INTEREST COVERAGE RATIOS (ICRs) AND FINANCIAL SUSTAINABILITY: APPLICATION TO FIRMS WITH BOVINE DAIRY LIVESTOCK

Abstract

Agricultural firms with bovine dairy livestock are characterized by high investments in capital equipment and this is determined by the biological cycle of production, which requires large investments in land, facilities and bovine herd. These large investments require funding from equity capital or debt capital, which generates financial costs. Therefore, it is necessary to assess not only the profitability of firms in the sector but also the financial sustainability of the business cycle, applying appropriate indexes. To analyze this issue, the article has developed an approach to the verification of the financial sustainability of debt, out of a sample of dairy companies in Italy, putting in comparison Interest Coverage Ratios (ICRs) calculated using different approaches. In the article, we propose a financial approach to calculate the ICRs and verify the correlation and diversity, where statistically significant, of ICRs calculated with the Financial (FICRs) and the Economic (EICRs) approaches. The research shows that the sample firms have difficulty in generating cash flow and this difficulty is highlighted by traditional profitability analysis. Likewise, EICRs traditionally applied by banks are statistically different, even if correlated, with respect to the FICRs proposed in the article. The results of the research suggest that firms in the sector must pay particular attention to the financial sustainability of operations, in particular in dealing with the banks for the financing of debts. Similarly, banks should put in place systems analysis that are more effective than those currently used to assess the agricultural firms. The suggested approach could be applied even to other sectors’ agrifood system, particularly if capital intensive; at the same time, the approach could be useful also if applied to agricultural cooperatives, even in developing countries that often suffer by financial constraints.