperatives were  changing the long-term structure of financing.  Since that time, there has been little change in  their long-term capital structure. Figure 5  illustrates this point as cooperatives began  using more equity to finance operations. This  resulted in a dramatic decline in this ratio until 1990, at which time the ratio of long-term debt  to equity has slowly inched upwards. Again, cooperatives need to examine their own  situation. If the cost of borrowing capital is high, cooperatives may find it advantageous to rely more on member equity than debt to finance operations. Using more debt when  interest rates are low could increase return on  members' investment. It is interesting to note  that the average amount of fixed assets  increased dramatically from 1990 to 1992.  Yet, during this period, the capital structure  did not change much.

    · Times-interest-earned  ratio—Cooperatives should try to obtain a  high times interest-earned (TIE) ratio. Higher  interest expense in 1994 lowered the ratio from  the 10-year high in 1993. However, figure  6 shows that the average ratio was still  slightly above 4:1. A ratio substantially  greater than 1:1 indicates cooperative  have a strong ability to pay the interest  on their debt. A lending institution will be  more willing to work with a cooperative in  this situation and might even charge  lower interest. A ratio of less than 1  means the cooperative will have problems  paying off its interest expense and might  have to start reducing its equity accounts  to cover the interest charges.  Cooperatives with a low TIE ratio might  have problems acquiring additional  borrowed funds.

Activity Ratios

    · Fixed asset turnover—Many factors  can affect the fixed asset turnover (FAT)  ratio. For example, the fixed assets  (property, plant and equipment) could be  old and close to fully depreciated, which  could inflate the FAT ratio. Even though  the ratio is high, maintenance costs to keep  the equipment running could be  excessive, lowering the overall  performance of the cooperative. On the  other hand, if the cooperative determines  that a larger production capacity is  needed in the future, it could immediately  begin building excess capacity. Generally,  fixed assets do not increase gradually over time; rather, they increase in "big  chunks." The excess capacity from, for example, plant expansion will temporarily  deflate the ratio until the plant reaches full  utilization. Therefore, care must be taken  when looking at changes in the value of  the ratio. For the average cooperative, the ratio value has been near 9:1 since 1988.  Figure 7 shows both the fixed and total asset turnover ratios.

    · Total asset turnover—Similar to  FAT, total asset turnover (TAT) can be  affected by many factors. Sharp changes in TAT value should be examined  carefully to determine if the change is  good or detrimental to the cooperative.  Over the past three years the average  value was near 2.5:1. However, this value  is down substantially from the mid- to  late-1980s, when the ratio reached 5.75:1.

Profitability Ratios

    · Gross Profit Margins—Gross profit margins in 1994 continued the upward  trend that began in 1989. Perhaps the greatest influence on the average gross  profit margin is the amount of farm supplies sold in relation to members products marketed. Farm supplies yield higher margins than do marketing sales of farm crops. The average farm supply margins in 1994 was 17 percent compared  to 4 percent for crop and livestock marketing. Not only is there a marked  variance between marketing and farm supply margins, there is also variance  among the farm supplies within each product category. Cooperative managers  should keep detailed records for each type of product and evaluate the changes  from year to year.

    · Return on total assets—The return on total assets (ROTA) provides the  cooperative with another measure on how efficiently a cooperatives uses its assets.  However, this ratio looks at the whole operation, not just sales. Net income  before interest and taxes is used to calculate ROTA because the goal is to  reveal total return on assets. Interest is a return to lenders while taxes can be  thought of as return to government  investment. Figure 9 illustrates the  historical movement of ROTA over the past few years. The average net income  generated from use of the cooperatives assets in 1994 was 7.2 percent. This  continues an upward trend following a near 10-year low of 6.5 percent in 1992.  However, it is not as high as it was in the late 1980s, when it averaged well over 8  percent.

    · Return on allocated equity—Since  this ratio looks at returns on member  investment only, it is determined by calculating net income after interest and  taxes. As is evident in figure 9, this ratio tends to fluctuate widely. When net  income is high, cooperatives generally revolve equity back to members. This  pushes the value up, as happened in the late 1980s. Low returns pull down the  ratio. Between 1993 and 1994, the return on allocated equity remained steady.  Returns that are too low might restrict the cooperatives cash flow.

    Although there is a tremendous amount of variance among cooperatives, most are showing financial strength to carry them into the 21st Century. Cooperatives need to keep track of their performance in relation to the industry. Thus, when there is a change in performance, managers and board members will be able to take corrective action to enhance the performance of the business and ensure its long-term viability.