layout4

United States

Department of

Agriculture

Rural Business–

Cooperative

Service

RBS Research

Report 175

Financial Management

and Ratio Analysis for

Cooperative Enterprises

Abstract

This study discusses dif ferences in ﬁ nancial management and goals between the

investor-oriented ﬁ rms and cooperatives. It brieﬂ y reviews what bankers look for when

appraising potential borrowers. A summary of standard ﬁ nancial ratios used to analyze

a variety of business structures is included, along with other modiﬁ ed ratios to address

deﬁ ciencies evident in standard ratios.

Key words: Cooperatives, ﬁ nancial ratio, liquidity , leverage, activity , proﬁ tability.

Financial Management and Ratio Analysis For Cooperative Enterprises

David S. Chesnick

Rural Business-Cooperative Service

U.S. Department of Agriculture

Research Report 175

January 2000

Price: Domestic — $5.00

Foreign — $5.50

Preface

Several unique ﬁ nancial characteristics dif ferentiate a cooperative from an investor-ori -

ented ﬁ rm (IOF). When evaluating the cooperative’ s performance, comparing a coop -

erative’ s ﬁ nancial position with an IOF can be misleading for those unfamiliar with

these characteristics. This report was written to help boards and managers assess the

ﬁnancial performance of their cooperatives and to familiarize potential creditors with

the unique ﬁ nancial characteristics and performance of cooperatives.

This study discusses the dif ferences in ﬁ nancial management and goals of coopera -

tives versus IOFs. It starts by discussing the contents of the various cooperative ﬁ n an -

cial statements and follows with a view of common sizing statements for analysis.

Next, it reviews the usefulness of standard ﬁ nancial ratios applied to the cooperative

framework. A brief review shows what lenders look for when analyzing potential bor -

rowers. Finally, ﬁ nancial ratios are developed to build on these standards with an eye

toward a comprehensive understanding of a cooperative s performance. Ratios will be

related to data during the last 18 years from the largest agricultural cooperatives.

Contents

Preface . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .i

Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .1

Financial Statements . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .2

Financial Statement Analysis . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .4

Common-size Statements . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .6

Analysis of Cash Flow . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .8

Ratio Analysis . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .9

Standard Financial Ratios . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .11

Interdependence of Ratios . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .11

Trends over Time . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .12

Ratios for Cooperatives . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .12

Data . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .13

Conversion Period of Inventories . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .13

Payout Ratio . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .14

Capitalization Growth Rate . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .14

Proﬁt Index . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .15

Local Return on Local Assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .15

Earnings Variability . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .16

Income Quality Ratio . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .16

Cash Interest Coverage Ratio . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .17

Conclusion . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .17

Bibliography . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .18

Contents

Financial Management and Ratio Analysis

for Cooperative Enterprises

David S. Chesnick

RBS Agricultural Economist

Introduction

An analyst must have a clear understanding of

the firm’s objectives to ef fectively measur e its business

performance and management. In most financial text -

books, the objective of a company is maximizing the

value of the owner ’s inter est in the firm. For the

investor -oriented firm (IOF), the firm’s value depends

on earnings used to r eward investors and to r einvest in

pr oductive assets that will generate futur e earnings.

The inter dependence of a firm’s value and its

earnings has led to the theory of pr ofit maximization.

The firm seeks optimum current and futur e earnings.

This ensur es that the long-r un r eturn for investors is

maximized through incr eased r eturns and the firm’s

appreciating stock value.

On the other hand, cooperatives have goals other

than generating dir ect pr ofits for their members. Thus,

in the cooperative envir onment, the inter dependence

giving rise to the theory of pr ofit maximization gener -

ally will not hold tr ue. In a cooperative, owners ar e the

primary users. Cooperatives have objectives other than

generating dir ect pr ofits for its owners. These unique

objectives may cause operational decisions made by

cooperative managers and directors to sometimes dif -

fer from those made by management of IOFs.

Investment in a cooperative is primarily based on

investors use of it. Appr eciation in the value of mem -

bers equity is not common. Additionally, legal r equir e-

ments often limit dividends paid on cooperative stock.

As a r esult, the traditional theory of the firm does not

fully hold in the cooperative envir onment. Profit maxi -

mization translates into neither gr eater dividend

streams nor appreciated value of the member ’s coop -

erative investment.

Why then would a producer invest in a coopera -

tive? Why would someone be willing to give up access

to these funds without the traditional investment

incentives? The unique natur e of the cooperative

owner/user relationship weakens this theory of pr ofit

maximization. Benefits of ownership ar e not gained

from the appreciation of the cooperative stock value,

but fr om assured access to competitively priced sup -

plies, assur ed pr oduct market thr ough the cooperative,

or simply access to goods and services not available

elsewhere.

T o further illustrate the dif fer ent functions

between the cooperative and IOF, consider this exam -

ple of a simplified income statement:

Sales

Less Cost of goods sold

———————————

Equals Gross Margin

Less Operating expenses

———————————

Equals Profits

Assuming a cooperative and an IOF have identi -

cal operating expenses, pr ofit for each is achieved by

maximizing the gross margin. If one assumes a com -

petitive external market, then the cooperative and the

IOF must take the price each r eceives as given, and,

ther efor e, can incr ease gr oss margins only by r educing

cost of goods sold (COGS). The IOF’s function is to

return more to the investors, ther eby trying to lower

the COGS and increase the pr ofits.

In a marketing cooperative, the COGS lar gely

represents payments to the member/owners for prod -

ucts marketed thr ough the cooperative. Ther efor e, the

cooperative seeks to r eturn the highest amount to the

member, through higher COGS and lower “profits.”

In a farm supply cooperative, sales lar gely r epr e-

sent purchases by the member/owner for product

received fr om the cooperative. Again, assuming com-

petitive external markets, both the cooperative and the

IOF must take the price at which it pur chases the pr o d -

uct for r esale as given (i.e., COGS is given). Ther efor e,

gr oss mar gins can be incr eased only by raising the

sales price placed on farm supply pr oducts. While this

is sound business for an IOF, the cooperative seeks to

limit these prices for its members, ther eby r educing

pr ofits.

Another concern facing cooperatives is the tr eat -

ment of equity. Under most cir cumstances, equity is

risk capital and usually consider ed permanent in IOFs.

On the other hand, Cobia and Br ewer claim that much

of cooperative equity is temporary because coopera -

tives have an implied obligation to r edeem it.

However, the equity is not temporary. Rather , it is

dynamic. Boards generally try to maintain an equity

base, but those who use the cooperative and own that

equity may change fr om year to year depending on the

use of it.

Fr om an analytical point of view, the most signifi -

cant information in the equity section of the balance

sheet r elates to the composition of the capital accounts

and to r estrictions. The analyst must know how to

reconstr uct and to explain changes in the capital

accounts, especially with cooperatives.

An analysis of r estrictions imposed on the distri -

bution of equity usually sheds light on the coopera -

tive’s fr eedom of action in such ar eas as patr onage dis -

tributions and levels of working capital. Such

restrictions also note the cooperative’s bar gaining

str ength and standing in the cr edit markets. Mor eover,

a car eful r eading of the covenants will enable the ana -

lyst to assess the potential for default.

Financial Statements

A brief r eview of cooperative financial statements

is warranted befor e starting a discussion of financial

analysis. Financial statements pr ovide certain basic

information that focuses on the entity as a whole and

meets the common needs of external users. Thr ee main

financial statements ar e r equir ed fr om businesses—a

statement of financial position (balance sheet), a state -

ment of activities (operating statement), and a state -

ment of cash flows.

The balance sheet states the cooperative’s assets,

liabilities, and members equity as of a particular date,

for example, as of Dec. 31, 2001. Asset values ar e usu -

ally stated at historical cost (what the cooperative paid

for it). However, some accounting standar ds pr escribe

using curr ent market values for specific assets.

The stated liabilities indicate the amount owed

and ar e stated at cost. Members’ equity is the dif fer-

ence between assets and liabilities. The balance sheet

of Farmer Cooperative is shown in table 1 . Notice that

cooperative equity is divided into allocated and unal -

located portions. Allocated equity is owned by specific

members. Unallocated equity is not earmarked for spe -

cific members and is used as a general r eserve.

The operating statement (table 2) reveals a coop -

erative’s performance during a particular period of

time, such as the fiscal year ending Dec. 31, 2001. It

reports r evenues fr om sales, services, and patr onage

refunds r eceived fr om other cooperatives. It also

includes various costs, including the cost of goods

sold, general and administrative expenses, inter est

expenses, and taxes. Some marketing cooperatives

report the r esults of their commodity pools in the oper -

ating statement.

The Statement of Cash Flows (SCF) indicates cash

receipts and cash disbursements during the accounting

year. The SCF summarizes the operating, investing,

and financing activities of a business enterprise during

an accounting period and completes the disclosur e of

changes in financial position that ar en’t r eadily appar -

ent in comparative balance sheets and income state -

ments ( table 3 ).

The SCF complements the financial description of

a business when used in conjunction with the operat -

ing statement and balance sheet. Looking at annual

“tr ends” of cash flows over several years enhances the

analysis. The SCF pr esents “pur e cash flow” informa -

tion that sometimes is dif ficult to glean fr om the other

statements.

Decisions that might not af fect the long-r un abili -

ty of the firm to generate a positive net income may

af fect the cash flow information disclosed for a partic -

ular period. The net cash flow fr om operations, how-

ever, shouldn’t be viewed as a substitute for net

income. Both the cash and accr ual descriptions of

events ar e important, and the inclusion of an SCF

ensures that both will be available for the assessment

of the futur e cash flow and income potential of the

cooperative.

One additional financial statement is fr equently

available in the annual r eports issued by cooperatives.

The Statement of Changes in Members Equity (table 4)

describes how various equity accounts ar e af fected

Table 1—Farmer Cooperative’s balance sheet for years ended Dec. 31, 2000 and 2001

Assets 2001 2000

Dollars

Current assets

Cash and equivalents 113 7

Accounts receivable 12,092 13,511

Inventories 21,825 20,805

Other current assets 333 274

______ ______

Total Current Assets 34,364 34,596

Investments

Bank for Cooperatives 3,679 3,225

Other cooperatives 505 443

Other businesses 0 0

Other investments 0 0

______ ______

Total Investments 4,184 3,668

Net plant, property and equipment 22,424 19,086

Other assets 312 301

______ ______

Total Assets 61,283 57,652

Liabilities and Members Equity

Current liabilities

Current portion long-term debt 1,246 1,783

Seasonal notes and loans 8 9,188

______ ______

Total Short-term Liabilities 1,254 10,971

Trade accounts payable 20,359 13,234

Cash payments to members 2,477 738

Patron and pool liabilities 0 0

Other current liabilities 2,001 1,054

______ ______

Total Current Liabilities 26,091 25,998

Long-term Debt 10,677 9,927

Other Non-current Liabilities 0 0

Minority Interests 0 0

Members’ Equity

Allocated

Preferred stock 288 320

Common stock 89 90

Equity certiﬁ cates 22,387 19,589

Unallocated capital 1,751 1,728

______ ______

Total Member Equity 24,515 21,727

______ ______

Total Liabilities and Equity 61,283 57,652

during the business cycle. Cooperatives generate equi -

ty fr om several sour ces, including net income, issuance

of stock, and per -unit capital r etains.

Financial Statement Analysis

The amount of information contained in a coop -

erative’s financial statements is voluminous, spanning

the cooperative’s internal operations, its r elationship

with the outside world, and its r elationship with its

member/patrons. To be useful, this information must

be organized into an understandable, coher ent, and

suf ficiently limited set of data. Financial statement

analysis can be beneficial in this r espect because it

highlights a firm’s str engths and weaknesses.

Data fr om a cooperative’s financial statements

reveal the company’s financial condition. Examining

common-size statements, cash flows, and financial

ratios pr ovides management, members, and creditors a

glimpse of the cooperative’s str engths and weaknesses.

The value of a particular ratio compar ed with a tar get

range of values indicates the firm’s financial health,

and also identifies potential pr oblem ar eas. Analysis

can also indicate ar eas of mismanagement and poten -

tial danger.

As with all analytical methods, common-size

statements, cash flow data, and financial ratios must

be used in the light of other r elevant facts. Also, the

analyst must r emember that financial statements ar e a

“snapshot” of a firm at a particular point in the past. In

a highly seasonal industry, conclusions drawn thr ough

Table 2—Farmer Cooperative’s operating statement for years ended Dec. 31, 2001 and 2000

2001 2000

Dollars

Revenues

Marketing sales 73,513 76,700

Farm supply sales 46,710 46,053

______ ______

Total Sales 120,223 122,753

Cost of sales 98,474 106,057

______ ______

Gross Margin 21,749 16,695

Other operating revenues 0 0

______ ______

Total Operating Revenue 21,749 16,695

Expenses:

General and administrative 11,850 10,263

Operating 2,759 2,836

______ ______

Net Operating Income 7,139 3,596

Other Revenues (expenses):

Patronage refunds received 483 348

Interest income 162 120

Other income 31 107

Interest expense (1,493) (2,095)

Other expenses 0 0

______ ______

Net Income, Continuing Operations 6,322 2,076

Other margin interests 0 0

Discontinued operations 0 0

Extraordinary items 0 0

______ ______

Net Income Before Taxes 6,322 2,076

Taxes 8 35

______ ______

Net Income to be Distributed 6,314 2,041

Table 3—Farmer Cooperative’s statement of cash ﬂows for years ended Dec. 31, 2001, and 2000

Adjustments to reconcile net margins to net cash ﬂ ows from operating activities

——————————————————————————————————————

2001 2000

Dollars

Net Margins From Operations 6,314 2,041

Depreciation and amortization 2,759 2,836

Deferred taxes 0 0

Loss (Gain) from asset disposal 7 (74)

Loss (Gain) from investment disposal 0 0

Patronage refunds received, (non-cash) (232) (221)

Other cash adjustments 0 0

Other non-cash operating adjustments 0 0

______ ______

Cash From Operating Activities 8,848 4,582

Cash Provided (Used) by Changes in Assets and Liabilities

Receivables 1,419 89

Inventories (1,022) 7,345

Other current assets (59) 8 8

Accounts pay 7,124 (4,188)

Due patrons 0 0

Other current liabilities 9 4 6 8 1

Other assets and liabilities 0 0

______ ______

Net Cash Flow Operations 17,256 7,997

______ ______

Net Cash Flow Discontinued Operations 0 0

______ ______

Net Cash Flow Operating Activities 17,256 7,997

Cash Flows From Investing Activities:

Purchases property, plant, and equipment (6,113) (4,162)

Proceeds sale or disposal PP&E 9 76

Purchases, equity in cooperatives (284) (1)

Redemptions equity in cooperatives 0 11

Change in other investing activities (9) 131

______ ______

Net Cash Flow Investing Activities (6,396) (3,946)

Cash Flow From Financing Activities:

Net change in short-term liabilities 0 0

Long-term bank debt

Proceeds 40,964 47,848

(Payments) (49,930) (49,858)

Capital lease payments 0 0

Stock transactions

Proceeds 3 1

(Redemptions) (36) (7)

Per-unit capital retains 0 0

Equity certiﬁ cates issued 0 0

Equity certiﬁ cates redeemed 0 0

Cash patronage refunds (1,732) (2,007)

Stock dividends (22) (28)

Other ﬁ nancing adjustments 0 0

______ ______

Net Cash Flow From Financing Activities (10,753) (4,051)

______ ______

Net Change Cash and Equivalents 106 0

Cash at Beginning of Year 7 7

______ ______

Cash at End of Year 113 7

Supplemental Information

Interest paid 1,697 2,056

Income taxes paid 26 (5)

ratio analysis might depend gr eatly on the period

being analyzed. Historical comparison adds to any

analysis.

Common-size Statements

When analyzing financial statements, it is helpful

to determine the pr oportion that a single account item

repr esents of a gr oup or subgroup total. This works

especially well for comparing various sizes of coopera -

tives. In a balance sheet, total assets is expr essed as 100

per cent. Each item in a common-size balance sheet is

expr essed as a per centage of the total assets. Similarly,

in the income statement, total net sales is set at 100

per cent and all other items ar e expr essed as a per cent -

age of net sales. Tables 5 and 6 illustrate the common-

size balance sheet and income statement for Farmer

Cooperative.

The analysis of common-size financial statements

may best be described as str uctural. In the analysis of

the balance sheet, the str uctural analysis focuses on

several important aspects. What is the capital str uctur e

of the cooperative? (E.g., how much of the coopera -

tive’s assets is financed by curr ent liabilities, long-term

liabilities, and member equity?) And what is the distri -

bution of the cooperative’s assets (curr ent, fixed, and

other)? Put another way, what is the mix of assets the

cooperative uses to conduct operations?

Common-sizing can also be used within sub -

gr oups on the financial statements. For example, it

may be of inter est to know both the per centage of cash

to curr ent assets as well as the per centage of cash to

total assets. Knowing both pr ovides a better under -

standing of the cooperative’s liquidity.

In the case of the income statement, common-size

analysis is a very useful tool, per haps more important

than the analysis of the common-size balance sheet.

The income statement lends itself to this form of analy -

sis. Each item in it is r elated to a central quantity, that

is, sales. W ith some exceptions, such as some adminis -

tration and over head, the level of each r evenue and

expense is dir ectly r elated to the level of sales. Thus, it

is instr uctive to know what pr oportion of the sales dol -

lar is absorbed by the various costs and expenses

incurr ed by the cooperative.

The use of common-size financial statements for

comparing cooperative financial performance over

time is valuable in focusing on changing pr oportions

of components within a gr oup of assets, liabilities, r ev -

enues, expenses, and other financial categories.

However, one must be car eful in interpr eting

changes. For example, the per centage of accounts

receivable to total assets could show an incr easing

tr end. Yet, the actual dollar value of accounts r eceiv -

able might be the same and the incr ease in the per cent -

age is caused by a decline in total assets, e.g., because

Table 4—Farmer Cooperative’s statement of changes in allocated patronage refunds and capital reserve for

years ended Dec. 31, 2001 and 2000

Unallocated Allocated

Equity Equity

Dollars

Balance - Dec. 31, 1999 1,567 19,701

Net Margins 2,041

Net Margins Allocated to Patrons (1,922) 1,922

Transfer 71 (71)

7% Dividend on Stock (29)

Patronage Distributions paind in cash

40 percent 2000 Patronage Refund (738)

Allocated Patronage Revolvement (1,225)

______ ______

Balance - Dec. 31, 2000 1,728 19,589

Net Margins 6,314

Net Margins Allocated to Patrons (6,253) 6,253

Transfer (16) 1 6

7% Dividend on Stock (22)

Patronage Distributions paind in cash

40 percent 2000 Patronage Refund (2,477)

Allocated Patronage Revolvement (993)

______ ______

Balance - Dec. 31, 2001 1,752 22,387

Table 5—Farmer Cooperative’s common size balance sheet for year ended Dec. 31, 2000 and 2001

Assets 2001 2000

Percent

Current assets

Cash and equivalents 0.2 0.0

Accounts receivable 19.7 23.4

Inventories 35.6 36.1

Other current assets 0.5 0.5

______ ______

Total Current Assets 56.1 60.0

Investments

Bank for Cooperatives 6.0 5.6

Other cooperatives 0.8 0.8

Other businesses 0.0 0.0

Other investments 0.0 0.0

______ ______

Total Investments 6.8 6.4

Net plant, property and equipment 36.6 33.1

Other assets 0.5 0.5

______ ______

Total Assets 100.0 100.0

Liabilities and Members Equity

Current liabilities

Current portion long-term debt 2.0 3.1

Seasonal notes and loans 0.0 15.9

______ ______

Total Short-term Liabilities 2.0 19.0

Trade accounts payable 33.2 23.0

Cash payments to members 4.0 1.3

Patron and pool liabilities 0.0 0.0

Other current liabilities 3.3 1.8

______ ______

Total Current Liabilities 42.6 45.1

Long-term Debt 17.4 17.2

Other Non-current Liabilities 0.0 0.0

Minority Interests 0.0 0.0

Members’ Equity

Allocated

Preferred stock 0.5 0.6

Common stock 0.1 0.2

Equity certiﬁ cates 36.5 34.0

Unallocated capital 2.9 3.0

______ ______

Total Member Equity 40.0 37.7

______ ______

Total Liabilities and Equity 100.0 100.0

of lower fixed assets or a write-of f of investments.

Because a pr oportion can change either in the absolute

amount of the item or in the total of the gr oup of

which it is a part, the interpr etation of a common-size

statement comparison requir es an examination of the

actual figur es and the basis on which they ar e comput-

ed.

Analysis of Cash Flow

While managers and financial of ficers know the

cash flow and earnings potential for their cooperative,

many potential cr editors might not. Most look at the

financial statements of the cooperative and pick out

specific information to determine if the cooperative

can r epay a loan.

For example, if inventory levels uncharacteristi -

cally incr ease without a corr esponding rise in sales, the

cr editor may per ceive the cooperative is in a less liquid

position—unaware the cooperative is pr eparing for

additional seasonal demand by purchasing early to

gain pr eseason discounts in the curr ent year . The

lender per ceives that the uncharacteristic incr ease is a

sign of old inventory left over fr om the prior season,

leading to obsolete goods and futur e sales losses.

In other situations, the loan of ficer may not have

a clear understand of the concept of pooling. The cr ed -

itor may see low pr ofitability ratios and deny the loan

because they do not believe the cooperative can gener -

ate enough r evenue. But a cooperative operating on a

pooling basis may show higher cost of goods sold

because of the way margins ar e distributed at the end

of the year.

It is imperative that the cooperative inform

lenders about the natur e of its business and the back -

Table 6—Farmer Cooperative’s common size operating statement for year ’s ended Dec. 31, 2001 and 2000

Assets 2001 2000

Percent

Revenues

Marketing sales 61.1 62.5

Farm supply sales 38.9 37.5

______ ______

Total Sales 100.0 100.0

Cost of sales 81.9 86.4

Gross Margin 18.1 13.6

Other operating revenues 0.0 0.0

______ ______

Total Operating Revenue 18.1 13.6

Expenses:

General and administrative 9.9 8.4

______ ______

Operating 2.3 2.3

Net Operating Income 5.9 2.9

Other Revenues (expenses):

Patronage refunds received 0.4 0.3

Interest income 0.1 0.1

Other income 0.0 0.1

Interest expense (1.2) (1.7)

Other expenses 0.0 0.0

______ ______

Net Income, Continuing Operations 5.3 1.7

Other margin interests 0.0 0.0

Discontinued operations 0.0 0.0

Extraordinary items 0.0 0.0

______ ______

Net Income Before Taxes 5.3 1.7

Taxes 0.0 0.0

______ ______

Net Income to be Distributed 5.3 1.7

gr ound behind sudden changes in financial position. If

left to an inexperienced or uninformed lender, the

cooperative may not r eceive its anticipated loan.

There are several key cash-r elated early warning

signs of financial dif ficulties. In addition to looking at

ratios, lenders often look at changes in various

accounts over time. They want to see if ther e ar e any

major changes or slow er osions taking place. In other

w o r ds, is the liquidity of the cooperative going to be a

problem befor e the loan is r epaid? Bankers look for

early warning signs, including: continued r eliance on a

line of cr edit, over drafts, incr eases in inventory and/or

receivables, patr onage r efunds and other payments to

members greater than earnings, and a history of poor

cash flow fr om operations. Most of these changes ar e

evident or can be determined fr om the SCF.

The SCF sheds light on the ef fects earning activi -

ties have on cash r esour ces and financing of the coop -

erative. It helps clarify the distinction between “r eport -

ed net income” and “cash pr ovided by operations”

—two differ ent concepts. Net income can be mislead -

ing because it is influenced by several estimated val -

ues (i.e., depr eciation schedules, bad debt expense,

and inventory valuation). Cash flow is “r eal cash”

flowing in and out due to operations, investing, and

financing activities. Consequently, cash flow should

never be confused with net income.

The ability of an enterprise to consistently gener -

ate cash fr om operations is an important indicator of

financial health. No cooperative can survive the long

term without generating cash fr om operations. While a

cooperative can inflate cash flows thr ough both financ -

ing and investment, operations must keep the coopera -

tive financially viable in the long r un. The interpr eta -

tion of cash flow fr om operations and r elated tr ends

must be made with care and a full understanding of all

circumstances.

Prosperous as well as failing entities may find

themselves unable to generate cash fr om operations at

any given time, but for dif fer ent r easons. The entity

caught in the pr osperity squeeze of having to invest its

cash in r eceivables and inventories to meet ever -

incr easing customer demand will often find that its

pr ofitability will facilitate financing by equity and

debt. That same pr ofitability should, ultimately, turn

cash flow fr om operations into a positive figur e.

The unsuccessful entity might find its cash

drained by slowdowns in receivables and inventory

turnovers, by operating losses, or by a combination of

these factors. These conditions usually contain the

seeds of further losses and cash drains that may even -

tually lead to the drying up of trade cr edit. In such

cases, a lack of cash flow fr om operations has a dif fer-

ent implication.

The next SCF category is cash flows fr om invest -

ing activities. Most businesses must r einvest cash in

or der to r emain viable. The lar gest cash flows fr o m

investments, by far, ar e those in pr operty, plant, and

equipment (PP&E). For the past 5 years, PP&E pur -

chases r epr esented 92 per cent of total cash outlays for

investments of the lar gest 100 agricultural coopera -

tives. Cash flow fr om investing activities generally is

negative, but not always. If a cooperative sells capital

assets or r eceives significant patr onage r efunds, the

value could be positive. However, a cooperative that

resorts to selling capital assets or pr oductive capacity

to generate a positive cash flow cannot do so indefi -

nitely.

Cash flow fr om financing activities varies

tremendously from year to year. Most inflows and out -

flows ar e either fr o m p r oceeds or fr om r epayment of

long-term debt. Between 60 and 70 per cent of both

cash inflows and outflows fr om the 100 lar gest agricul -

tural cooperatives since 1987 wer e fr om these two cate -

gories. However, if the tr end for the cooperative is a

continuous inflow of cash fr om financing and the

cooperative is not expanding, then a closer look is war -

ranted. For example, if the cooperative is using exter -

nal funds to pur chase capital assets, it is investing in

the futur e. On the other hand, if it is using external

funds to finance operations, the cooperative could be

heading toward a liquidity crisis.

After looking at all those sour ces of cash—opera -

tions, investment, and financing—a cr editor can get an

idea of wher e the cooperative is heading financially.

T able 7 illustrates some general guidelines on wher e to

focus the analysis. An analyst should look at the tr ends

and the magnitude of change over the years and not

just a single year of information.

Above all, the SCF must be appr oached with car e.

The analyst must understand the concept of cash ﬂ o w

and other non-cash expenses in r elation to net income.

If not, the analyst may be trapped by the numer ous

cliches and useless generalizations, which ar e all too

often employed even by those who should know better.

Ratio Analysis

Ratios ar e the most widely used tools for finan -

cial analysis. Yet, their function is often misunder -

stood, and, consequently, their significance may easily

be overrated.

A ratio expr esses the mathematical r elationship

between two quantities. The ratio of 200 to 100 is

expr essed as 2:1 or 2. While the computation of a ratio

involves a simple arithmetical operation, its interpr eta -

tion is far mor e complex.

The ratio must expr ess a r elevant r elationship.

For example, ther e is a clear , dir ect, and understand -

able r elationship between the sales price of an item

and its cost. On the other hand, ther e is no r eal rela-

tionship between salaries and investments in other

cooperatives.

Ratios ar e analysis tools that pr ovide clues to

help identify symptoms of underlying conditions.

Analysts, depending on their needs, may dif fer in the

ratios they find useful when examining a cooperative’s

financial position. Short-term cr editors ar e primarily

inter ested in the cooperative’s curr ent performance

and its holdings of liquid assets that can pr ovide a

ready sour ce of cash to meet curr ent cash r equir e-

ments. These assets include cash, marketable securi -

ties, accounts r eceivable, inventory, and other assets

which can be sold for cash or can become cash thr ough

the normal course of a business cycle. Long-term cr edi -

tors and member/owners, on the other hand, are con -

cerned with both the long-term and short-term out -

look. Management will also find ratios useful in

measuring its own performance.

As a final note of caution, the analysis of ratios is

useful only when all influencing factors ar e interpr eted

skillfully and intelligently. This is, by far , the most dif -

ficult aspect of ratio analysis. Look at a simple exam -

ple r elating to a non-financial pr oblem. In comparing

the ratio of gas consumption to mileage driven, driver

A claims to be mor e ef ficient than driver B (i.e., A gets

30 mpg and B only gets 20 mpg). Assuming that both

drive the same car, it would appear that driver A is

more ef ficient. However, other facts should be consid -

er ed:

● weight of the load carried,

● type of terrain (flat versus hilly),

● city or highway driving, and

● speed at which the car was driven.

Table 7—Cash ﬂow analysis

Scenario

–––––––––––––––––––––––––––––––––––––––––––––––––——————–––––––––––––––––––––––

1 2 3 456 7 8

Cash From Operation + - + + - - + -

Cash From Investment + + - + - + - -

Cash From Financing + + + - + - - -

(+) increase in cash ﬂ o w

( -) decrease in cash ﬂ o w

Scenario

1. The cooperative is using cash ﬂ ow from all three areas (operations, investments, and ﬁ nancing) to build up cash reserves. The cooperative

may be looking for acquisition. This position is not stable in the long run.

2. The cooperative is subsidizing its operations through debt/equity and selling off parts of its investments. This situation is not stable in the

long run.

3. The cooperative is expanding its operation, using the positive cash ﬂ ows from operations and ﬁ nancing to expand its capital base. This

scenario is stable.

4. The cooperative is selling off its assets and using the cash from operations to pay off member equity/debt. However, the cooperative can

not keep selling off its investments and survive in the long run. This is a stable scenario in the short run.

5. The cooperative could be expanding operations because of increased business or business could be in a downturn. Either way, it is not a

stable long-term position. This scenario is indeterminate.

6. The business is contracting and the cooperative is selling off its investments to fund operations and retire its equity/debt. This situation is

not stable.

7. The cash ﬂ ows from operations are funding capital expansion and debt/equity retirement. This scenario shows very strong operations and

is stable.

8. The cooperative is drawing down its cash reserves and may face liquidity problems in the near future. This situation is not stable.

All of these driving factors influence gasoline

ef ficiency. In financial analysis, the same pr emise

holds. The ratios should be used as a tool to help find

str engths and weaknesses but, other factors should

also be consider ed.

Standard Financial Ratios—Four categories of

ratios ar e typically used in analyzing financial

position:

● Liquidity

● Leverage

● Activity

● Pr ofitability

Liquidity ratios measur e the ability to fulfill

short-term commitments with liquid assets. Such

ratios ar e of particular inter est to the cooperative’s

short-term cr editors. These ratios compar e assets that

can be converted to cash quickly to fund maturing

short-term obligations. The curr ent ratio and the quick

ratio ar e the two most commonly used measures of liq-

uidity. For most cooperatives, these two ratios pr ovide

a good indication of liquidity. However, these ratios do

not addr ess the quality of liquid assets.

Leverage ratios measur e the extent of the firm’s

“total debt” bur den. They r eflect the cooperative’s

ability to meet both short- and long-term debt obliga -

tions. The ratios ar e computed either by comparing

earnings fr om the income statement to inter est pay -

ments or by r elating the debt and equity items fr o m

the balance sheet. Cr editors value these ratios because

they measure the capacity of the cooperative’s r ev -

enues to support inter est and other fixed char ges, and

indicate if the capital base is suf ficient to pay of f the

debt in the event of liquidation.

In terms of debt load, the mor e pr edictable the

returns of the firm, the mor e debt will be acceptable,

because the firm will be less likely to be surprised by

cir cumstances that pr event fulfilling debt obligations.

For example, utilities (i.e., r ural electric cooperatives)

have historically had r elatively stable incomes, but ar e

also among the industries with the heaviest debt str uc -

tur e. By contrast, fr uit and vegetable cooperatives ar e

in a cyclical business, wher e income is gr eatly influ -

enced by weather conditions, and they normally carry

a far lower pr oportion of debt in their capital str uctur e.

Activity ratios show the intensity with which the

firm uses assets in generating sales. These ratios indi -

cate whether the firm’s investment in curr ent and

long-term assets is too lar ge, too small, or just right. If

too lar ge, funds may be tied up in assets that could be

used more productively. If too small, the firm may be

pr oviding poor service to customers or inef ficiently

producing products.

There are two basic appr oaches to the computa -

tion of activity ratios. The first looks at the average

performance of the firm over the year. The second uses

year -end balances in the calculations.

The first method is pr eferr ed if asset balances

fluctuate significantly during the year. For example,

inventory levels for most fr uit and vegetable coopera -

tives vary significantly, depending on the time of the

season. If the fiscal year ends befor e the harvest, when

inventories ar e low, calculations using year -end bal -

ances will be biased and the r esulting ratios will be of

little value for comparing between dif fer ent coopera -

tives. The second method is the most commonly used

approach because in practice, data limitations often

for ce outside analysts to use year -end data.

Pr ofitability ratios measur e the success of the

firm in earning a net r eturn on its operations. Pr ofit is

an important objective of a cooperative, so poor per -

formance indicates a basic failur e that, if not corr ected,

would probably r esult in the firm going out of busi -

ness. Cooperatives must operate pr ofitably, although

their definition of pr ofitable might dif fer from an

IOF’s. Hence, appr opriate pr ofitability ratios pose the

biggest challenge for analyzing cooperatives.

Patr onage r efund policies have a dramatic ef fect

on cooperative pr ofitability ratio analysis. Some coop -

eratives r eturn patr onage at the end of the operating

year and show significant pr ofits on the closing state -

ments. Other cooperatives have dif fer ent operational

policies and may show little end-of-the-year pr ofits.

Lending institutions not familiar with these businesses

may shy away from cooperatives with low r eported

net income. This will be especially tr ue for pooling

cooperatives that generally r eport a minimum amount

of income at year -end.

Common ratios used to analyze the four ar eas of

financial performance can be found in most basic

financial textbooks and wer e developed to analyze a

wide variety of businesses. Most of these ratios ar e

applicable to the cooperative form of business, while

others should be viewed with some reservation.

Interdependence of Ratios—Ratios must be

evaluated together, not independently. A firm may

have low liquidity ratios, but mor e than adequate

leverage, inter est coverage, and pr ofitability ratios.

This firm would be in a good position to obtain

additional long-term funds, and in the pr ocess, pay

down short-term debt or purchase liquid assets. This

firm would improve its liquidity ratios while main-

taining adequate levels of the r emaining performance

measures.

The net operating mar gin (net mar gin/sales) will

be used to further illustrate the inter dependence

between ratios. Knowing the value of the net operating

m a r gin without knowing the level of sales is not too

helpful. The net operating ratio may be lower than the

industry average, but this might be because the firm

has cut mar gins to incr ease total sales. The r esult may

be that the firm’s r eturn on assets is extr emely high for

the industry, if the firms incr eased sales ar e suf ficient

to compensate for the lower r eturn per dollar of sales.

Consider this example:

In this example, if the net operating mar gin is

low and the assets turnover ratio (sales/assets) is high,

return on total assets may be high. Consequently, a

low operating margin due to a price cut policy that

incr eases sales may pr ove to be a very pr ofitable situa -

tion.

Similarly, the net operating mar gin may be high

but the r eturn on total assets may be poor. This occurs

when the firm has excess operating capacity and con -

sequently a high level of non-performing fixed assets.

However, more information is needed to understand

whether or not this is a good situation for the coopera -

tive. For example, this may be the case wher e the

firm’s business is contracting and could benefit by sell -

ing of f unused facilities or by using the r emaining

fixed assets mor e ef ficiently . On the other hand, the

firm may experience a tr emendous increase in sales

and is expanding its pr oduction facilities beyond their

curr ent needs, expecting to gr ow into the facilities in

the futur e.

Trends over time—Historical information can be

very beneficial when analyzing financial performance.

When analysis reveals certain weaknesses in a

cooperative’s financial health, the initial management

reaction may be to take immediate action to corr ect the

situation. However, if historical tr end analysis

indicates the situation is impr oving, the best r emedy

may be to monitor performance for continued

improvement—in other words, don’t overr eact.

Historical tr ends ar e important for other r easons

as well. During the life of the firm, pricing, cr edit poli -

cy, production methodology, and other ar eas under

managerial contr ol can change. Each change has an

ef fect on the firm’s performance. Ratios analyzing

these changes pr ovide feedback to management. A

thor ough analysis of the performance ratios r egar ding

managerial policies in ef fect at each period of time

may guide future policy decisions.

Another reason to look at historical performance

of a cooperative is to avoid the dif ficulties encounter ed

when comparing two similar cooperatives. Although

comparisons should be between like firms, generally,

no two firms ar e exactly the same.

While two farm supply cooperatives may be of

similar size, one may sell mostly bulk feed with lower

m a r gins, while the other sells mor e agr onomy prod-

ucts, which typically carry higher mar gins. Also,

boards may vary on their philosophy on the ideal capi -

tal str uctur e. One cooperative may be debt-fr ee but the

another cooperative boar d might feel that r eturns fr o m

leveraging the cooperative outweigh the risk of acquir -

ing the debt.

Ratios for Cooperatives

There are some inher ent pr oblems associated

with some common ratios used in cooperative finan -

cial analysis. Some pr oblems ar e intrinsic with the

ratios themselves and some ar e with the cooperative

str uctur e. For instance, the curr ent ratio is used to ana -

lyze liquidity. It pr ovides a good benchmark for deter -

mining whether a cooperative has liquid assets to

cover curr ent payments. However, interpreting these

ratios beyond the conclusion that it r epr esents curr ent

resour ces over curr ent obligations at a given point in

time r equir es a mor e in-depth look at the tr ends of the

individual parts that make up the ratio. A curr ent ratio

doesn’t show the quality of the liquid assets which can

gr eatly af fect the “tr ue” liquidity.

Pr ofitability ratios can also be deceiving. As men -

tioned earlier, cooperatives ar e generally not pr ofit

motivated. They ar e mor e concerned toward serving

member-owners. Therefor e, low pr ofit ratios can be

misleading to the analyst, especially with some pool -

ing cooperatives.

This next section looks at limitations and tries to

remedy the shortcomings of common ratios. Along

with each ratio, a table illustrates the values fr om the

database of the lar gest agricultural cooperatives. These

values ar e pr esented to show an or der of magnitude.

The average values and the high and low corr espond-

ing to the 95 per centile ar e included in the table. These

Net margins Net margins Sales

—————— —————— —————

Total assets Sales Total assets

ratio values might not r elate to the optimal value for

ef ficient operations, but have value for comparison

purposes.

Data

The ratios wer e developed fr om financial data

taken fr o m 1 13 cooperatives acr oss an 18-year period—

1980-97. When two or more cooperatives mer ged, no

attempt was made to estimate the financial statements

as if they had mer ged prior to the point of mer ger.

Once a cooperative ceased to exist, either thr ough

m e r ger or thr ough cessation of operations, it was no

longer included in the database. A ratio for each coop -

erative was computed fr om 18 years of data. If the

cooperative was less than 18 years old, the total num -

ber of years the cooperative was in service was used.

These values were then averaged.

Conversion Period of Inventories

Cr editors must be concerned not only with the

curr ent liquidity position of the firm, but also with its

overall financial position. The curr ent or quick ratios

alone do not tell the whole story. A firm with adequate

liquidity ratios might be a gr eater thr eat to short-term

cr editors if its liquidity is tied up in uncollectible

accounts r eceivable or outdated inventory. However,

this does not imply that liquidity ratios ar e irr elevant.

On the contrary, a higher liquidity ratio is generally

pr eferr ed.

A look at the quality of the curr ent assets indi -

cates how well the cooperative can meet curr ent oblig -

ations. The average cooperative has mor e than 75 per -

cent of curr ent assets tied up in inventories and

accounts r eceivable, so the asset quality warrants clos -

er examination. One way to examine the liquidity of

accounts r eceivables and inventories is to calculate the

conversion period of inventories.

Although not a cooperative-specific ratio, the

conversion period of inventories is used to analyze the

quality of the least liquid curr ent assets—inventory

and accounts r eceivable. The value r epr esents the aver -

age number of days it takes to convert inventories into

cash. The ratio is calculated in thr ee steps. Each step is

important on its own.

The first step is to determine the number of days

it takes to sell inventory. This is calculated by dividing

the average inventory by the cost of goods sold multi -

plied by 360 days or 360 days divided by the inventory

turnover ratio. This ratio pr ovides insight into how

many days the average inventory sits on the shelf or in

storage. Usually a lower value is better (Table 8).

The use of average monthly inventory is pr efer -

able to taking the beginning and ending inventory

divided by two. Many cooperatives end their fiscal

year when inventory levels ar e at their seasonal low.

This will suppr ess the value. Due to limited informa -

tion, these values ar e calculated by taking the begin -

ning and ending inventory levels divided by two.

However, 360 days is an arbitrary number. Most

businesses have fewer than 360 working days. But,

using a standar dized number allows comparisons

between dif fer ent time periods and cooperatives.

If all sales ar e cash, this pr ocedure gives the num -

ber of days to convert inventory to cash. However, two

m o r e steps ar e needed if ther e ar e cr edit sales—calcu -

late the days in accounts r eceivable and add that value

to days in inventory. To calculate this ratio, use the

average accounts r eceivable divided by the total cr edit

sales for the year multiplied by 360 days. As with the

days to sell inventory, the days in accounts r eceivable

is 360 days divided by accounts r eceivable turnover

(T able 9).

In the thir d step, the conversion period is calcu -

lated by adding the days to sell inventory and days in

accounts r eceivable. Although using cr edit sales to

determine days in accounts r eceivable is mor e accu -

rate, total sales works without mor e detailed informa -

Average Inventory

———————— * 360 days

Days to sell inventory =

Cost of goods sold

Table 8—Days to sell inventory

95 Percent Conﬁdence Interval

————————————————

Average High L o w

All495740

Cotton 63 98 27

Dairy 19 26 11

Diversiﬁ ed 44 49 39

Farm Supply 41 52 30

Fruit/Vegetable 105 136 74

Grain 46 55 37

Poultry/Livestock 4 8 0

Rice 90 134 45

Sugar 58 78 38

Average accounts receivable

Days in accounts receivable (————————————)* 360 days

Credit sales

tion. If a distinction between cr edit and cash sales can

be made, the following weighted average formula

should be used:

This value should help management and credi -

tors gauge liquidity of the cooperative’s inventory and

accounts r eceivable. If the cooperative has a substan -

tial per centage of curr ent assets tied up in these two

accounts, then a high ratio number implies the cooper -

ative’s curr ent position might not be very liquid (Table

10).

Payout Ratio

This ratio measur es the pr oportion of curr ent and

past earnings r eturned to members during the year,

looking only at total cash disbursements. The numera -

tor consists of all cash payments to members. This is

important because the equity portion of cooperatives is

not static. This ratio examines the equity r evolvement

and dividend policy.

A value of less than 1 indicates the cooperative is

gr owing its equity position or not r evolving member

equity, while a value of gr eater than 1 implies a shrink -

ing of its equity base. While this ratio is important to

all cr editors, those with a long-term stake should look

at the tr end during the past few years to see if the

cooperative’s at-risk capital is being maintained (Table

11).

Capitalization Growth Rate

The payout ratio can further determine the capi -

talization gr owth rate of the cooperative. In other

w o r ds, cr editors and members may want to for ecast

the gr owth of the cooperative’s at-risk capital base.

This will show whether the cooperative can continue

revolving member equity and still maintain the equity

base to ensur e enough capital to satisfy cr editors.

Table 9—Days in accounts receivable

95 Percent Conﬁdence Interval

————————————————

Average High L o w

All273024

Cotton 17 20 14

Dairy 26 28 23

Diversiﬁ ed 42 66 17

Farm Supply 30 36 23

Fruit/Vegetable 36 48 24

Grain 20 24 17

Poultry/Livestock 22 40 4

Rice 32 39 24

Sugar 25 31 19

Table 10—Conversion period of inventories

95 Percent Conﬁdence Interval

————————————————

Average High L o w

All 758467

Cotton 80 116 44

Dairy 44 52 37

Diversiﬁ ed 86 1 14 57

Farm Supply 71 84 58

Fruit/Vegetable 141 169 113

Grain 66 75 58

Poultry/Livestock 26 45 7

Rice 121 165 78

Sugar 83 99 68

Percent Cash Sales * Days to Sell Inventory

+Percent Credit Sales * (Days to Sell Inventory +Days in Accounts

Receivable)

——————————————————————————————

Conversion Period of Inventories

Table 11—Payout ratio

95 Percent Conﬁdence Interval

————————————————

Average High L o w

All 0.59 0.66 0.51

Cotton 0.85 0.99 0.71

Dairy 0.72 0.84 0.60

Diversiﬁ ed 0.23 0.44 0.01

Farm Supply 0.46 0.61 0.32

Fruit/Vegetable 0.66 0.88 0.44

Grain 0.42 0.52 0.31

Poultry/Livestock 0.47 0.62 0.31

Rice 0.61 0.90 0.33

Sugar 0.63 1.00 0.25

C ash patronage dividends + other

dividends + revolving equity redeemed

Payout Ratio ———————————————————

N et margins

However, car e must be used when interpreting the

gr owth rate. The analyst must look at the rate over

time to smooth out the boom/bust years (Table 12).

Proﬁt Index

The profit index looks at pricing policy and

inventory contr ol. Although generally associated with

retail sales, it can be used for marketing cooperatives.

However, some marketing cooperatives show higher

values due to value-added activities and timing of

inventory r ecor ding. A few of the lar gest cooperatives

have been using this ratio for some time in analyzing

their inventory contr ol and pricing policy.

The ratio is calculated by taking the gr oss mar gin

percent times inventory turnover. If a cooperative

maintains its inventory and mar gins so that the pr ofit

index is close to 1, the cooperative will likely be pr of-

itable. If the cooperative has certain inventory items

that have a high turnover (e.g., feed), the pr ofit mar gin

will not need to be high. High volume and low mar -

gins should generate enough r evenues to cover over -

head expenses. However, if the cooperative has items

that don’t have a high sales volume (e.g., tractors), a

higher margin will be needed to compensate for the

low turnover (Table 13).

Local Return on Local Assets

One area in which cooperatives can get them -

selves into tr ouble is r elying on patr onage r efunds

fr om other cooperatives to balance r evenue against

expenses. For perspective, nine of the lar gest coopera -

tives in this database would have r eported a net loss

without patr onage r efunds fr om other cooperatives in

1997. Because this income sour ce r elies on the opera -

tions fr om an outside business, it does not r eflect the

operations of the cooperative being analyzed.

Therefor e, excluding this sour ce of income will pr o -

vide a mor e accurate analysis of the cooperative’s

operation.

Similarly, investment in other cooperatives

should not be included in the asset base when looking

at r eturn on assets. The equity investment in other

cooperatives r epr esents business conducted with them.

The investment is made at face value and later

redeemed at face value. There is no secondary market

for cooperative stock, and most cooperative stock is

non-transferable. Ther efor e, as an asset, it is consid -

er ed a non-performing asset and should not be includ -

ed within the calculation of the r eturn on assets.

Local r eturn on local assets is calculated by tak -

ing net income befor e income taxes and inter est less

patr onage r efunds r eceived divided by total assets less

investments in other cooperatives. This ratio pr ovides

a better indication of the cooperative’s operation and

its ability to generate r evenues (Table 14).

Capitalization growth rate = (1 - Payout Ratio) * Return on Equity

Table 12—Capitalization growth rate

95 Percent Conﬁdence Interval

—————————————————

Average High Lo w

All .06 .07 .05

Cotton .05 .08 .03

Dairy .04 .08 .01

Diversiﬁ ed .07 .13 .00

Farm Supply .08 .11 .05

Fruit/Vegetable .05 .08 .01

Grain .08 .10 .06

Poultry/Livestock .07 .11 .03

Rice .02 .04 .00

Sugar .02 .04 .01

(S ales-cost of goods sold) S ales

Profit index = ——————————— * ————————

Sales A verage inventory

Table 13—Proﬁt index

95 Percent Conﬁdence Interval

—————————————————

Average High L o w

All 2.83 4.10 1.57

Cotton 2.31 4.72 (0.09)

Dairy 4.59 7.00 2.18

Diversiﬁ ed 0.96 1.24 0.69

Farm Supply 1.17 1.46 0.88

Fruit/Vegetable 4.54 10.41 (1.32)

Grain 0.93 1.21 0.65

Poultry/Livestock 3.52 5.26 1.79

Rice 1.77 1.96 1.57

Sugar 2.14 2.92 1.37

Net income before interest and

income taxes - patronage refunds

Local return on local assets = ————————————————

Total assets - investments

in other cooperatives

Earnings Variability

Lenders ar e concerned with lar ge debt bur dens

only if the futur e earnings of the cooperative ar e

uncertain. While futur e earnings ar e unpr edictable, a

look at the past can give a clue to the risk associated

with the cooperative’s business. A statistician defines

“risk” as the variation about the mean, or expected

return. A cr editor defines “risk” as the pr obability of

having to take an unacceptable loss. However, these

two definitions ar e closely r elated. Both try to define

how much the actual return dif fers fr om the expected.

A cr editor might want to look at the variability

over time of the cooperative’s earnings to see if it is

cr edit worthy. The income variability ratio examines

how much income varies from year to year compared

to the period-average income. It is calculated by taking

the standar d deviation of the year -to-year change in

local earnings befor e inter est and income taxes fr o m

several years divided by the average level of local

earnings over the entir e period analyzed. This pr o -

vides a good pr oxy for earning variability (Table 15).

Local earnings ar e mor e appr opriate and focuse on the

operations of the cooperative and don’t r ely on patr o n -

age r eceived fr om other cooperatives.

While ther e is no set r ule of thumb for an income

variability value, a value between 0 and 1 indicates

fairly stable income. A negative number will indicate

that the cooperative, on average, has a negative

income. A number greater than 2 usually means that

the cooperative will have a lar ge variance in its net

m a r gins. This ratio works well for pooling coopera -

tives that r eport minimal net income because it doesn’t

rely on the magnitude of the earnings. While this ratio

gives the variability of a cooperative’s income, it

doesn’ t illustrate the quality of that income.

Income Quality Ratio

Both the variability and quality of a cooperative’s

earnings ar e important. The ratio of cash flow fr o m

operations to net income pr ovides some insight into

the quality of earnings. The cash flow fr om operations

has a financing rather than a pr ofit-measur ement focus

and is well suited in evaluating short-term liquidity

and long-term solvency. Cash flow fr om operations

repr esents cash in the bank that can be used to pay of f

the loan. Reported net income often has estimated val -

ues placed on various r evenues and expenses that can

distort the amount of funds available. A cooperative

can r eport a positive net income and yet not have

funds to pay of f its cr editors.

The higher this ratio, the higher the quality of the

reported net income. For example, if the cooperative is

selling mor e pr oducts because of a r elaxed cr edit poli -

cy, accounts r eceivable might be higher and less col -

lectible. Ther efor e, the incr ease in accounts r eceivable

will cause the cash flow fr om operations to fall r elative

to net income, ther eby lowering the income quality

ratio (T able 16).

Table 14—Local return on local assets

95 Percent Conﬁdence Interval

—————————————————

Average High L o w

All .05 .06 .04

Cotton .11 .15 .06

Dairy .07 .09 .05

Diversiﬁ ed .03 .05 .02

Farm Supply .06 .09 .03

Fruit/Vegetable .03 .04 .02

Grain .03 .05 .02

Poultry/Livestock .06 .13 (.02)

Rice .04 .05 .03

Sugar .03 .05 .01

S tandard deviation (local earnings

- local earnings

t - 1)

Earnings Variability = ———————-———————

A verage local earnings

Table 15—Earnings variability

95 Percent Conﬁdence Interval

———————————————————

Average High L o w

All 1.41 1.79 1.03

Cotton 0.81 1.27 0.34

Dairy 0.93 1.31 0.55

Diversiﬁ ed 1.49 2.33 0.65

Farm Supply 2.50 3.93 1.07

Fruit/Vegetable 2.54 3.76 1.32

Grain 0.59 1.37 (0.19)

Poultry/Livestock 1.08 2.06 0.10

Rice 1.00 1.01 0.99

Sugar 1.47 2.24 0.70

Cash flow from operation

Income quality ratio = ———————-—————

Net income

Cash Interest Coverage Ratio

“Cold hard cash” is critical to the successful oper -

ation of any business. Fixed char ges ar e paid with

cash. Net mar gins taken fr om the statement of opera -

tions might not pr ovide a r eliable measur e of cash

available to meet these fixed-debt char ges. Net mar -

gins contains many items that do not generate cash as

well as expense items that do not r equir e the curr ent

use of cash.

Therefor e, an alternative measur e is to use the

pr etax cash flow fr om operations. The cash inter est

coverage ratio is similar to the inter est coverage ratio.

However, non-cash expenses ar e added back and non-

cash r evenues ar e deducted fr om net margins. When

these net mar gins ar e adjusted for non-cash items, the

result is cash generated fr om operations. This value is

included in the cash flow statement as cash flow fr o m

operations (Table 17).

Conclusion

Financial r eports contain a lot of information. The

main objective of financial analysis is to sort thr ough

that information to find useful and r elevant data in

analyzing a business. Literatur e is rich with financial

analysis tools that examine the performance and

str ength of businesses. However, not all businesses ar e

alike. Dif fer ences between IOFs and cooperatives

mean that some standard financial analyses do not

relate well with cooperatives. This is especially r ele-

vant for pr ofit-oriented ratios. This r eport pr ovides a

supplement to standard analysis with an eye toward

cooperatives. Some ratios help analyze the coopera -

tive’s financial performance and cash flow analysis.

Managers and creditors should find these findings

helpful in appraising the financial str ength of the

cooperative. While ther e is no set standar d at this time,

using these analysis tools should help the cooperative

develop its own performance measurements.

Table 16—Income quality

95 Percent Conﬁdence Interval

————————————————

Average High Lo w

All 0.77 1.00 0.53

Cotton 0.33 1.14 (0.48)

Dairy 0.82 1.01 0.64

Diversiﬁ ed 0.81 1.08 0.54

Farm Supply 0.58 0.80 0.36

Fruit/Vegetable 1.58 2.73 0.43

Grain 0.35 0.58 0.13

Poultry/Livestock (0.00) 0.89 (0.90)

Rice 0.75 0.90 0.60

Sugar 0.88 0.92 0.84

Cash flow operations + Income tax +

Interest expense

Cash interest coverage ratio = ———————-———————

Interest expense

Table 17—Cash interest coverage

95 Percent Conﬁdence Interval

——————————————————

Average High L o w

All 3.02 3.93 2.12

Cotton 4.18 10.05 (1.70)

Dairy 6.80 9.28 4.32

Diversiﬁ ed 1.97 3.34 0.59

Farm supply 1.98 3.42 0.55

Fruit/Vegetable 1.69 3.02 0.36

Grain 1.42 2.72 0.11

Poultry/livestock 0.30 2.70 (2.09)

Rice 1.69 2.43 0.96

Sugar 1.83 2.10 1.56

Bibliography

Br ealey, Richar d and Stewart Myers, Principles of

Corporate Finance , Second Edition, McGraw Hill.

1984.

Br ownlee, Richar d, Kenneth Ferris and Mark Haskins,

Corporate Financial Reporting , Second Edition,

Irwin. 1994.

Cobia, David ed., Cooperatives in Agricultur e, Pr entice-

Hall. 1989.

Franks, Julian, John Br oyles and Willar d Carleton,

Corporate Finance , Kent. 1985.

Leopold A. Bernstein, Financial Statement Analysis ,

Fifth Edition, Irwin. 1993.

U.S. Department of Agriculture

Rural Business–Cooperative Service

Stop 3250

Washington, D.C. 20250-3250

Rural Business–Cooperative Service (RBS) provides research,

management, and educational assistance to cooperatives to

strengthen the economic position of farmers and other rural

residents. It works directly with cooperative leaders and

Federal and State agencies to improve organization,

leadership, and operation of cooperatives and to give guidance

to further development.

The cooperative segment of RBS (1) helps farmers and other

rural residents develop cooperatives to obtain supplies and

services at lower cost and to get better prices for products they

sell; (2) advises rural residents on developing existing

resources through cooperative action to enhance rural living;

(3) helps cooperatives improve services and operating

efficiency; (4) informs members, directors, employees, and the

public on how cooperatives work and beneﬁt their members

and their communities; and (5) encourages international

cooperative programs. RBS also publishes research and

educational materials and issues Rural Cooperatives magazine.

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