How’s Your Farm’s Liquidity?

Farmer with Corn

Think short-and long term to strengthen your farm’s financial footing.

A trio of factors continue to increase financial stress on a lot of farms around the U.S., though there are indicators of how much damage that stress is inflicting and what it means to future financial viability.

At the 2019 USDA Agricultural Outlook Forum in February, Economic Research Service (ERS) Economist Greg Lyons presented data showing how the seven-year downturn in grain markets is influencing key variables that indicate farm operations’ financial strength — namely farm incomes, the farmland market, and interest rates. While the first two have fallen and weakened, the third is ticking slightly higher. The combination of the three has prompted a lot of questions about how much stress farmers are enduring, especially as it pertains to their ability to generate income to service debt and meet short-term financial obligations.

U.S. Department of Agriculture data shows net cash farm income and net farm income in general both began falling in 2012, prompting a decline over the same time leading up to today in term debt coverage ratios (TDCR). An operation’s TDCR — the value reflecting cash divided by debt principal and interest — shows its ability to service debt. The ratio is historically around eight and topped out just over 10 in 2012. Today it’s around seven, a sign that a growing number of farmers are facing difficulty in meeting debt requirements.

Short-term data

There’s a size component to the equation when it comes to those operators whose TDCR is one or below, or those who are essentially “just skating by” with income slightly higher than total principle + interest on expenses. According to Lyons’ ERS data, a higher percentage of larger farmers — those with annual gross cash farm income (GCFI) of $100,000 or above — have a TDCR of one or below than do farmers with a GCFI of $100,000 or less.

At the same time, the margin between current assets and current liabilities (farmers’ ability to meet short-term financial obligations based on assets versus liabilities) has been closing consistently since 2000. The current ratio is around two, down from greater than four in 2010.

At the same time, ERS data show the number of farmers in the sub-one TDCR category are having increasing difficulty maintaining the liquid assets to cover current financial obligations.

 A longer view

Despite all of those signs, Lyons’s data presented at the Outlook Forum showed that in a long-term perspective, general farm balance sheets remain strong. This is especially true compared to the early 1970s and the latter years of the farm crisis in the 1980s into the early 1990s.

However, that could change. We’re about seven years into a downturn in the grain markets that was initially pegged to last only three years before turning around. In the future, one sign of precarious financial footing in the ag sector will be farms’ debt-to-asset ratios.

After spiking to around 0.23 during the mid-1980s farm crisis, ERS data show the average ratio has been below 0.15 — the 50-year average since the late 1990s. Debt-to-asset ratios have been generally trending higher since 2012, with the trend pointing to the highest level since a spike in late 2009 and early 2010.

That points to increasing farm numbers that could be considered “highly leveraged” in USDA data, Lyons said. Just as with TDCR, there’s a farm size correlation with debt-to-asset ratios given current economic conditions in the ag sector. Farms with more than $500,000 in GCFI are likely to have a higher ratio and, as a result, be more highly leveraged. And USDA data show that larger farms with younger operators are more likely to have a higher ratio than those with older operators.

Management implications

The recent USDA data definitely reflect the increasing weight of bearish grain markets and their influence on farm profitability. Lower farm-gate prices likely will continue to lead more farmers to seek financing for things like operating expenses. If that trend continues, it could lead to more farms being highly leveraged.

Higher grain prices will obviously ease the pressure to borrow to support operations. There have been occasional rallies in the cash grain market, and it’s important to be attentive to those peaks when selling opportunities arise. But you can’t control the marketplace.

There’s a lot you can control on your farm. It’s important to ensure you’re not becoming so highly leveraged that you can’t sustain your farm well into the future. But where do you start?

One good starting point is by benchmarking your operation, a process in which you measure the financial health of your farm business compared to others like it. If there are glaring areas where you can strengthen your business management or cut costs, that’s a good starting point for improvements. Use metrics like per-acre yield or livestock rate of gain to start drilling down into specific parts of your balance sheet that can be adjusted to maintain your liquidity.

Once you know where you stand in relation to other farms similar to yours, seek out new or different ways to cover expenses or purchase critical inputs to help you reach stronger financial footing. Expect these changes to be incremental. For example, simply changing your fertilizer buying strategy won’t cause huge changes in your balance sheet. But every change like this can add up.

While you can’t control interest rates, you can control the rates you pay, to some extent. When rates are low, it’s a good time to lock them in for the long term as a way to manage overall interest costs.

Finally, if changes like those are in fact too incremental and you see more farm-wide restructuring to be the answer, approach it prudently and with the right financial partner. Restructuring farms to free up working capital is one way to strengthen your farm’s financial standing. It is a decision that you should make only after determining how it can positively impact your farm’s financial future.

If you’re uncertain how to get started, contact us to find out how we can work together to ensure your farm is successful both tomorrow and for decades to come.

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