Financial Ratios Part 21 of 21: Net Income Ratio
What is a business or farm’s profit when compared to its gross income?
Financial ratios and 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 is one in a series of articles published by Michigan State University Extension about 21 commonly used ratios and indicators.
Net Income ratio is a measurement of financial efficiency and is determined based on information derived from a business or farm operations’ financial statements, specifically using the financials that determine gross farm income. The term “financial efficiency” refers to how effectively a business or farm is able to generate income. Looking at the financial efficiency of a business or farm assists the owner(s) in determining how the various aspects of the business such as production, financing, marketing, etc. affect the gross income of the business.
The Net Income ratio is measured as a percentage; the higher the percentage the stronger the ratio. The Net Farm Income ratio provides the percentage of income left following the payment of all expenses, with the exception of unpaid labor and management. The higher the percentages, the better; a business or farm should be no lower than 20 percent to be considered strong. Any percentage less than 10 percent may indicate that the business or farm is spending too much of its gross income on its expenses or not recovering enough income through production and marketing of its product or service. If the percentage is lower than a farm or business would like, an assessment should be completed to determine where expenses can be cut, how the business or farm can better market its product or service or how it can accomplish higher yields or productivity.
When you take the Operating-Expense ratio, Depreciation-Expense ratio, Interest-Expense ratio and the Net Income ratio and add them up, they should equal 100 percent.
The following equation(s) will determine your Net Income ratio:
Net Income ratio = Net Farm Income / gross income
You can read the other articles in this series at the links below.
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 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