By Carole R. Engle*
While related, these categories of business performance are measured and interpreted differently. The problem for many aquaculture businessmen is that there are many different ways to measure and analyze financial performance. Textbooks present dozens of financial indicators, and it can be challenging for businessmen to know which is most important.
This column presents a set of eight measures of financial performance that aquaculture businessmen should calculate and assess each year (Fig. 1). An annual review should be done and specific goals set to improve the business’s performance for the upcoming year. The checklist to assess these measures is divided into rows under the headings of “Cash Flow,” “Financial Position,” and “Profitability.” After calculating the value for each from the appropriate financial statement, the owner/manager should check whether the business’s performance was “Good,” “Marginal,” or a “Problem.”
The first measure is the ending cash balance, calculated from the cash flow budget. If cash balance at the end of the year is higher than at the beginning, then the performance was “Good.” If the value is slightly lower than at the beginning, then the “marginal” box should be checked. If the ending cash balance is a great deal lower than at the beginning, the business has a problem that requires attention.
Also under the Cash Flow heading is the balance outstanding on the operating loan. If lower than at the beginning of the year, the “Good” category should be checked. If the end-of-year balance is only slightly higher than at the beginning of the year, then the marginal category should be checked. If the balance on the operating loan is greater at the end of the year than at the beginning, then there is a problem that needs attention.
The next two rows of the checklist measure cash flow risk. The first calculates the percent that revenue can decline with the business still able to cash flow. Generally if revenue can decline by more than 25% and still meet cash flow obligations, the business is in a good cash flow position. The cash flow position is moderate if the calculated value is 15%, but is a problem if the value is less than 15%.
A second measure of cash flow risk is to calculate the percent that operating expenses can increase and still meet cash flow obligations. If the value calculated indicates that operating expenses can increase by more than 15%, the overall cash position is good. If the calculated value is 10 to 15%, then the cash flow position is marginal, but if the value is less than 10%, there is a problem that merits attention.
The next three rows of the checklist monitor financial position. A current ratio that is greater than 1.5 would be considered good. If the current ratio is between 1 and 1.5, then the business’s performance is judged to be moderate. A current ratio less than 1.0 indicates a liquidity problem the coming year and requires the owner/manager to develop a comprehensive cash flow plan to avoid serious problems the next year.
The debt-to-asset ratio calculated in the next row provides guidance on whether the debt load is excessive or whether the business can assume additional debt without an excessive increase in financial risk. If the debt-to-asset ratio is less than 40%, the business has low financial risk. If the debt-to-asset ratio is 40% to 65%, then the financial risk is moderate. If the debt-to-asset ratio is greater than 65%, the business is at high financial risk and specific goals need to be set to reduce it the following year.
The third indicator to calculate from the balance sheet is net worth. If net worth has increased compared to the previous year, then the performance was “good.” Net worth is marginal if decreasing or low, but still positive. However, if net worth is negative, then the business is insolvent and net worth is a problem.
The final pillar of financial performance is that of profitability. The key indicator of profitability is net farm income, calculated from the income statement (also called profit and loss statement). Net farm income is good if positive and high. If positive, but low, then it is classified as marginal. Net farm income is a problem if it is negative.
Once all indicators are calculated and classified as in Fig. 1, it is easy to identify the types of goals to be prioritized the coming year. All rows classified as a problem require attention. Plans and specific goals for the degree of improvement should be established for each problem identified. The best pathway to success for an aquaculture business is to complete a financial analysis each year and set specific goals for the coming year to improve the weakest parts of the business.
Dr. Carole Engle is an Aquaculture Economist with more than 30 years of experience in the analysis of economics and marketing issues related to aquaculture businesses. She is the Editor-in-Chief of Aquaculture Economics and Management.