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Working capital key to weathering farm income slide
As 2014 nears, concerns continue to abound about a looming decline in farm profit potential fueled by lower grain markets. Though no revenue loss is a welcome one, recent data show how much of a hit farmers can take without sinking their entire operations. There are obviously a lot of variability and farm-specific factors in play, but in the end, it depends on how much working capital you have in relation to your year-to-year equity and expenses. So, is your farm set up to survive the oncoming downturn?
"Most everyone agrees that farmers are in better financial health and have better debt-to-assets ratios than in the '80s," says Ohio State University farm management specialist Chris Bruynis. "However, that does not mean there won’t be financial stress or that some farms will not survive the financial tightening that appears to be coming quickly."
In the four years preceding 2013, gross and net farm income, assets, and working capital have all steadily climbed. But so have cash expenses and total overall liabilities. That's according to recent numbers released by the University of Minnesota FINBIN Farm Financial Database, which audited the financial standing of 300 farms ranging in size between 1,500 and 10,000 acres in five Midwestern states.
That trend higher won't continue forever, though. In fact, most experts expect 2014 to see a downturn in farm income driven mostly by lower grain prices.
"As farmers have increased their farm income and current assets, they have also increased their current liabilities. Even with increasing current liabilities, their working capital increased and their liquidity position improved," Bruynis says. "Examining farm solvency shows a similar trend as liquidity. Solvency is the ability of a farm business to pay all its debts if it were sold tomorrow. Farm assets are up over $2 million while farm liabilities grew $630,000. Farmers during the past four years have also improved their solvency ratios as well. This all looks promising. So why are agricultural professionals concerned?"
That answer's simple: $4 corn and $9 soybeans, prices that mirror 2009. A glimpse at the FINBIN data for farm income and expenses shows that net income could fall by as much as $590,000, the difference between 2009 and 2012. In the latter year, FINBIN's data show net farm income at $769,458, up from $179,365 in 2009.
Data courtesy University of Minnesota FINBIN Farm Financial Database
The biggest wildcard now lies on the expense side: Will they fall in a similar fashion? They're historically slower to adjust downward during times of slipping incomes. That's likely true of some expense sectors, while it may not happen at all in others.
"There could be some softening of farm inputs, but intermediate and long-term loan payments for land and equipment will not change. Although some of the purchases were financed from profits, the current liabilities on the balance sheet increased from $585 million to $683 million. Also, the renegotiation of land rents downward will be slow to occur," Bruynis says. "In addition, farmers have increased their personal living expenses on the average from $68,000 to $88,000 annually in the past four years."
So, if you're like the average farmer consulted in FINBIN's Farm Financial Database, you stand to lose as much as $150,000 a year for the next few years. That is a tough pill to swallow. But if your working capital is near the FINBIN representative farm's level of $1.16 million – and you haven't leveraged yourself too far to reach it – you should be able to weather the storm for a while under current projections.
"The average farm can withstand this because of a healthy working capital balance of $1.16 million," Bruynis says. "But what about the farmers who have borrowed excessively to purchase new equipment and tile in order utilize accelerated depreciation as a tax management strategy? Or the farmer who has purchased additional land at high market prices? Or the farmer who has aggressively rented land for top-of-the-market prices and rented land is 90% of their operation? Some farm businesses may be at significant risk of financial problems."
The best way to avoid too much pain from the expected farm income downturn is to plan now to keep working capital as consistent as possible, even if it means that year-to-year income suffers. You'll be better off this way in the long-run, Bruynis says.
"Farmers should be examining their working capital and overall financial position now to prepare for the possible financial belt-tightening that could occur in the next few years," he says. "Because of delaying crop income to the next year, farmers who primarily manage taxes and not overall finances will not realize the impact on their financial position until 2014 or 2015, which may be too late to take corrective action."