Financial Ratios Part 16 of 21: Replacement Margin Coverage Ratio

Can the business or farm pay all of its term debt payments on time and purchase needed capital assets in cash?

Financial Ratios & indicators can assist in determining the health of a business. There is a minimum of 21 different ratios and indicators that can be looked at by many 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 Coverage Ratio 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 Coverage Ratio simply measures whether or not a business or farm had the capability to pay all of its term debts on time and purchase needed capital assets solely on income vs. the requirement of additional debt. Any number less than “1.0” means that a business or farm did not have the cash on-hand to make term debt payments on time and was not able to purchase in cash any capital assets necessary. These would have had to be covered through the use of additional debt, the liquidation of inventory on hand, or the sale of assets.

The following equations will determine your Replacement Margin Coverage Ratio:

Replacement Margin Coverage Ratio = Capital Debt Repayment Capacity / (Scheduled Principal & Interest on term loans and leases + and cash used to purchase replace capital assets or its replacement allowance)

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 14: Replacement margin
Part 15: Term debt coverage
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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