Financial ratios part 14 of 21: Replacement Margin

How much of a business’ or farms’ income is left after loans have been made and the cash purchases of capital assets?

Financial Ratios & indicators can assist in determining the health of a business. There are a minimum of 21 different ratios and indicators that can be looked at by financial institutions. You cannot look at a single ratio and determine the overall health of a business or farming operation. Multiple ratios and indicators must be used along with other information to determine the total and overall health of a farming operation and business. This series of articles will look at 21 commonly used ratios and indicators.

Replacement Margin is a measurement of Repayment Capacity and is determined based on information derived from a business’ or farm operations Cash-Flow Statement. The term Repayment Capacity refers to the borrowers ability to repay term debt on time. Typically Repayment capacity is not considered a measurement of a farm or business’ performance because Repayment Capacity also uses a borrowers non-business and/or non-farm sources of income. The Replacement Margin simply measures the dollar value of income that remains following the payment(s) for principal and interest on term loans and any purchased capital assets paid for in cash.

The following equations will determine your Replacement Margin:

Replacement Margin = Capital Debt Repayment Margin – Unfunded (Cash) Capital Replacement Allowance

Capital Debt Repayment Margin = Capital Debt Repayment Capacity – Scheduled Principal & Interest on term loans and leases.

Capital Debt Repayment Capacity = Net Income + Depreciation Expense + Non-Farm/Business Income – Family Living Expenses & Income Taxes + Interest Expense on Term Loans

If you have any further question please feel free to contact your local Farm Management Educator or the author. 

You can read the other articles in this series:
Part 1: The current ratio
Part 2: Working capital.
Part 3: Working capital to gross revenues
Part 4: Debt-to-asset ratio
Part 5: Equity-to-asset ratio
Part 6: Debt-to-equity ratio
Part 7: Net farm income
Part 8: Rate of return on assets
Part 9: Rate of return
Part 10: Operating profit margin
Part 11: The EBITDA measurement of profitability
Part 12: Operating profit margin
Part 13: Capital debt repayment margin
Part 15: Term debt coverage
Part 16: Replacement margin coverage ratio
Part 17: Asset turnover rate
Part 18: Operating-expense ratio
Part 19: Depreciation-expense ratio
Part 20: Interest-expense ratio
Part 21: Net income ratio  

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