Tag: net farm income

Is Net Farm Income Affected by Debt Levels?

# Introduction
Net Farm Income (NFI) is probably the ultimate measure of farm success. Farms that generate an adequate income can cover family living expenses and will remain viable operations. Farming requires a substantial amount of capital though for the business to function. Debt capital is used by nearly every farmer but farms vary in their use of debt. Debt capital is not free and any interest expense will lower NFI. However, debt capital can help a farm become larger which could improve net farm income. In the paper AgManager GI-2018.8, I examined farms by quintiles based on the D/A ratio to determine the level of risk for farmers in the Kansas Farm Management Association (KFMA) program. While there is a wide range of debt levels among farms, there is a question about how this debt affects farm profitability. This paper examines the net farm income by quintiles of the D/A ratio.

# Procedure
To generate the quintiles, the D/A ratio for all the farms each year are ranked in order from highest to lowest. The 20 percent of farms with the highest D/A ratios are put into group one, the next highest set of D/A ratios are in group two, etc. The bottom 20 percent of farms with the lowest D/A ratios would be in group five. Once the grouping of farms is established, the average net farm income for each group is calculated.

# Results
Figures 1 and 2 show the average net farm income for the different quintiles. The results are broken into two parts to make the trends easier to read. Prior to 2006, most farms had NFI below $100,000. After 2006, the increase in grain prices greatly increased the NFI of all quintiles. Thus, 2006 made for a good point to divide the results. Notice that the two figures have different Y-axis scales. Figure 1 also has removed quintile groups 2 and 4 to make it easier to read. Groups 2 and 4 have results that fit into the range of the other three groups.

Average NFI by D A Ratio Quintiles

Copy of Average NFI by D A Ratio Quintiles

As the figures show, group one, the group with the highest debt-to-asset ratios tended to have the lowest net farm income. The other four groups tended to have NFI that was closer together which made it difficult to say that one group had higher net income than another. One reason why the highest leveraged farms had the lowest NFI may have been because these farms were also the smallest.

Figure 2 indicates that the highest leveraged farms did not see the big increase in NFI from 2007 until 2014 that the less leveraged farms did. However, the farms with very little debt didn’t see as much of an increase in NFI over this time period as did groups two, three, and four. Thus, it appears that farms with moderate debt were the ones to benefit the most from the higher grain prices of 2007 through 2014.

An important observation from Figure 2 is that the farms with very little debt had the least variability in net farm income. While these group five farms had the second lowest NFI from 2007 until 2014, these farms had the highest NFI in 2015 and 2016. Farms with the highest leverage, group 1, have been hit the hardest by the current downturn in the farm economy. However, during the peak of the 1980’s farm crisis, these group 1 farms were even in worse financial shape as there were 6 years in a row where their average NFI was below zero. The higher interest rates of the 1980’s were likely a factor contributing to these lower NFI for highly leveraged farms.

Family Living for Kansas KFMA Farms

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Most farm families depend on income from their farm business to cover their family living expenses. Thus, one would expect there to be a strong correlation between net farm income and family living. It turns out there is a fairly strong correlation of 0.62. However, as the figure above indicates, there is a lag before family living adjusts.

Net farm income increased substantially in 2007 for grain farms in Kansas and other states thanks to much higher grain prices. Net farm income remained higher than average through 2013 before starting to decline in 2014. As can be seen in the figure, farm families did not start to adjust their family living until later. The figure above is based on real dollar amounts so that historical numbers are comparable to current dollars. Family living went from around $50,000 before the increase in net farm income in 2007 to around $70,000 now.

Now that net farm income has declined for two years, family living expenses are only now starting to decline. 2015 saw net farm income fall to a near record low for Kansas KFMA farms. However, the drop in family living was not nearly as great. The question going forward is what happens if net farm income is again at very low levels in 2016. Will farm families be able to adjust their family living downward at a rapid rate. As nearly any family can confirm, adjusting spending upward when there is additional income is an easy thing to do. Adjusting spending downward is not nearly as easy

Update to Kansas Net Farm Income

Net farm income (NFI) for the Kansas Farm Management Association (KFMA) was near a record low for 2015, even when adjusting for inflation. The average net farm income for the entire state and for all farm types was less than $5,000. The median NFI for 2015 was only slightly better at just over $9,000. You have to go all the way back to 1981 to find a lower average NFI. The figure below shows the inflation adjusted average and median NFI for the entire state and for all farm types. Older values were adjusted by the CPI index so that comparisons across time could be more accurately made. This adjustment makes a dollar in the past comparable to a dollar today.

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While the average and median values show a lot about what happened to farm income in Kansas across time, the use of these measures tends to obscure much of the details of how different farm segments are faring. To show how a broader cross section of farms is doing, NFI for all the farms in a given year are ranked in order and the NFIs are divided into deciles. Thus, the top 10 percent of net farm incomes would be in decile number 1, the second 10 percent of net farm incomes would be in decile number 2, etc. The lowest 10 percent of net farm income farms would be in the lowest decile (#10). Every year, the net farm incomes are re-ranked so a farm may move among decile groups across time depending upon the level of net farm income compared to the other farms. 

By using decile groups we can see how the entire cross section of farms is doing in any one year. In particular, the farms in the bottom two or three decile groups are of interest as these are the farms most at risk when the state average NFI is low. 

The next figure shows the net farm income by decile group for the entire state from 1975 through 2015. As can be seen from this figure, decile groups 3 through 8 are usually fairly consistent across time. These groups usually earn between $0 and $100,000 when adjusted for inflation. Even during the period from 2007 through 2013, when average net farm income increased greatly, these middle deciles groups showed more consistent net farm income. 

 

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The large increases in average net farm income from 2007 through 2013 can mainly be attributed to the top two decile groups. These top earning farms helped to bring up the overall state average from $55,000 in 2006 to $132,000 in 2007 (adjusted for inflation). 

By contrast, the bottom decile group tends to lose money in a given year while the ninth decile group tends to break even. Even during the very profitable years from 2007 through 2013, the bottom decile group lost money. Keep in mind though, the bottom 10 percent of farms is not the same each year.

This past year in 2015, net farm income resembles what happened in 1981. In 1981, the bottom decile group lost $245,000. In 2015, the bottom decile group lost $306,000. Also, in 1981, decile groups 6 through 10 lost money. In 2015, groups 7 through 10 lost money and the 6th decile group averaged less than $1,000 of NFI.

2015 was a very difficult year for many farms across the state. Although the average NFI was positive, four of the decile groups averaged negative NFI while the next group had an average NFI close to zero. Thus, nearly 45 percent of the KFMA farms lost money in 2015.

Full details on this article can be found at Net Farm Income by Decile Group – A Historical Comparison