The silver lining of an agricultural downturnThe silver lining of an agricultural downturn
During an agricultural bust, opportunities are abundant. However, know your ratios to make sound financial decisions for your operation’s future.
November 8, 2019
What did the average farm make in the United States in 2018? Any guesses?
According to the USDA, the estimated median farm income was -$1,548.
Surprised? If you’re living in rural America, chances are it’s either you, the neighbors or both of you who are struggling, and sadly, 2019 may be the end gate for many producers.
According to the Wall Street Journal (recapped by Jake Thomas for The Intellectualist), “Bankruptcies in three regions covering major farm states last year rose to the highest level in at least 10 years. The Seventh Circuit Court of Appeals, which includes Illinois, Indiana and Wisconsin, had double the bankruptcies in 2018 compared with 2008. In the Eighth Circuit, which includes states from North Dakota to Arkansas, bankruptcies swelled 96%. The 10th Circuit, which covers Kansas and other states, last year had 59% more bankruptcies than a decade earlier.”
Producers, dealing with back-to-back years of incredibly damaging weather conditions, volatile markets, uncertainties due to ongoing trade wars and a fickle domestic consumer who wants to change the very foundations from which they’ve always operated, are now facing the unthinkable.
Do we sell off precious assets to keep the home operation intact? Do we put land up for auction? Do we all need to get jobs in town in support the farm or ranch? How do we make this work? And for how long can our businesses sustain losses?
The USDA reports that more than half of U.S. farm households lost money farming in recent years. Although the factors are much different this time around, many feel 2019 mirrors the crisis that so producers experience in the 80s.
According to the Wall Street Journal, “U.S. farm debt—covering operations, land, equipment, livestock and more—last year climbed to more than $409 billion, according to a USDA forecast. That’s the largest sum in nearly four decades and a level not seen since the 1980s, when farmland values plunged and interest rates skyrocketed, boosting debts and pushing many farmers and lenders out of business.
“Nationwide, the volume of loans to fund current operating expenses grew 22% in the fourth quarter from year-ago levels, hitting a quarterly record of $58.7 billion, according to the Federal Reserve Bank of Kansas City. The average size of these loans rose to $74,190, the highest fourth-quarter level in history when adjusted for inflation, the bank said.”
Economist John Newton recently explained the trend of farm bankruptcies in a column for the American Farm Bureau Federation.
Newton writes, “USDA currently projects farm income in 2019 to reach $88 billion – the highest net farm income since 2014’s $92 billion, but still 29% below 2013’s record high. In addition, nearly 40% of that income – some $33 billion in total -- is related to trade assistance, disaster assistance, the farm bill and insurance indemnities and has yet to be fully received by farmers and ranchers.
“Moreover, farm debt in 2019 is projected to be a record-high $416 billion, with $257 billion in real estate debt and $159 billion in non-real estate debt. The repayment terms on this debt, according to data from the Kansas City Federal Reserve, reached all-time highs for a variety of categories. All non-real estate loans saw an average maturity of 15.4 months, feeder livestock had an average maturity period of 13 months, other livestock had a maturity period of 18 months and other operating expenses, i.e., loans primarily for crop production expenses and the care of feeding livestock, had an average maturity period of 11.5 months – all record highs. Put simply, farmers are taking longer to service their debt – a trend made easier due to historically low interest rates.”
Personally, I suspect there will be fewer cattle on the range come 2020, and even more consolidation in the feedlot sector and producers step away from the business. However, I also think there is a silver lining to a slump in the agricultural cycle.
With prices in the cellar, there are opportunities for growth and expansion. I anticipate more land will be for sale in the upcoming months, and there will be plenty of dispersal sales from breeders who have decided to exit the business before facing another brutal spring calving season.
However, while there may be new opportunities ahead, we must be careful to ensure we don’t over-leverage ourselves and end up in the same boat as so many as a result of our eagerness.
In a column for AgCarolina Farm Credit, David Kohl, an agricultural economist, shares some tips for monitoring your financial ratios in the upcoming year. He says we need to closely track three ratios — working capital to expenses, operating expense to revenue and term debt and lease coverage.
Kohl writes, “One of the areas that needs to be intensely analyzed is the top half of the balance sheet. Working capital is a measure of liquidity calculated using current assets minus current liabilities. Rather than using the current ratio or working capital to revenue, I prefer the working capital to expenses ratio. If revenues decline and working capital remains the same, the working capital to revenue ratio will improve and give a false positive signal. Working capital to expenses indicates what percent of the expenses can be covered by the owner versus the lender.”
He adds, “One of my favorite ratios is calculated by dividing operating expenses, excluding depreciation and interest expenses, into total revenue. The ratio quantifies financial efficiency of the business. If this ratio is monitored monthly or quarterly, one can make adjustments in revenue and expenses as the year progresses.
“Finally, I recommend monitoring the term debt and lease coverage ratio monthly or quarterly to evaluate repayment ability. This ratio is the Farm Financial Standards Council’s metric that lenders utilize to gauge a borrower’s ability to service debt. The term debt and lease coverage ratio is calculated by dividing the total repayment capacity of the business by the annual debt service payments. The goal is to make sure the ratio exceeds 100%, but preferably above 125%.”
This year has certainly been a wild ride. Hang onto your hats and get your financials in order for the opportunities that will rise within the chaos.
The opinions of Amanda Radke are not necessarily those of beefmagazine.com or Farm Progress.
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