One critical aspect of this economic downturn in agriculture is the possibility of increased risk with larger farms. The financial plight of many larger producers is not measured by acreage or livestock numbers, but by farm net income. My good friends at University of Minnesota’s Center for Farm Financial Management provide excellent analysis of their FINBIN database. I will continue to follow this data with interest as the economic downturn unfolds.
The main concern for lenders and regulators is the concentration of debt with fewer producers. Data suggests that 10 to 12 percent of U.S. farms and ranches carry 63 percent of farm debt, which has increased dramatically in recent years. Many of the larger farms have significant equity in the form of farmland. However, even strong equity does not change the fact that only profits and cash flow pay the bills, not dirt.
Houston, we have a problem!
No, this is not the Apollo 13 moon flight, but this problem cannot be fixed with duct tape either. According to FINBIN data on 2015 net farm income of larger operations, both crop and livestock, there may be a possible blowout looming. In the database, all farms with more than $2 Million in gross revenue generated a median net farm income of just over $126,000. The top 20 percent of farms generated slightly over $579,000. However, the median net farm income for the lower 20 percent was $-332,000. Losses of this size are unfortunately, sometimes an ugly reality of larger operations.
Interestingly, for smaller farms in the $1-$2 Million range of gross revenue, the losses of the low 20 percent of profitability were approximately $159,000. For those farms with gross revenue between $500,000 and $1 Million, losses were approximately $85,000 for the same group. For farms with gross revenue under $500,000, the lower 20 percent of profitability had net losses under $50,000.
Demonstrated by the data, well-managed, larger farms can generate significant profit. However, if management is not proactive and proficient, losses can compound rapidly. Losses of $200,000 to $300,000 over multiple years can quickly reduce working capital as well as overall equity of the farm business. Add these losses to declining land values and what seemed like a “bulletproof” balance sheet can quickly destabilize.
It is interesting to note that losses from the lower 20 percent of profitability in small farms were generally under $50,000. Most likely, these farms could return to profitability with a relatively simple plan of improvement. That plan could include some amount of off-farm income, quick cuts to the family living or small cuts to the largest four or five farm expenses. Whatever the strategy, these farms could overcome their negative profits with a bit more proactive management.
In summary, bigger is not always better. In fact, management deficiencies are magnified in larger operations, sometimes causing exponential losses. However, on the other side, management proficiencies can bring exponential profits. An economic downturn can amplify issues that may go unchecked in the positive part of the cycle. When assessing your farm or ranch operation, remember that most often, practices determine profitability.