AFM Financial Analysis & Budgeting in Farm Management 3 — Questions and Answers
Question 1: A farm shows a debt-to-asset ratio of 0.65. How would this farm be classified financially?
- Financially strong with low leverage
- Marginally leveraged with moderate risk
- Highly leveraged with vulnerable financial position (Correct answer)
- Technically insolvent
Correct answer: Highly leveraged with vulnerable financial position
A debt-to-asset ratio of 0.65 means 65% of assets are financed by debt, which is considered a highly leveraged and financially vulnerable position.
Question 2: Which measure best captures a farm's ability to generate cash from operations to service debt?
- Net farm income
- Term debt coverage ratio (Correct answer)
- Working capital ratio
- Return on assets
Correct answer: Term debt coverage ratio
The term debt coverage ratio measures whether farm income is sufficient to cover scheduled principal and interest payments on term debt.
Question 3: On an accrual-adjusted income statement, an increase in grain inventory from the beginning to the end of the year would:
- Decrease net farm income
- Have no effect on net farm income
- Increase net farm income (Correct answer)
- Increase cash receipts only
Correct answer: Increase net farm income
An inventory increase is added to cash sales on an accrual basis, increasing the value of farm production and therefore net farm income.
Question 4: A farmer is considering leasing versus purchasing equipment. Which financial factor most favors leasing?
- Desire to build equity in the asset over time
- Need to preserve working capital and credit capacity (Correct answer)
- Long-term ownership and residual value recovery
- Lower total cost of ownership
Correct answer: Need to preserve working capital and credit capacity
Leasing preserves working capital and avoids large down payments, maintaining credit capacity for other farm needs.
Question 5: In break-even analysis for a crop enterprise, the break-even yield is calculated as:
- Total fixed costs divided by market price
- Total variable costs divided by market price per unit
- Total costs (fixed + variable) divided by market price per unit (Correct answer)
- Net farm income divided by total acres
Correct answer: Total costs (fixed + variable) divided by market price per unit
Break-even yield equals total costs (fixed plus variable) divided by the expected market price, representing the minimum yield needed to cover all costs.
Question 6: A farmer uses an accrual accounting system. When is revenue from a grain sale recognized?
- When the crop is harvested
- When the cash payment is received
- When the grain is delivered and title transfers to the buyer (Correct answer)
- When the sale contract is signed
Correct answer: When the grain is delivered and title transfers to the buyer
Under accrual accounting, revenue is recognized when the earnings process is complete and title transfers, not when cash is received.
Question 7: Which of the following is a measure of farm efficiency rather than profitability?
- Net farm income
- Return on equity
- Operating expense ratio (Correct answer)
- Return on assets
Correct answer: Operating expense ratio
The operating expense ratio (operating expenses divided by gross revenue) measures how efficiently expenses are managed relative to revenue, not absolute profit.
AFM Financial Analysis & Budgeting in Farm Management 3
A farm shows a debt-to-asset ratio of 0.65.
How would this farm be classified financially?