How solid is the first financial line of defense for Canadian farms?
FCC’s Outlook for farm assets and debt 2017-18 provided a picture of the overall financial health of Canadian agriculture using Statistic Canada’s Balance Sheet of Agriculture. Industry financial ratios are indicative of trends, but do not reflect any one operation and are of limited use for benchmarking purposes.
Collaboration between Statistics Canada, FCC and a research analyst leveraged the 2015 Farm Financial Survey (FFS) to paint a more detailed picture of the financial health of Canadian agricultural operations. Throughout the next few weeks, we'll be sharing information to help put your farm financials into a larger context and make sense of key financial tools.
In this blog post I will look specifically at the liquidity position of Canadian agriculture. A key measure of liquidity is the current ratio, which measures a business' ability to meet financial obligations as they come due, without disrupting normal operations. That’s the first line of defense for an operation. It is computed by measuring current assets over current liabilities.
What does the current ratio tell you?
There are no hard rules about current ratios, but the financial literature suggests a ratio in the range of 1.5 - 3.0 is healthy. If an operation’s current ratio is greater than 3.0, it may not be using cash as efficiently as possible. A current ratio of 1 to 1.5 indicates a farm is technically liquid, but it could be exposed to financial challenges if market conditions worsen. A current ratio less than 1.0 means that a farm lacks the current assets to cover short-term liabilities.
Canadian farm operations are liquid
Overall, the liquidity position of Canadian agriculture is strong. Canadian farms had an average current ratio of 3.0 in 2015. The liquidity position is the strongest for grain and oilseed operations as well as poultry operations with current ratios of 3.6 and 3.0, respectively.
The average current ratio is the weakest for potato, dairy, and fruit operations at 1.8, 1.8, and 1.7, respectively. The average liquidity position of all other sectors is considered adequate as ratios are all above 1.5.
Where is some potential weakness in liquidity?
While the overall liquidity position of all sectors in Canadian agriculture is adequate, there are some underlying areas to monitor.
Data from the FFS reveals that nearly 80% of beef producers have a liquidity position greater than 2.0. This is not surprising as cattle prices were high in 2014 and first part of 2015. Strong demand for grain and oilseed, greenhouse vegetables, field vegetables, and poultry have supported strong liquidity in these sectors.
Operations where the current ratio is below 1.25 may not have sufficient working capital if there are disruptions in production or cash flow. Approximately 50% of both dairy and fruit operations have current ratios of less than 1.25 and point out liquidity as an area to monitor in the future. For sectors that have continuous production and predictable cash flows, such as dairy, it is not surprising that the average liquidity position is lower than sectors that only sell once per year.
Overall liquidity of Canadian farms was adequate in 2015. Evolution of commodity prices in the last 2 years is bound to have impacted the liquidity position of Canadian farms. Working capital remains the first line of defense for an operation when faced with challenging market conditions.
Does your operation have sufficient liquidity? It is important to work with your financial institution and accountant to ensure that you are well positioned to take advantages in the marketplace or protect against disruptions.
Craig joined FCC in 2009 as an Agricultural Economist, specializing in monitoring and analyzing the macroeconomic environment, modelling industry health, and providing industry risk analysis. Prior to FCC, he worked in the livestock branch of the Saskatchewan Ministry of Agriculture. Craig holds a Master of Agricultural Economics degree from the University of Saskatchewan.