Current ratio: The foundation of farm financial fitness
Strong working capital is always important. It’s your first line of defence when expenses grow faster than revenues. This post describes the current ratio, or liquidity, and the importance for Canadian farm profitability.
Current ratio
The current ratio measures a business' ability to meet financial obligations as they come due, without disrupting normal operations.
Current ratio = current assets / current liabilities
How it works
There are no hard and fast rules about current ratios, but the financial literature suggests a ratio higher than 1.5 is healthy. If an operation’s current ratio is too high, 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. If working capital is the first line of defence, its absence can force an operation into secondary means of repayment (refinancing of debt) or possibly even selling assets.
When current liabilities grow at a pace faster than current assets, the current ratio will fall, lowering farm financial fitness.
Figure 1 shows the most recent five-year history of the average current ratio for dairy, hogs, cattle, and grains and oilseeds farms – four of Canada’s largest ag sectors – using FCC’s portfolio data.
Figure 1: Sector’s current ratio reached a peak in 2022 – declined slightly in 2023
Source: FCC Portfolio Data
These ratios reflect differences arising from each sector’s unique production cycles and volatility in revenues and costs.
How an agricultural current ratio evolves
Figure 1 reports the average ratio by sector. The average is a great benchmarking tool, but individual producers should use it with caution. Some mature grains and oilseeds operations may have a stronger working capital position than other operations that are, for instance, more heavily leveraged during an aggressive expansion phase. The current ratio in both scenarios could be appropriate, each reflecting a healthy operation with different business strategies.
What does the future hold?
When profitability shrinks, cash, as the saying goes, is king. To learn about responding to changing commodity prices and input costs, look for our post on the operating expense ratio.
Current ratio is important – but only up to a point. Work with your lender and accountant to determine the suggested ratios for your industry. Be sure you consider your own strategy and the risks facing your operation.
*This analysis is based on data from FCC’s portfolio (2019 – 2023).
Are you comfortable using financial statements to better manage your operation? A good place to start is your accountant or an FCC Relationship Manager.
Article by: Amanda Norris, Senior Economist
From cash flow planning to net worth statements, get the basics you need to prepare for a loan application.
Learn how a commodity market balance sheet can help.