Most farms have some level of debt. How much and what kind of debt will vary from farm to farm.
What do we mean by “what kind”? If I owe someone money, I owe someone money!
Yes, but “what kind” refers directly to how long you have to pay it back from the time you borrowed the money. If a loan has to be paid back in a year or less, it is a current loan. If you have more than a year to pay it back, it would be a non-current loan.
Non-current loans can then be categorized as intermediate or long-term. Loans for more than one year and less than 10 or 12 years are intermediate-term loans. These loans are typically for machinery, equipment and breeding livestock. Long-term loans are due in more than 10 or 12 years. Long-term loans are typically for land, buildings or improvements such as roads and tile. Loans should be no longer than the expected “life” of the asset being financed.
Affects liquidity
Why do we care? In February, we looked at the liquidity of dairy farms, or the ability to pay cash obligations when they are due. Focusing on the current debt, current ratio, working capital and working capital to gross income are important measures of liquidity. Now we will take the next step and look at the whole farm picture, or solvency.
Solvency refers to the ability of the farm to repay all of its debt obligations if the business had to be sold.
By the numbers
To do this, we pull out the balance sheet again and look at the debt-to-asset ratio. Here we are comparing the farm’s total debt obligations to the all of the farm’s assets. Solvency measures for the dairy farms that participated in the 2013 Ohio Farm Business Summary (farms are working on their 2014 analysis now), are shown in Table 1.
Debt-to-Asset (D/A) and Equity-to-Asset (E/A) ratios are opposite ways of looking at the same thing: How much of your business do you own, and how much does someone else own. You should own at least 70 percent of your own business. This gives you a cushion of borrowing potential to tap in a bad year or when you want to borrow more money to grow your business.
Consequently, we would like to see D/A ratios less than 30% or E/A ratios more than 70%. D/A could reasonably be higher if the farm is just entering the dairy business or in a growth phase, and is projected to be profitable enough to pay down the additional debt.
Debt per cow is also included in Table 1. A simple calculation, we take the total debt from the balance sheet and divide it by the total mature cows (milking and dry) from the same balance sheet.
The Debt/Asset and Debt/Cow measures are lower for the top 20 percent of farms compared to the average of all farms in the analysis. At 30 percent, the average of all farms’ D/A ratio is good, with some borrowing reserves available. However, this is the average, which means that some of the farms are pushing into challenging territory.
Now what? What is the next step? How much debt is too much debt? While some farms can handle $3,000 or $4,000 of debt per cow, others struggle at $2,000. Next time, we will take a closer look at the ability of the cows to repay debt.
Need help crunching numbers? These are just a few of the important numbers you should know about your farm business. Analysis of your farm business is available through the Ohio Farm Business and Benchmarking Program. If your farm records are good, you can start right into an analysis of 2014.
The Ready, Set, Go! Program is available this year to work towards an analysis of 2015. Contact us to talk about what would work well for your farm at 330-533-5538 or shoemaker.3@osu.edu.
