Capital Turnover Drives Profits

Recently I was a co-instructor at the South Dakota Advanced Agrilender School. Bob Craven, University of Minnesota, made an interesting point. A recent study at their university found that the capital turnover variable was the single most important ratio to predicting farm profits.

This ratio is derived by finding your total farm assets from the balance sheet and dividing farm revenue into that figure. For example, if you had $1 million of land and $500,000 in yearly revenue, the ratio would be 50%. This figure divided into one would indicate the farm turns its capital every two years.

The higher the percentage, the quicker the turn of capital. Farm and ranch businesses that rent or lease turn their capital faster, contrasted with those who own most of the asset base that turn at a slower rate.

Combine this indicator with your profit margin and you get your return on assets. For example, if a producer had a 15% profit margin and a 50% capital turnover ratio, the return on assets would be 7.5%, which is excellent in today’s world.

Click here for an illustration of this calculation.
(This requires Adobe Acrobat Reader, download at: www.adobe.com.)

The bottom line is to keep overhead in your asset base low and work on your profit margin so you can be globally competitive.

Side Note Mr. Greenspan indicated that we have a pension challenge on the horizon in Social Security. This could spill over into private and public organizations as well.

My e-mail address is:sullylab@vt.edu

Editors' note: Dave Kohl, The Corn and Soybean Digest Trends Editor, is an ag economist specializing in business management and ag finance. He recently retired from Virginia Tech, but continues to conduct applied research and travel extensively in the U.S. and Canada, teaching ag and banking seminars and speaking to producer and agribusiness groups.

To see Dave Kohl's previous road warrior adventures type Dave Kohl in the Search blank at the top of the page.

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