7 dips (not of snuff)
June 8, 2015
The South Dakota Annual Report is a collection of data from producers enrolled in the SD Center Farm/Ranch Management program and contains a wealth of financial information. The 2014 edition was recently published and I would like to highlight the status of farm debt given the downturn in overall profitability.
It comes as no surprise that the three-year period from 2010 through 2012 produced some exceptionally-high profit levels, especially for grain farmers. We have now recorded two consecutive years of modest profitability and there are plenty of expectations for diminished returns in 2015. During this five-year time frame, total farm debt as a percentage of assets has actually decreased slightly from 37 percent to 34 percent. A similar trend is also noted in the four-state area of South and North Dakota, Minnesota, and Nebraska with that data being maintained at the University of Minnesota's Center for Farm Financial Management (FINBIN). Overall, it appears farm operations are generally in sound financial condition as indicated by farm debt to assets being well within manageable levels; however, that doesn't mean caution is not warranted moving forward.
When looking a little more closely at the five-year trend in debt, it should be noted that most farm operations are carrying a higher percentage of their debt in short-term liabilities. This is readily evident when looking at the current ratio which has slowly eroded not only for South Dakota farms but also in the four-state area. Once again, this indicator remains above the key benchmark range of 1.7 to 2.0 but will be vulnerable to further erosion with tight profit margins. Many agricultural lenders also track working capital to gross revenue as a key indicator of financial health. A downward trend is also noted over the last five years but yet remains above the key level of 25 percent. Nevertheless, the direction of these key indicators should prompt many farm operations to scrutinize their debt structures. One remedy to "free-up" more working capital is to refinance some short-term liabilities into intermediate debt. This can be a great strategy if the farm can eventually generate an adequate level of cash flow to better service the debt over a three-to-five year period.
If the decision is made to restructure short-term debt, the challenge will be to maintain working capital until profit margins return to a sustainable level. Remember, there are only two ways to accomplish this: increase the value of current assets and/or decrease short-term liabilities. We all know production agriculture is a cyclical business and managing financial risk takes on a greater role during lean times.
The 2014 SD Annual Report is available on our web-site: sdcfrm.com. The FINBIN data is available at finbin.umn.edu.