Category: Farm profitability

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.

Debt Levels of KFMA Farms

Introduction

The current median debt-to-asset (D/A) ratio for all farms in the Kansas Farm Management Association (KFMA) is 20%. While this number is usually considered very good, half the farms have ratios higher than this. The median value has no way to show the variability of financial risk that some farmers have so other ways of examining the D/A ratio are needed. This article examines the quintiles of the D/A ratio to see how much variation there is in the risk level of Kansas farms.

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 ratio would be in group five. Once the grouping of farms is established, the median D/A ratio is calculated for each group. The median works better than the average for these type of calculations as some financial ratios can distort averages. This would occur for farms in group one particularly.

Results

Figure 1 shows the median D/A ratios of each of the five quintiles when farms are ranked by their D/A ratio. Group one, with the highest D/A ratios, has a median ratio of almost 70 percent. While this number is high, it is actually below what it has historically been. Back during the 1980’s farm crisis, this highest risk group had a median value above 100 percent. The other four groups have median D/A ratios that are more in line with standard norms for acceptability. The group five set of farms carry very little debt. In fact, the median D/A ratio for these farm is zero.

Quintiles of D_A Ratio.pdf

While Figure 1 shows that all groups have reduced their median D/A ratios since the farm crisis of the 1980’s it has not been the case that farmers have reduced their debt. As shown in Figure 2, the three groups with the highest level of financial risk have increased their debt levels substantially while the two groups with the lowest level of financial risk have not increased their debt levels very much.

Median Debt by D_A Ratio Quintiles.pdf

The major reason that D/A ratios increased during the farm crisis was that asset values (i.e., land values) declined. When comparing Figures 1 and 2, notice that farmers stopped adding debt from 1980 through through the mid 1990’s. Meanwhile the D/A ratios continued to climb until about 1986 because of declining land values. Thus, the numerator in the ratio stayed the same while the denominator in the ratio decreased resulting in a higher D/A ratio. The reverse situation happened from about 2002 until 2015. In this timeframe, farmers added debt but their D/A ratio stilled declined. This occurred because land values rose faster than the debt added. One interesting point from Figure 2 is that group one (with the highest D/A ratios) has nearly the same amount of debt as group two. This would indicate that group two farms are bigger in size. Farmers with the highest D/A ratios are mostly likely younger, beginning farmers (note: a future paper will investigate the age aspect of farm debt).

Conclusion

Debt to assets ratios appear to be at acceptable levels now. However, as the farm crisis of the 1980’s showed, D/A ratios are really a trailing indicator of problems. Farms have added a lot of debt during the past 15 years. So far this has not been a problem thanks to rising land values. However, a repeat of the 1980’s where land values declined significantly could change the D/A picture considerably.

KFMA Relative Expenditure Indexes

 Background

In AgManger publication GI-2017.4, the price indexes for major expense categories was discussed so that farmers could see how expenses have changed over time. This previous publication focused solely on the USDA price index (a national price index). This USDA index puts the cost of an input on a scale relative to some base year. It is not examining how much farmers are spending on an input, only the cost of an input per unit over time.
This publication builds on AgManager publication GI-2017.4 by examining the price indexes of inputs used by farmers in Kansas. Data from expenditures of farmers in the Kansas Farm Management Association (KFMA) program was used to build the indexes shown here. Because actual expenditures are used, the results are different from those shown by the USDA. The USDA focus is on cost per unit while this study focuses on cost per category where the number of units used is allowed to vary.
In this publication, the broad expense categories of fertilizer, fuel, hired labor, machinery, and seeds are examined to see how these expenditures have changed since 1977 and 2006. To create this baselines, the expenses in the baseline year are set to 100. The percentage change in expenditures for an expense category is then computed for each year and these percentage changes are used to adjust the baseline index.
Another difference in this publication is that the KFMA expenditures were already adjusted to real dollar terms before computing the indexes. Unlike publication GI-2017.4, where the CPI index was needed to show how expenses had changed relative to inflation, the expense index lines in the figures below already reflect an inflation adjustment. Thus, any line showing above 100 is increasing faster than the inflation rate.

Results

Results are shown for price expenditure indexes for fertilizer, fuel, labor, machinery, plus an index for total crop production expenditures per acre. Results are shown with a baseline start of 1977 and 2016 and also for eastern, western, and central parts of Kansas. The machinery expenditures used here includes management depreciation (actual decline in the market value of machinery), the interest cost of dollars invested in the machinery, repairs and maintenance, and also the fuel cost.
In eastern Kansas, nearly all expenditures have matched the inflation rate since 1977 (see Figure 1). The only exception is for seed expenses which have tripled since 1977. Contrast this to the USDA price index where machinery costs increased the most. This difference can be explained by how farmers have adjusted their machinery use. While an individual piece of machinery is certainly more expensive, size advantages, new technologies, and the use of reduced tillage have all led to the actual machinery expenditures not changing very much over 40 years.

Figure 1. Index of KFMA Expenditures for Eastern Kansas Since 1977

Figure 2 shows the expense expenditures in eastern Kansas since 2006. This figure shows that all expense categories except fuel have increased by 50%. 2006 was the start of a period of high grain prices so most likely, farmers were still profitable with these higher prices. The higher grain prices likely led to more intensive farming as well which is why the fertilizer expenditure shows the second biggest increase when the actual price for a unit of fertilizer did not increase very much. Now though, with grain prices back at low levels again, these higher expenses are affecting the profitability of many farms.

Figure 2. Index of KFMA Expenditures for Eastern Kansas Since 2006

Figures 3 and 4 show the expense expenditures for central Kansas. Fertilizer use now shows the largest increase in expenditures since 1977 with seeds the second largest. Starting with a base year of 2006, seeds have been the most expensive. These two figures are likely showing how the crop mix has changed in the drier parts of the state. Higher corn prices have led to more corn acres which increased the seed and fertilizer expenses.
Another difference between eastern and central Kansas is difference in labor expenses. In eastern Kansas, labor actually saw the largest increase in expenditures since 2006 while in central Kansas the labor expenditures matched the inflation rate.

Figure 3. Index of KFMA Expenditures for Central Kansas Since 1977
Figure 4. Index of KFMA Expenditures for Central Kansas Since 2006

Figures 5 and 6 show the expense expenditures for western Kansas. The same trends seen in central Kansas are apparent here too. Fertilizer and seed expenditures have increased the most due in part to a switch away from wheat acres and to more intensive farming.

Figure 5. Index of KFMA Expenditures for Western Kansas Since 1977
Figure 6. Index of KFMA Expenditures for Western Kansas Since 2006

Discussion

As noted in the discussion of the USDA price indexes, seed costs need to be monitored especially closely. Seed expense per unit as provided by the USDA have increased the most since 2006. Seeds are also one area where it is especially difficult to adjust spending. While machinery expenses and cash outflow can be controlled to some degree by delaying equipment purchases, seeds will always be needed to grow a crop. There may be options to lower plant populations or use a lower priced seed but be sure to check with agronomists about the consequences of these types of actions.

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

Net Farm Income for Kansas by Decile

 

 NFI by profitability decile

Figure 1. Net Farm Income by Decile for KFMA Grain Farms

 

 

Lower grain prices the last several years have helped to decrease net farm income for grain farms in the Kansas Farm Management Association. Net farm income for these farms is shown in the figure by deciles from 2002 through 2014. The deciles are calculated by ranking the farms in order by net farm income each year and then putting the top 10% of farms in the 1st decile, the second 10% of farms in the 2nd decile, etc. During the years from 2007 through 2012 when average net farm income was very strong, it was the upper 10% of farms that was really raising the average. For the most part, the largest percentage of farms in any given year earn from $0 to $100,000. 

As the figure indicates, the 9th decile usually breaks even while the bottom decile normally loses some money each year. Fortunately, the farm makeup of this bottom decile changes so that farms are not consistently in the bottom decile. The last two years have seen a dropoff in net farm income as grain prices have declined. The affect of these lower grain prices has probably had a more profound affect on the bottom 2 deciles. 

 

 

Bottom 2 deciles NFI

Figure 2. Net Farm Income for the Bottom 2 Deciles of KFMA Grain Farms

 

Figure 2 isolates how the bottom 2 deciles have been affected by lower grain prices. These two groups lost a considerable amount of money in 2014. The 9th decile, which normally earns very little net farm income but also normally loses very little net farm income, lost nearly $30,000. The bottom decile lost well over $150,000. Loses of these amounts will quickly put farms in a precarious financial position.  If these farms want to maintain their level of family living, the cash will need to come from a reduction in their equity, an increase in debt, or from some outside revenue. Obviously farms cannot lose this amount of income and hope to be viable operations very long.